[Editor's note: This article was originally published on Sept. 5, 2012.]
The rich are different -- they invest in better companies than the average investor.
But exactly how do they do this?
Well, rather than buying shares on the stock exchange, savvy big hitters write a very large check to a very special kind of firm. To be eligible to invest like this, federal law stipulates that an investor needs to have at least $200,000 a year in annual income ($300,000 for a couple) and more than $1 million in net worth, excluding a primary residence.
That is a very high bar. Those rules block 94% of investors.
And in reality, the entry point is much higher. A million dollars isn't what it used to be. I don't say that to be glib: The law that created these rules was passed in 1933, when $1 million was the equivalent of $17.2 million in today's terms. When this law was passed, a $200,000 annual salary was enough to keep a Rockefeller -- or Mae West -- very happy.
While the law hasn't been updated, the marketplace has kept pace with the times. Today, the unofficial minimum investment with these special firms is typically $15 million to $20 million.
The "relationship" only increases from there...
The official name for these highly-exclusive firms is "private equity."
That term probably sounds familiar. It's the area of the business world where Gov. Mitt Romney, the Republican nominee for president, made his fortune. Mr. Romney earned his paycheck by helping companies expand, gain efficiency and increase profitability. As the value of these companies grew under his leadership, so did Romney's own net worth.
A private-equity firm has more than a pile of investor cash to offer. It also provides executive mentoring and business advice -- often from some of the biggest names in corporate America. The smartest, most capable finance geniuses and managerial wizards go to work for companies like Bain Capital, which over the years has invested in companies as diverse as the office products store Staples and fast-food giant Burger King.
As these businesses grow, private-equity backers get phenomenally rich. In some cases, the private equity firm is more than happy to collect rich dividends from the company's profitable operations. In other cases, the private equity firm sells its stake in the company, sometimes to another corporation, sometimes to investors. These can be, and often are, billion-dollar payoffs.
Readers of my Game-Changing Stocks newsletter pay me to read the fine print, and I love doing it. Let me share with you something I've shared with them. It's something I have seen in dozens of multi-hundred-page prospectuses of any recent initial public stock offering. After the description of the business, a discussion of the risks of investing in the shares and tons of financial charts, there is always a list of the major shareholders. There is always -- and I mean always -- a private equity company that is raking in an enormous pile of cash. It's not uncommon at all for a $20 million investment to turn into a ten-figure sum in just a few years.
I like private equity because a lot of private-equity firms do the exact same thing I try to do with Game-Changing Stocks. They try to find "the next big thing," and they seek to invest in it before anyone else realizes that they've found the Golden Ticket.
Here's the good news. Private equity doesn't have to be our competitor. It can be our partner. In fact, you and I can put private-equity and its consultants to work for us the same way the billionaires do.
That's because there is a way around the rules that bar ordinary investors like you and me from investing in private-equity deals.
Right now, there are 4,647 stocks on U.S. exchanges with a market capitalization of more than $50 million. Of those, only about two dozen -- less than 1% -- are a special type of entity known as a business development company, or "BDC."
These companies, which Congress laid out the rules for in 1980, operate in the same manner as private-equity firms: They invest in and advise private companies, typically smaller "middle market" ones, which are generally defined as companies with more than $100 million but less than $1 billion in annual revenue.
In addition to a BDC's potential for a huge payout -- when they sell a company -- BDCs also pay huge dividends. It's not unusual to see double-digit yields from these companies.
Here's a list of the Top-10 highest yielding BDCs on the market...
[Note: You can see a complete list of all the BDCs on the market if you're a subscriber to my Game-Changing Stocks advisory]
As a matter of law, BDCs have to have a code of ethics. They're disallowed from certain transactions, they have to maintain diversity in their portfolio and, perhaps best of all, they are limited in the amount of debt they can carry.
Add it all up, and BDCs offer a surprisingly safe way to invest in high-risk areas on the cutting edge.
Unlike corporations, which only pay dividends when they want to, BDCs are legally obligated to return cash to shareholders. The reason is because, like a partnership or a trust, the entity itself is not subject to income taxes. Instead, income is passed directly along to shareholders and is then taxed at their ordinary income rate rather than the dividend rate. And not only do almost all BDCs pay a dividend, but many pay monthly rather than quarterly.
> The bottom line is that strong BDCs can deliver a one-two punch: Capital appreciation from harnessing the power of The Next Big Thing and a strong, steady income stream.
The question I'm sure you're dying to ask, then, is this: Just how do I pick the best BDC?
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