Business Development Companies

Venture capital funds historically restricted access to institutions and affluent individuals through private placements to avoid concerns related to the Investment Company Act of 1940. This was achieved by limiting participation to 100 or fewer investors or individuals meeting specific wealth criteria, referred to as "qualified purchasers."

Lately, venture capitalists have shown a growing interest in attracting public investors. Companies aiming to secure venture capital funding from the public, while avoiding the restrictions of the 1940 Act, typically opt for one of the following approaches:

Venture capital funds can avoid being categorized as investment companies through:

Rule 3a-1 Exclusion: This rule states that a company won't be considered an investment company if no more than 45% of its asset value comprises "investment securities," and no more than 45% of its after-tax net income is derived from such securities.
SEC Exemptive Order: A venture capital fund may obtain an exemptive order from the SEC under Section 3(b)(2) of the 1940 Act, declaring the entity to be primarily engaged in a non-investment company business, thus exempting it from the provisions of the 1940 Act.

Companies relying on Rule 3a-1 or an SEC exemptive order are exempt from the provisions of the 1940 Act. However, they must adhere to the specific constraints of the chosen exemption. Rule 3a-1 imposes numerical limitations, while companies with exemptive orders must comply with the conditions outlined in the granted order.

Another option for venture capital companies seeking public market access is to opt for regulation under the 1940 Act as a business development company (BDC).

Regulating Business Development Companies

The provisions of the 1940 Act regulating business development companies (BDCs) can be categorized into two groups. The first category promotes investment in developing businesses, including lower asset coverage requirements for borrowing, mandatory investment in small businesses, and relaxed restrictions on affiliated transactions. The second category focuses on compensating BDC employees in line with venture capital industry practices, allowing the issuance of certain equity-based compensation and facilitating loans to employees for purchasing company securities. These provisions aim to encourage venture capitalists to establish public funds for private investment while complying with 1940 Act regulations.

In order to qualify as a Business Development Company (BDC), a company must generally engage in providing capital and offering substantial managerial assistance to businesses that lack ready access to capital through traditional financial channels. Specifically, to be eligible for BDC status, a company must:

To be eligible for BDC status, a company must:

Be a domestic company.
Have registered a class of its securities or filed a registration statement with the SEC under Section 12 of the Exchange Act.
Operate with the purpose of investing in the securities of eligible portfolio companies, including less seasoned or emerging companies and those recovering from financial distress.
Offer substantial managerial assistance to eligible portfolio companies.
File a proper notice of election with the SEC (or, under specific circumstances, intend to file).

Under the 1940 Act, BDCs are subject to various regulations, including:

Limitations on the issuance of senior equities and debt securities.
Restrictions on the issuance of warrants and options.
Prohibitions on certain transactions with affiliates, requiring SEC exemptive relief.
Approval from stockholders for changes in the nature of business or fundamental investment policies.
Valuation of portfolio investments at market value or fair value if market value is not readily available.
Adherence to a new regulatory structure

Election And 1934 Act Registration

A BDC is subject to Sections 54 through 65 of the 1940 Act, known as the BDC provisions. To qualify for the exemption, a closed-end investment company must elect BDC status and file a notice on Form N-54A with the SEC. Notably, a company making the BDC election must have a class of equity securities registered under the Securities Exchange Act of 1934 (1934 Act). Consequently, BDC shares are typically listed for trading on public exchanges. Unlike closed-end funds, BDCs must file periodic reports (e.g., Forms 10-Q, 10-K) and other reports (e.g., Form 8-K), similar to publicly traded operating companies. Management personnel must report stock trading, facing restrictions on obtaining short swing profits within a six-month period. BDCs, like other 1934 Act registrants, are subject to the proxy solicitation requirements of Section 14 of the 1934 Act

Required Investments

The Business Development Company (BDC) is mandated by Section 55(a) to allocate a minimum of 70% of its investments toward eligible assets. Within the context of Section 55(a), eligible assets encompass various categories, including:

Securities of an "eligible portfolio company": These are securities acquired through private transactions with the said company.
Securities obtained by the BDC in connection with its ownership of securities of an "eligible portfolio company": This refers to securities received as a result of the BDC's ownership of securities in a company deemed eligible for the portfolio.
Cash, cash items, government securities, or high-quality debt securities with a maturity of one year or less from the time of investment: This category includes liquid assets such as cash, government securities, or debt securities of exceptional quality, provided they mature within a year from the time of investment.

