This or That? BDCs vs. Interval Funds

October 22, 2024

In recent years, the U.S. Federal Reserve’s aggressive tightening of its monetary policy and the conservative lending practices of traditional banks, including as a result of the closure of prominent local and regional banks, have paved the way for significant interest in private debt markets. Easier access to capital and more flexible terms have led borrows to seek direct lending alternatives. It is against this backdrop that private credit continues to grow at a rapid rate. Private credit had total assets under management (“AUM”) of approximately US$1.5 trillion as of 2022, representing a 21.3% increase over 2019, with AUM projected to reach US$2.8 trillion in 2028.¹

Alternative investment fund managers have historically capitalized on interest in private credit markets through traditional private fund structures. While private funds continue to thrive, business development companies (“BDCs”) and closed-end interval funds are gaining popularity amongst alternative investment fund managers because they are hybrid investment vehicles that incorporate aspects of traditional private funds and registered funds and provide greater access to diverse classes of investors, enhanced liquidity options and built-in regulatory tax efficiencies. In 2007, there were only a handful of closed-end interval funds² and approximately 20 BDCs.³ As of 2023, there were approximately 100 active interval funds⁴ and 120 BDCs.⁵ As of the third quarter of 2023, total AUM of BDCs and closed-end interval funds was up to US$325 billion, representing a 12% increase year-over-year.

At a high level, BDCs provide small- and middle-market companies with access to capital and are either privately offered or publicly offered on an exchange or non-traded. Interval funds are unlisted closed-end funds that generally provide access to more illiquid investments. While both investment vehicles offer attractive alternatives to traditional private and registered funds, there are several important distinctions for fund managers to consider, including fee structures, timing and nature of liquidity provisions, and composition of the investor base and of the underlying portfolio investments, that are summarized in the chart below.

Key Contacts

Richard Horowitz

Partner New York
+1 212 698 3525 richard.horowitz@dechert.com
Michael M. Piri

Associate New York
+1 (212) 641-5674 michael.piri@dechert.com

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Private Credit

Financial Services and Investment Management

Permanent Capital

Private Funds

Global Asset Manager Regulation

	Publicly Offered BDCs	Privately Offered BDCs	Interval Funds
Fees	Base management fees (generally, 1.25% annually on net assets); and Incentive fees based on (1) income (12.5% on net investment income, subject to a hurdle rate and catch-up), (2) and capital gains (12.5% of realized gains net of realized and unrealized losses)	Same as publicly offered BDCs	Base management fees: (generally, 2.00% annually on net assets); and Incentive fees based on income only (generally 12.5-15.0%), subject to certain exceptions
Portfolio Construction	Must invest at least 70% of assets in “Eligible Portfolio Companies”	Same as publicly offered BDCs	Not subject to BDC limits with potential for more diverse portfolio
Manner of Offering/Blue Sky Requirements	May be offered through general solicitation, but must be qualified in each state before offering	Only offered through private placements to accredited investors and not subject to blue sky	May be offered through general solicitation and not subject to blue sky
Potential to Offer Multiple Classes of Shares (with varying sales loads and servicing fees)	Yes, subject receipt of SEC exemptive relief	The SEC has been unwilling to grant exemptive relief to private BDCs	Yes, subject to receipt of SEC exemptive relief
Potential to Co-Invest with Affiliates	Yes, subject receipt of SEC exemptive relief	Same as publicly offered BDCs	Yes, subject to receipt of SEC exemptive relief
Leverage	150% asset coverage (2:1 debt to equity)	Same as publicly offered BDCs	300% asset coverage for debt (0.5:1 debt to equity) and 200% asset coverage for preferred
Liquidity	Discretionary repurchases; generally between 2.5% - 5% of the BDC	Same as publicly offered BDCs	Must adopt a fundamental policy to engage in repurchases at set intervals (quarterly, semi-annual, or annual) for between 5% - 25% of the fund
Taxation	RIC for tax purposes (A RIC blocks effectively connected income (ECI) for non-US investors and unrelated business taxable income (UBTI), for US tax exempt investors)	Same as publicly offered BDCs	RIC for tax purposes

Footnotes

¹ Source: Preqin, Private Debt global AUM tracked as of 2022.

² Source: Morningstar, Interval Funds: Are They Worth What You Give Up?

³ See supra note 1.

⁴ See supra note 2.

⁵ See supra note 1.

Dechert & Private Credit

Dechert has advised private credit clients for over 30 years, helping them to innovate and thrive as the industry has grown into a complex and diverse US$1.7 trillion market. We create value on the full spectrum of strategies and sub-strategies, including asset-based, distressed debt, permanent capital, direct lending, subordinated debt, specialty financing, special situations and venture debt. With more than 80% of Private Debt Investor’s top 100 private credit firms as clients, we offer market-leading fund formation, financing, regulatory, M&A and tax expertise across the U.S., Europe, the Middle East and Asia.

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Related Professionals

Partner

Richard Horowitz

New York +1 212 698 3525

Associate

Michael M. Piri

New York +1 (212) 641-5674

Related Services

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