Fund and vehicle structures
BDC, drawdown fund, interval fund and SMA - leverage limits, asset coverage arithmetic, and how a Level 3 mark becomes a NAV.
The same loan produces different investor economics depending on the wrapper it sits in, because the wrapper sets the leverage limit, the fee base, the liquidity promise, and the valuation regime. Three of those are arithmetic and one is judgement, and the judgement one - valuation - determines the other three in a stressed period. The statutory limits below are real and citable; the fee and leverage levels used in the worked examples are illustrative inputs.
Vehicle comparison
Statutory references are to the Investment Company Act of 1940 unless stated.
| Attribute | BDC | Private drawdown fund | Interval fund | Separately managed account |
|---|---|---|---|---|
| Regulatory regime | Elects BDC status under Investment Company Act s.54; subject to ss.55-65 | Exempt under s.3(c)(1) or s.3(c)(7); adviser registered under the Advisers Act | Registered closed-end fund; repurchases under Rule 23c-3 | No fund-level registration; the account is the client's |
| Leverage limit | Asset coverage under s.61: 200 percent, reducible to 150 percent on board and shareholder approval per the Small Business Credit Availability Act of 2018 | Contractual only - the LPA and the facility documents | s.18 asset coverage: 300 percent for debt, 200 percent for preferred | Contractual only, set by the client |
| Maximum debt-to-equity implied | 1:1 at 200 percent; 2:1 at 150 percent | Whatever the LPA permits | 0.5:1 for debt | Client's choice |
| Investor liquidity | Listed BDC: daily on an exchange at a market price that may differ from NAV. Non-traded: periodic tender offers. | None; capital is locked for the fund term | Periodic repurchase offers at NAV, between 5 and 25 percent of shares outstanding at each interval | Negotiated; typically the most liquid of the four |
| Capital deployment | Permanently capitalised; raises when it can | Commitments drawn as needed | Continuously offered; NAV-based subscriptions | Funded by the client |
| Valuation regime | Fair value under ASC 820, board-determined, with the s.2(a)(41) fair value process and Rule 2a-5 requirements | ASC 820 fair value per the valuation policy; audited annually | ASC 820, with a daily or periodic NAV struck for subscriptions and repurchases | Per the client's policy and its own auditors |
| Fee base convention | Frequently gross assets, which includes borrowed money | Commitments during the investment period, then invested capital | Managed assets, commonly net of leverage or gross depending on the prospectus | Negotiated, often lower and often on net assets |
| Tax | Typically elects RIC status under IRC Subchapter M; must distribute at least 90 percent of investment company taxable income | Partnership, flow-through | RIC | Depends on the client |
Asset coverage arithmetic
Asset coverage is total assets less all liabilities other than senior securities, divided by the amount of senior securities representing indebtedness. E is net assets (equity), D is senior securities. ACR = (D + E) / D, so the implied maximum leverage is D <= E / (ACR_min - 1).
| Required ACR | Statutory source | Implied maximum D/E | At E = 100: max D | Total assets |
|---|---|---|---|---|
| 300 percent | Investment Company Act s.18(a)(1), registered closed-end funds including interval funds | 0.50x | 50 | 150 |
| 200 percent | Investment Company Act s.61(a), BDC default | 1.00x | 100 | 200 |
| 150 percent | s.61(a)(2), available to a BDC after board and shareholder approval under the Small Business Credit Availability Act of 2018 | 2.00x | 200 | 300 |
| Worked cushion at 150 percent | D = 150, E = 100, assets = 250, ACR = 166.7 percent | 1.50x | Breach when assets fall below 1.50 * 150 = 225 | Assets can fall 25, being 10.0 percent of assets or 25.0 percent of NAV |
ASC 820 fair value hierarchy applied to private credit
The hierarchy classifies by the observability of the inputs to the valuation, not by the type of asset and not by the confidence of the valuer.
| Level | Inputs | Where private credit assets fall |
|---|---|---|
| Level 1 | Quoted prices in active markets for identical assets | Almost nothing in a private credit portfolio. Listed equity received in a restructuring, occasionally. |
| Level 2 | Observable inputs other than Level 1 quotes - quoted prices for similar assets, observable indices, broker quotes in a functioning market | Broadly syndicated loans with dealer quotes; some larger club deals with observable comparables. |
| Level 3 | Unobservable inputs; the valuation reflects the reporting entity's own assumptions | The great majority of directly originated loans. Valued by discounted cash flow with a market yield input, or by an enterprise value waterfall. |
| Required disclosure for Level 3 | Reconciliation of opening to closing balances, transfers in and out, quantitative information about significant unobservable inputs, and a description of the valuation processes | The unobservable-input table - typically the discount rate range - is the most informative disclosure a private credit vehicle publishes. |
Entries
Asset coverage ratio
The statutory leverage constraint on a BDC and on a registered closed-end fund. Total assets less liabilities other than senior securities, divided by senior securities representing indebtedness. A BDC may not issue senior securities unless the ratio is at least the applicable minimum immediately after, and may not pay distributions if the ratio is below it.