These provisions under Section 55(a) outline the specific types of assets that contribute to the required 70% investment threshold for a BDC, emphasizing a focus on eligible portfolio companies and certain specified financial instruments.

An eligible portfolio company is described as an entity organized in the United States with its primary business location in the country. It excludes investment companies, except for small business investment companies entirely owned by the BDC. Additionally, it must not possess any category of publicly traded securities for which a broker could provide credit. In summary, the definition outlines specific criteria, ensuring that eligible portfolio companies are U.S.-based, not standard investment firms unless wholly owned by the BDC, and lack publicly traded securities conducive to broker credit extension.

Managerial Assistance

Business Development Companies (BDCs) are obligated to offer substantial managerial assistance to the companies within their investment portfolios. This assistance is deemed significant when the BDC is actively involved in providing substantial guidance and advice related to the management, operations, and business goals and policies of a portfolio company. This involvement may take various forms, including but not limited to activities such as facilitating financing arrangements, overseeing relationships with sources of financing, participating in the recruitment of management personnel, and assessing potential opportunities for acquisitions and divestitures. In essence, significant managerial assistance involves a hands-on approach by the BDC in helping shape and enhance the strategic and operational aspects of its portfolio companies.

Capital Structure

Unlike other investment companies, BDCs are able to issue options, warrants and rights to convert to voting securities to their officers, employees and board members.

Any issuance of derivative securities requires the approval of the company’s board of directors and authorization by the company’s shareholders. The company also may not issue derivative securities to its nonemployee directors unless it first obtains an exemptive order from the SEC.

In broad terms, Business Development Companies (BDCs) are subject to a restriction wherein the total amount of voting securities resulting from the exercise of all derivative securities issued by the BDC at the time of issuance cannot surpass 25% of the outstanding voting securities of the BDC. However, there's a nuanced provision: if the derivative securities issued to management personnel as part of their compensation constitute 15% of the BDC's outstanding shares, then the overall limit on the issuance of derivative securities, measured as a percentage of total outstanding shares, is reduced to 20%. This stipulation emphasizes a balance between allowing the issuance of derivative securities and maintaining reasonable limits to ensure prudent corporate governance and investor protection within the BDC framework.

Leverage

Business Development Companies (BDCs) enjoy more flexibility in terms of the level of debt they can carry compared to closed-end funds. Typically, a BDC is permitted to issue a class of senior security representing indebtedness, but with a crucial requirement: immediately after such issuance or sale, the BDC must maintain at least double the asset coverage.

For instance, if a BDC possesses $1 million in assets, it has the leeway to borrow up to $1 million. This borrowing would lead to a scenario where the BDC holds assets worth $2 million and incurs a debt of $1 million. This doubles the asset coverage, providing the BDC with a reasonable level of financial leverage.

This stands in contrast to other types of investment companies, which are subject to more stringent regulations. In the case of other investment companies, they are typically required to have triple the asset coverage for any class of senior security representing indebtedness. The relatively lower asset coverage requirement for BDCs reflects a regulatory distinction designed to provide them with greater flexibility in managing their capital structure.

Operational Considerations

As with any other company subject to the 1940 Act, a BDC must adhere to certain substantive regulatory requirements with respect to its operations.

Composition Of Board of Directors

A majority of the directors of a BDC must be persons who are not “interested persons” of the BDC. The 1940 Act defines interested persons to include, among others:

Officers, directors and employees – however, no person is deemed to be interested solely by reason of being a member of the board of directors

A 5% or more voting shareholder of the company

A person who is a member of the immediate family of an affiliate of the company

Legal counsel for the company

Any natural person whom the SEC determines to have had a material business relationship in the past two completed fiscal years with the company or its CEO

Indemnification

A BDC is prohibited from protecting any director or officer from any liability to the company – or its security holders – arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office. This prohibition also applies to the company’s investment adviser, if it is externally managed.

