Those who head business development companies (BDCs) tend to try and predict the future. Is aligning with this company a safe bet? Will it grow and prosper to the degree we, and our investors, hope? It has been said that any given BDC is two bad deals away from extinction, and as a result, we have to hone our predictive abilities.
It is the same now, as the world begins to emerge from the coronavirus pandemic and accompanying economic downturn. When will things be back to normal, or a reasonable facsimile thereof? The conclusion that could be reached by April 2021 is that BDCs are on the rebound.
The Cliffwater BDC Index, which measures the performance of companies in our sector, confirmed as much: It showed that while business development companies bottomed out in the early stages of 2020 -- May and June were particularly rugged months -- they have rebounded since, and now are performing at a level comparable to before.
Other analysts had noted that the comeback was already well underway in the latter stages of 2020 and that the tailwinds boded well for 2021 and beyond -- that BDCs would recoup most, if not all, of their losses, and continue to surge. There were, prior to that, those who predicted the economy wouldn’t stabilize until mid-2022, or even 2023, in large part because of the challenges of developing and distributing a COVID-19 vaccine. However, those fears have largely been allayed. It now seems certain that everyone in the U.S. who wants a vaccine will have received one by this summer. While there will always be a certain percentage of the population that will avoid inoculation, distribution has not been the great concern it once seemed destined to be.
The political unrest that bubbled to the surface on Jan. 6 was of no less concern, as it raised the specter of governmental destabilization. There was ultimately a peaceful transfer of power, however, and soon after a $1.9 trillion stimulus bill was approved -- with the promise of more government spending beyond that. There is the worry, especially among lenders like BDCs, about inflation -- no one ever wants to make a loan and have it paid back with cheaper dollars -- but that is something to contemplate further down the road. The immediate issue is getting back on our feet, and forging ahead.
Certainly, BDCs have learned some lessons from this chapter in American history, not the least of which were about the value of relationships and recurring revenue, stability of software companies and the importance of unitranche debt, and the value of looking within and clinging to your principles.
To the latter point, we found ourselves at Saratoga Investment Corp. staging weekly, portfolio-focused conference calls in the early months of the pandemic, as our deal-making was greatly curtailed. That enabled us to lean on our deep institutional knowledge, to stand firm in the belief that yes, the crisis will pass, as indeed has been the case with every crisis in the past.
Our portfolio proved to be resilient, as we have long aligned ourselves with technology companies and those in the Software as a Service (SaaS) sector. Such enterprises are often spurned by traditional lenders who tend to target companies marked by positive cash flow and significant tangible assets. They are, however, in the wheelhouse of BDCs because of the recurring revenue they accrue as a result of their subscription business model. In our case, we have found that while these companies did not continue to grow at the same rate as they had before the pandemic, they didn’t backslide, either.
Another principle that has been reaffirmed is the value of unitranche lending, a mixed loan structure that melds highest-priority and lower-ranking debt -- i.e., first- and second-lien loans -- making possible mid-range interest rates. We have seen the benefit of being the first dollar risk on a balance sheet, which ensured that our interest wouldn’t be furloughed by any senior lenders.
Finally, there is the importance of relationships. We helped many of our sponsors through a tough time, whether by waiving covenants or helping them work through any issues they might have had, all with the understanding that the success of our portfolio companies is our success, too.
While a continuing dearth of in-person conferences might make it difficult to form new relationships, the importance of servicing existing ones cannot be overstated, as it can only continue to push your company forward.
All in all, the picture is far rosier for business development companies at this point in the pandemic than it was months ago. With vaccinations a reality, the economy has begun to ramp up, and BDCs have learned some valuable lessons about holding fast to tried and true principles -- principles that have served them well in the past, and promise to continue to do so not only as the pandemic plays out, but after it’s over.