| Field | Value |
|---|---|
| Formula | ACR = (Total assets - liabilities other than senior securities) / Senior securities = (D + E) / D. Implied maximum leverage: D <= E / (ACR_min - 1). |
| Worked, 150 percent limit | E = 100 net assets. D_max = 100 / (1.50 - 1) = 200. Total assets 300, ACR = 300 / 200 = 150 percent exactly. |
| Worked, 200 percent limit | D_max = 100 / (2.00 - 1) = 100. Total assets 200, ACR = 200 / 100 = 200 percent. |
| Worked, cushion | Running at D = 150 and E = 100: assets 250, ACR = 250 / 150 = 166.7 percent. Breach when assets fall below 1.50 * 150 = 225, a decline of 25 - which is 10.0 percent of assets and 25.0 percent of NAV. |
| General cushion identity | Permitted asset decline as a fraction of NAV = (assets - ACR_min * D) / E. Each turn of leverage divides the NAV cushion. |
- The cushion is the number that matters and it is not the ratio. A BDC reporting 166.7 percent asset coverage has 25 percent of NAV of room; the same vehicle at 155 percent has under 8 percent. Reported ACR is a level; the distance to the limit expressed in NAV is a risk measure.
- The constraint binds on marks, not on cash. A vehicle whose portfolio is performing but whose Level 3 marks fall is in the same position as one whose loans have defaulted, which makes the valuation policy part of the leverage policy.
- Breaching the ratio does not force a sale, but it prohibits issuing further senior securities and prohibits distributions. For a RIC with a 90 percent distribution requirement that is a genuine bind, because the distribution obligation and the prohibition can point in opposite directions.
- The 2018 reduction from 200 to 150 percent doubled the permitted leverage of the entire BDC sector without changing any individual credit. Comparing a BDC's historical return series across that change is comparing two different vehicles.
Source: Investment Company Act of 1940 s.18 and s.61; s.61(a)(2) as amended by the Small Business Credit Availability Act of 2018.
Business development company (BDC)
A closed-end investment vehicle that elects BDC status under s.54 of the Investment Company Act, invests predominantly in private US operating companies, and is subject to a reduced set of the Act's provisions - notably the asset coverage limit, affiliate transaction restrictions, and the 70 percent qualifying assets test. Most elect RIC tax status and therefore distribute substantially all of their taxable income.
| Field | Value |
|---|---|
| Qualifying assets test | At least 70 percent of total assets in eligible portfolio company securities and other qualifying assets, tested at the time of each non-qualifying acquisition |
| Leverage | Asset coverage of 200 percent, reducible to 150 percent on board plus shareholder approval; implies 1:1 rising to 2:1 debt-to-equity |
| Distribution requirement | As a RIC, at least 90 percent of investment company taxable income must be distributed to avoid entity-level tax |
| Affiliate transactions | s.57 restricts co-investment with affiliates; most advisers operate under an SEC exemptive order permitting allocated co-investment |
- The combination of a RIC distribution requirement and a portfolio with non-cash income is the structural tension in the wrapper. PIK and OID accretion are taxable income without cash, so the distribution obligation can exceed cash received - funded from borrowings, return of capital, or realisations.
- A listed BDC trades at a price the manager does not control, and the discount or premium to NAV is itself a constraint: issuing shares below NAV is restricted under s.63, so a BDC trading at a discount cannot raise equity to de-lever. Leverage capacity and market price are linked.
- Non-traded BDCs replace exchange liquidity with periodic tender offers, usually capped as a percentage of shares per quarter. The cap is the liquidity term, and it is the term that binds when everybody wants out at once.
- The 70 percent test is measured at acquisition, so a portfolio can drift below it through appreciation of non-qualifying assets without a violation. It constrains what can be bought, not what can be held.
Source: Investment Company Act of 1940 ss.54-65; RIC provisions at Internal Revenue Code Subchapter M.