Valuation

The board of directors of a BDC is required to value portfolio assets on a quarterly basis in connection with filing certain required periodic reports. Assets must be valued on the basis of market value, if available; in the absence of a readily ascertainable market value for an asset, the board must in good faith determine the “fair value.”

Transactions With Related Persons

Transactions involving a BDC and certain persons related to it, including, among others, officers, directors, employees, members of an advisory board, the investment adviser, the principal underwriter, and persons controlling or under common control with the BDC, are generally prohibited, absent an SEC exemptive order. Transactions involving a BDC and companies that it controls (i.e., those in which it owns more than 25% of the voting securities) generally are not subject to this limitation.

Code Of Ethics

Officers and directors of a BDC and its external investment adviser (if any) are subject to general fiduciary duties with respect to the conduct of their duties as they impact the BDC. A BDC (and its investment adviser) must adopt a code of ethics and institute procedures reasonably necessary to ensure that its employees and certain affiliates adhere to the code.

Fidelity Bond

A BDC must provide and maintain a bond issued by a reputable fidelity insurance company to protect the company against larceny and embezzlement. The bond must cover each officer and employee with access to securities and funds of the company with the required coverage tied to the amount of the company’s assets.

Taxation

A BDC may elect to be taxed either as a C corporation (like typical operating companies) or as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986. As a regulated investment company (RIC), a BDC can avoid taxation at the company level on that portion of income and capital gains distributed to shareholders. To qualify for RIC treatment, in general, at least 90% of the BDC’s income must consist of interest, dividends, gains from sales of securities, and similar types of income and gains, and the BDC must distribute to its stockholders for each taxable year at least 90% of its investment company taxable income (consisting generally of net investment income from interest and dividends and net short-term capital gains). The RIC provisions also require a BDC to comply with certain requirements with respect to its portfolio diversification.

Gayatri GuptaDecember 4, 2023

Nasdaq Compliance

The Nasdaq Stock Market features three tiers of listed companies, namely: (1) The Nasdaq Global Select Market, (2) The Nasdaq Global Market, and (3) The Nasdaq Capital Market. These tiers are characterized by progressively stringent listing requirements, with the Nasdaq Global Select Market setting the highest standards for initial listings and the Nasdaq Capital Market serving as the entry-level tier, particularly suitable for most small-cap issuers.

To list securities on Nasdaq, a company must fulfill minimum listing requirements, encompassing defined criteria related to financial performance, liquidity, and corporate governance. Nasdaq retains extensive discretion in the listing process and reserves the right to reject an application, even if the technical prerequisites are satisfied, if it deems such denial essential to safeguard the interests of investors and the public.

After securing a listing on Nasdaq, a company is obligated to adhere to ongoing listing standards. To initiate the listing process, a company seeking inclusion on Nasdaq must diligently complete and submit a comprehensive listing application to Nasdaq. This application should include specific documents and information as outlined by Nasdaq's requirements.

Typically, the application process spans a duration of four to six weeks. Once the application is submitted, a Nasdaq analyst is designated as the primary liaison with the company. Within two to three weeks of submission, the company can expect to receive an initial comment letter. The comment and review process persists until a decision is reached on the approval or denial of the application. Similar to filing with the SEC, a meticulously prepared Nasdaq application tends to attract fewer comments and facilitates a more streamlined process. Generally, the company's securities counsel assumes a leading role, serving as the primary contact for preparing the application and engaging in communication with Nasdaq.

Similarly to the SEC review process, Nasdaq conducts a thorough examination of publicly accessible information pertaining to a company. This encompasses, but is not limited to, SEC filings, the company's website, management communications and speeches, as well as press releases. The iterative nature of the review process typically doesn't necessitate a formal protocol, and communication is commonly facilitated through email correspondence and phone calls.

Listing Criteria For Nasdaq
For a company to list its securities on Nasdaq, it must satisfy the following criteria:

Specific Initial Requirements:
- Quantitative Standards: Meeting defined thresholds for both quantitative and qualitative factors.
- Qualitative Standards: Fulfilling certain qualitative benchmarks.
Continuing Requirements:
- Quantitative Criteria: Adhering to ongoing quantitative benchmarks.
- Qualitative Criteria: Maintaining specified qualitative standards.

