Riding the BDC Consolidation Wave

Consolidation among business development companies (BDCs) has been a hot topic of conversation in 2015. Over the last 18 months, activity levels in the BDC space have heated up: Oak Hill Advisors, L.P. assumed the external advisory role for NGP Capital Resources Company (now OHA Investment Company), PennantPark Floating Rate Capital Ltd. acquired MCG Capital Corporation, and, as many are aware, TICC Capital Corp. has received advances from no fewer than three suitors.

So, why is BDC consolidation on everyone’s mind? What’s driving this trend, and will consolidation continue? Importantly, from a legal perspective, if consolidation is coming to the BDC space, how will it work, and what do market participants need to know?

Members of Dechert’s leading Permanent Capital Practice recently addressed these questions during the webinar “Riding the BDC Consolidation Wave,” the primary focuses of which were the legal and technical aspects of BDC consolidation transactions. Here are the key takeaways.

Increased interest in BDC consolidation is largely the result of:

• The low interest rate environment continues to compress yield margin for BDC investments.
• Shares of many listed BDCs have been trading at or below NAV, creating a challenging environment for new capital raising.
• BDCs aspire to grow so as to increase scale and spread their fixed costs over more assets.
• BDCs remain an attractive vehicle among asset managers, making M&A transactions a potentially appealing way to enter the space.

What does Dechert see as likely pathways for BDC consolidation?

• Acquisition of a BDC through a merger, in exchange for cash, stock or a combination of cash and stock.
• Acquisition of a BDC’s investment adviser.
• Negotiation of a new investment advisory agreement with a BDC (either with the BDC’s existing board or by engaging in a solicitation to seat a new board).

What are the major considerations of a BDC merger?

• Negotiating NAV – It can be challenging to agree on pricing mechanics, especially when acquirers use stock as consideration for an acquisition.
• Structure – Potential acquirers must consider tax, change of control and diligence findings in pursuing an optimal transaction structure.
• 1940 Act – Numerous 1940 Act considerations must also be taken into account early and thoughtfully, especially concerning required board and shareholder consents.

Acquiring an Investment Adviser or Entering Into an Advisory Agreement may seem straightforward, but...

• The approval of a new investment advisory agreement by the BDC’s board is central to any acquisition of an investment adviser, even though the acquisition of the investment adviser may not explicitly involve the BDC.
• A new advisory agreement with a new investment adviser or the acquisition of an existing investment adviser to a BDC will require shareholder approval.
• Recent case law makes full and fair disclosure of the terms of any adviser acquisition to BDC shareholders critical.
• Strong consideration should be given to the ultimate structure and treatment of costs incurred in connection with such adviser-related transactions.

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If you are interested in discussing more specifically how a consolidation strategy might work for your firm, please contact one of our presenters.