Private drawdown fund
A closed-end limited partnership with a defined investment period and term, funded by capital calls against LP commitments, relying on the s.3(c)(1) or s.3(c)(7) exclusions from the Investment Company Act. Leverage, fees, and recycling are contractual rather than statutory.
| Field | Value |
|---|---|
| Leverage limit | Whatever the LPA permits, commonly expressed as a percentage of commitments or a debt-to-equity cap, plus the covenants in the facility itself |
| Fee base | Commitments during the investment period, then invested or net invested capital thereafter, which mechanically steps the fee down as the fund harvests |
| Recycling | The right to reinvest repaid principal within the investment period, up to a stated percentage of commitments - a return term located in the legal documents |
| Distribution waterfall | Return of capital, then a preferred return, then a catch-up or straight split, with either a whole-fund or deal-by-deal carry and a clawback |
- Recycling is the most underweighted term in a credit LPA. A fund permitted to recycle repaid principal for the full investment period can invest well over its committed capital in aggregate, which raises TVPI on the same paid-in base and is the main reason two credit funds with the same loss experience report different multiples.
- Because loans repay early, a credit drawdown fund's capital is in motion continuously. Fee on commitments during the investment period is therefore a materially different economic term from fee on invested capital, and the gap is largest exactly when deployment is slow.
- A whole-fund carry with a clawback and a deal-by-deal carry with an escrow can be described identically in a marketing document and differ substantially in the amount of carry actually paid on a portfolio with dispersed outcomes.
- The absence of a statutory leverage limit is the material difference from a BDC. The limit is in the LPA and in the facility's LTV covenant, and the second is the one that acts first.
Interval fund
A registered closed-end fund that offers to repurchase a stated percentage of its outstanding shares at NAV at periodic intervals under Rule 23c-3, rather than offering daily redemption. It is continuously offered, available to retail investors without an accreditation test, and constrained by the s.18 leverage limits applicable to registered closed-end funds.
| Field | Value |
|---|---|
| Repurchase mechanics | Rule 23c-3 requires repurchase offers at periodic intervals - three, six, or twelve months - for between 5 and 25 percent of outstanding shares, at NAV determined after the repurchase request deadline |
| Leverage | s.18(a)(1) asset coverage of 300 percent for debt, implying a maximum of 0.50x debt to net assets; 200 percent for preferred stock |
| Oversubscription | If requests exceed the offered amount, the fund repurchases pro rata; the remainder is not repurchased and must be requested again at the next interval |
| Liquidity requirement | Rule 23c-3 requires the fund to hold liquid assets sufficient to satisfy the repurchase offer from the notification date to the repurchase pricing date |
- The 5 percent quarterly offer is a promise about the queue, not about the investor. An investor requesting full redemption in an oversubscribed quarter receives a pro rata slice, and at 5 percent per quarter a full exit takes years if everyone else is also leaving. That is the point of the structure and it is not always how it is sold.
- The liquidity sleeve required to meet repurchases is a permanent drag: capital held in liquid assets is not earning the illiquidity premium the fund exists to harvest. The stated yield is therefore a blend of the credit portfolio and the sleeve.
- Because subscriptions are struck at NAV and NAV is largely Level 3, the price at which new money enters and old money exits is set by the same valuation the adviser produces. That is true of any NAV-traded private vehicle, and the continuous offering makes it a recurring event rather than an annual one.
- The 300 percent asset coverage limit means an interval fund cannot lever a credit portfolio anywhere near BDC levels. Comparing an interval fund's yield with a 2:1 levered BDC's is comparing two different amounts of risk on the same underlying assets.
Source: Investment Company Act of 1940 Rule 23c-3 and s.18(a).
Separately managed account (SMA)
A single-investor mandate in which the investor owns the assets directly and the manager invests under a negotiated agreement. There is no fund, no other investors, no commingled leverage, and no shared liquidity queue.
| Field | Value |
|---|---|
| What is negotiable | Fee level and base, leverage, concentration limits, exclusions, reporting frequency, valuation policy, and termination rights |
| Leverage | Contractual; the investor may forbid it entirely or provide it themselves at their own cost of funds |
| Liquidity | The investor can terminate the mandate, though the underlying loans remain illiquid, so termination usually means transfer of assets in kind or a managed wind-down |
| Trade-off | Loss of diversification per dollar and loss of access to the manager's leverage facility, in exchange for control and fee leverage |
- The economics of an SMA versus a commingled fund are not primarily about fees. They are about who provides the leverage. An investor who can borrow more cheaply than the fund's facility should provide the leverage themselves and take the spread; one who cannot is better off in the levered vehicle even at a higher fee.