The initial quantitative thresholds are typically set at a higher level than those required for continued listing. This distinction aims to ensure that companies achieve a sufficient level of maturity before being listed. Additionally, Nasdaq imposes rigorous corporate governance standards that listed companies must adhere to throughout their tenure on the exchange.

Before formally submitting a comprehensive listing application, a company has the option to pursue a preliminary listing eligibility review. In this stage, the Listing Qualifications Staff conducts a thorough examination of the company's public filings to assess its compliance with numerical listing requirements. Additionally, the team evaluates the company's adherence to corporate governance requirements outlined in the Marketplace Rules ("Rules"). This preliminary review provides valuable insights into the company's eligibility for listing on Nasdaq before committing to the full application process.

Upon completion of the preliminary review, the Listing Qualifications Staff will make an assessment regarding whether the company meets the numerical listing criteria. Additionally, any corporate governance or regulatory concerns raised during this phase will be considered to determine their impact on the listing approval. It's important to note that while the preliminary review provides insights, final approval necessitates the submission of a formal listing application. This application undergoes a thorough examination by the NASDAQ Listing Qualifications Staff. Furthermore, the final approval process involves satisfactory compliance with specific qualitative reviews. This includes an examination of the regulatory history of the company's officers, directors, and significant shareholders. Meeting these criteria is integral to obtaining the final approval for listing on Nasdaq.

Financial And Liquidity Requirements

    Requirements

    Equity Standard
    Market Value of Listed Standard
    Net Income Standard

    Listing Rules

    5505(a)
and
5505(b)(1)
    5505(a)
and
5505(b)(2)
    5505(a)
and
5505(b)(3)
    
    Stockholders Equity

    	$5 million
    	$4 million
    	$4 million
    
    The market value of publicly held shares

    $15 million
    $15 million
    $
      5 million
    
    Operating History

    	Two years
    N/A
    N/A
    
    The market value of listed securities

    N/A
    $50 million
    N/A
    
    Net income from continuing operations (in the latest fiscal
a year or in two of the last three
fiscal years)

    N/A
    N/A
    $750,000
    
    Publicly held shares

    	1 million
    	1 million
    	1 million
    
    Bid Price

    	$4
    	$4
    	$4)
    
    Closing Price

    	$3
    	$2
    	$43
    
    Corporate Governance

    Yes
    Yes
    Yes
    
    Total Shareholders

    300
    300
    300

Corporate Governance Requirements

Across all three tiers of the Nasdaq Stock Market, corporate governance requirements remain largely consistent. The categories encompassing corporate governance standards include:

Distribution of Annual or Interim Reports
Independent Directors
Audit Committee
Compensation Committee
Nomination of Directors
Code of Conduct
Annual Meetings
Solicitation of Proxies
Quorum
Conflict of Interest
Shareholder Approval
Voting Rights

These governance elements play a crucial role in ensuring transparency, accountability, and ethical conduct within listed companies, irrespective of the specific tier within the Nasdaq Stock Market.

Companies seeking listing on Nasdaq must adhere to specific corporate governance standards, including the following:

Compensation Committee with Independent Directors:
- The company is required to establish a compensation committee comprised of independent directors.
- The committee must consist of at least two members.
- Rule 5605(d)(2)(A) introduces an additional independence test for compensation committee members.
Responsibility for Executive Compensation:
- The compensation committee is tasked with determining or recommending to the entire board the compensation of the chief executive officer (CEO) and all other executive officers.

These standards are designed to ensure a level of independence and scrutiny in the decision-making processes related to executive compensation within the company.

The Application And Documents

The Nasdaq application package encompasses several key components:

Symbol Reservation Form:
- Used to request the reservation of a specific trading symbol for the company.
Listing Application:
- Requires supplemental documents and details about the company's financials, operations, and other pertinent information.
Listing Agreement:
- A formal agreement outlining the terms and conditions of the listing on Nasdaq.
Corporate Governance Certification:
- A certification affirming the company's commitment to meeting Nasdaq's corporate governance standards.
Initial Application Fee:
- Payable via check or wire transfer, this fee is a prerequisite for initiating the listing process.
Logo Submission Form:
- Used for submitting the company's logo for use in Nasdaq's materials.