- Allocation is the risk. An SMA relies on the manager allocating comparable assets to it alongside its funds, and the allocation policy - not the fee schedule - determines whether the mandate performs like the flagship.
- Because the investor owns the assets, they also own the valuation problem, the audit, and the administration. That cost is real and is usually understated when comparing an SMA fee to a fund fee.
ASC 820 fair value and Level 3 marks
The accounting framework requiring investments to be measured at the price that would be received in an orderly transaction between market participants at the measurement date, classified by the observability of the valuation inputs. Directly originated private loans are almost entirely Level 3, valued using unobservable inputs.
| Field | Value |
|---|---|
| Formula | Yield method: Fair value = sum over t of CF_t / (1 + y)^t, where y is a market yield calibrated at origination and adjusted for changes in credit quality, base rates, and spreads. Enterprise value method: value the borrower, then apply the waterfall. |
| Worked, yield method | A 100 par loan with a 9.00 percent coupon and 3 years remaining, held at a market yield of 9.00 percent, is at par. If the market yield rises to 11.00 percent: value = 9/1.11 + 9/1.11^2 + 109/1.11^3 = 8.108 + 7.305 + 79.700 = 95.11. |
| Worked, credit deterioration | Same loan at a 15.00 percent required yield: 9/1.15 + 9/1.15^2 + 109/1.15^3 = 7.826 + 6.805 + 71.669 = 86.30 |
| Sensitivity | Roughly 2.5 points of value per 100 bps of yield at this tenor and coupon. Disclosed discount-rate ranges are therefore directly convertible into a mark range. |
- The yield method calibrates to origination and then moves the discount rate for observable changes. Its weakness is that it holds the contractual cash flows constant, so a loan can be marked near par on a rate adjustment while its probability of repaying par has changed materially. The enterprise value method catches that and the yield method does not.
- The Level 3 disclosure that carries the most information is the quantitative table of significant unobservable inputs, because a discount rate range converts directly into a price range using the arithmetic above. A portfolio marked at 99 with a disclosed discount rate range far above its weighted average coupon is internally inconsistent.
- Fair value is an exit price at the measurement date, not a hold-to-maturity value and not the manager's view of recoverable value. Those three numbers diverge most in exactly the conditions where the mark matters.
- Rule 2a-5 places responsibility for fair value determination on the fund's board, permitting designation to the adviser subject to oversight, reporting, and specified process requirements. It changed the governance of the mark, not the mark itself.
Source: FASB ASC 820, Fair Value Measurement; Investment Company Act Rule 2a-5; Investment Company Act s.2(a)(41).
Fee base - gross assets, net assets, or commitments
The quantity on which the management fee is computed. Because the same percentage on gross assets, net assets, or commitments produces very different amounts, the base is a more important term than the rate.
| Field | Value |
|---|---|
| Formula | Fee as a percentage of investor equity = rate * (Fee base / E). On gross assets, that is rate * (1 + L). |
| Worked, gross assets | 1.00 percent of gross assets of 300 = 3.00, on equity of 100. That is a 3.00 percent fee on the investor's capital, because L = 2.0 and 1.00 * (1 + 2.0) = 3.00. |
| Worked, net assets | 1.00 percent of net assets of 100 = 1.00, a 1.00 percent fee on the investor's capital, regardless of leverage |
| Worked, commitments | 1.00 percent of 100 of commitments during an investment period in which only 60 is deployed = 1.00, which is a 1.67 percent fee on invested capital |
| Equivalence | A 1.50 percent fee on net assets equals a 0.50 percent fee on gross assets at 2:1 leverage. Headline rates are not comparable across bases. |
- Normalising every fee to a percentage of investor equity is the only way to compare vehicles, and it is a one-line calculation that is almost never presented. A vehicle advertising a low headline rate on gross assets at high leverage can be the most expensive of a set.
- A fee on gross assets pays the manager for using leverage, whose cost the investor bears. That is a genuine incentive misalignment, and it is the reason the shift to 150 percent asset coverage was an economic event for BDC managers and not only a risk event for BDC shareholders.
- A fee on commitments during the investment period pays for undeployed capital, which is defensible as compensation for readiness and indefensible if deployment is slow for reasons within the manager's control. The step to invested capital at the end of the investment period is the corrective, and its date is negotiable.
- Whether the fee base is struck before or after the deduction of accrued fees and expenses is a small technical point that compounds; ask which, and ask whether it is averaged over the period or taken at period end.