These application forms are completed through the Nasdaq website listing center, utilizing the online platform to facilitate the submission of supplemental and supporting documents. It is advisable to thoroughly review all required paperwork in advance, ensuring that the necessary information is readily available before initiating the application process.

Symbol Reservation Form

The symbol reservation form is a concise, one-page electronic form where applicants input information for Nasdaq's consideration. Nasdaq symbols, limited to 1-5 characters, adhere to guidelines established by the Intermarket Symbols Reservation Authority (ISRA). The ISRA system is designed to organize symbols efficiently, prevent duplication, and reduce programming and operational complexities. The ISRA operates within the framework of the NMS Symbology Plan, a plan utilized by Nasdaq.

Key details about the symbol reservation process:

Symbol Choices:
- The form allows applicants to propose three symbol choices in order of preference.
- While Nasdaq generally honors the first choice if available, it retains the authority to assign, rescind, or reassign a trading symbol at its discretion.
ISRA and Nasdaq Authority:
- The ISRA and Nasdaq have overarching authority in managing the assignment of symbols.
Additional Information:
- The form captures essential details about the issuer and the planned public offering.
- Information may include the name of the attorney, lead underwriter (if applicable), CEO and CFO names, yearly revenues, company website, and the sector in which the company operates.

Completion of this symbol reservation form initiates the process of securing a trading symbol on Nasdaq, and it's essential to provide accurate and comprehensive information to facilitate this stage of the listing application.

The Application

The Nasdaq listing application process is comprehensive and varies based on the circumstances surrounding the listing sought. There are twelve distinct listing applications catering to different situations, including changes of control, switches from other exchanges or markets, spin-offs, and initial public offerings (IPOs). Each application, spanning approximately seven pages, collects detailed information about the company, covering areas such as address, contact and billing details, securities attorney and auditor information, transfer agent particulars, and the company's officers and directors. Specific information on the company's securities, including type, par value, and cusip number, is also required.

Furthermore, the application mandates disclosure of legal proceedings involving the company, its officers or directors, or significant shareholders over the past ten years. This encompasses inquiries, investigations, lawsuits, litigation, arbitrations, and other legal and administrative proceedings. Documents supporting the backup and final disposition of these matters must be provided.

Regarding private offerings within the prior six months, including bridge financings, shelf registrations, and Regulation S offerings, the company is required to disclose such activities. Additionally, the application delves into the company's background, posing questions to ensure compliance with seasoning rules.

While Nasdaq retains the right to request relevant supporting documents, specific documents are mandatory based on the application type. For an uplisting from an existing U.S. market, the application must include letters from three market makers confirming their commitment to making a market in the subject securities. Other required documents include a listing agreement, a logo submission form, a corporate governance certification form, regulatory correspondence over the past 12 months, and shareholder confirmation documents. Nasdaq often seeks confirmation from the company's transfer agent regarding the eligibility of the security for the direct registration program (DRS).

During the review of an up listing application, Nasdaq may request additional information, such as a Broadridge share range analysis and NOBO list, a certified shareholder list, details about mitigating any going concerns or opinions, income statement and/or balance sheet projections for the next 12 months, and confirmation of Sarbanes Oxley Section 302 and 906 certifications by the company, among other inquiries related to compliance and financial matters.

The Listing Agreement

The Listing Agreement is a concise document, spanning two pages, serving as a formal affirmation of the company's commitment to adhere to all rules and regulations set forth by the Nasdaq Stock Market. It includes provisions for indemnifying and holding Nasdaq harmless from liability. Notable points in the agreement include:

Compliance Assurance:
- The company explicitly agrees to comply with all rules and regulations stipulated by the Nasdaq Stock Market.
Indemnification Clause:
- The company indemnifies Nasdaq, meaning it undertakes to compensate or reimburse Nasdaq for any losses or damages incurred. This includes harm resulting from third-party trademark infringement claims related to the company's symbol and logo, as well as Nasdaq's use of the same.
Disclaimer of Warranty and Liability:
- The agreement contains a disclaimer of warranty and liability against Nasdaq for trading issues, with the exception of those resulting from gross negligence or willful misconduct.

This agreement establishes a clear framework for the relationship between the listed company and Nasdaq, emphasizing the company's commitment to regulatory compliance while providing indemnification for certain specified matters and delineating the scope of Nasdaq's liability.

Corporate Governance Certification Form

The corporate governance certification form certifies compliance with the governance requirements related to an audit committee, director nomination process, compensation committee, board composition, executive sessions, quorum, and codes of conduct. Where an exemption applies, the form requires specification of the exemption terms. The document specifies the different rules and exceptions in a check-the-box format.

Logo Submission Form

The logo submission form contains the guidelines for the logo and affirms Nasdaq’s rights to use the same. Nasdaq uses company logos in its marketing materials, on the MarketSite Video Wall and Tower, and websites.

Fees

Entry fees are based upon the aggregate number of shares to be listed at the time of initial listing, regardless of class, with a maximum cap of $75,000. Fees are assessed on the entry date in The Nasdaq Capital Market, except for $5,000, representing a non-refundable application fee. This fee must be submitted with the company’s application.

Nasdaq does not charge application or entry fees for any securities transferred from a national securities exchange.

Benefits Of Trading On An Exchange

There are many benefits to trading on an exchange instead of the OTC Markets. The most significant benefits to a business are the ability to attract analyst coverage and institutional investors and the corresponding increase in liquidity that comes with both. Stocks that trade on Nasdaq tend to have a lower bid/offer spread — again encouraging trading volume and liquidity. Exchange-traded securities are exempt from the penny stock definition, allowing more market maker and broker-dealer participation. As further explained below, a broker-dealer cannot recommend a penny stock transaction to its retail clients. Therefore, no analysts, financial advisors, or institutional investors make recommendations for purchases of penny stocks.

As an aside, this is one of the reasons that OTC Markets created the OTCQX market tier, which does not list penny stocks. It is also why the small-cap industry is pushing for a supported valid venture exchange (for further reading.

In today’s world, depositing stock and/or trade-in non-exchange traded securities is increasingly difficult. Despite the congressional efforts and SEC rulemaking in support of small-cap capital formation (for example, the JOBS Act, including the emerging growth company regulations, new Regulation A+ and Title III Crowdfunding and the new FAST Act), through enforcement and investigative proceedings, both the SEC and FINRA continue to apply pressure on broker-dealers, clearing firms and transfer agents to reduce the secondary trading and free flow of penny stocks. For more information on difficulties in depositing stocks.

Further On Penny Stocks

NASDAQ and NYSE MKT traded securities are exempted from the definition of a “penny stock” due to the initial and ongoing listing standards. Penny stock rules focus on broker-dealers’ activity in effectuating trades in penny stocks. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the “Penny Stock Act”) prohibits broker-dealers from effecting transactions in penny stocks unless they comply with the requirements of Section 15(h) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The rules promulgated thereunder, particularly Exchange Act rules 15g-1 through 15g-100 (the “penny stock rules”).

Section 15(h) of the Exchange Act provides that no broker or dealer may effectuate a customer’s purchase or sale of any penny stock unless such broker or dealer.

Approves the customer for the specific penny stock transaction and receives a written agreement to the transaction from the customer.
Furnishes the customer a risk disclosure document describing the risks of investing in penny stocks.
Discloses to the customer the current market quotation, if any, for the penny stock, including the bid and ask prices and the number of shares that apply to such bid and ask prices.
Discloses to the customer the amount of compensation the firm and its broker will receive for the trade.

In addition, after executing the sale, a broker-dealer must send its customer monthly account statements showing the market value of each penny stock held in the customer’s account.

Moreover, brokers and dealers subject to the penny stock rules are subject to additional disclosure requirements outlined in Rules 15g-2 through 15g-9. For my information on penny stocks and the rules affecting broker-dealer activity.

Securities Lawyer Blog

Business Development Companies

Listing Criteria For NasdaqFor a company to list its securities on Nasdaq, it must satisfy the following criteria:

Licensed in District of Columbia, State of Colorado, US District Court for the District of Columbia, US District Court for the District of Colorado, with pro hac vice Admission for the State of Maryland and Virginia.

Listing Criteria For Nasdaq
For a company to list its securities on Nasdaq, it must satisfy the following criteria: