Tuesday, July 06, 2010

Medley Capital BDC and the high fees and dilution.

Medley Capital BDC has filed its latest N-2/A detailing plans to sell 13.3 million shares at $15.00/share. The initial portfolio will be contributed by some of the managers private funds, who will exchange loan assets for shares in the new BDC. This is similar to what THL capital did for its IPO. However unlike THL Credit (TCRD) Medley's fee structure is much more favorable to the manager, being (2% gross assets + 20% xs of quarterly 8% hurdle with a catchup). Unlike THL there is no total return requirement, nor any exception on paying an incentive fee for non-cash PIK interest.

The most worrysome aspect of Medley Capital's offering statement is that the company intends to pay 50% of the management incentive fee in shares of stock issued at the then current market price. This could lead to incredible dilution if the company manages to have decent earnings while trading below NAV. Constant issuance of new shares may also become a drag on total returns because of insidious dilution.

Subject to receipt of exemptive relief, we have agreed pursuant to the investment management agreement with our adviser to pay 50% of the net after-tax incentive fee in the form of shares of our stock at the then current market price, which may be below our NAV; this may affect the market price of our stock and may result in dilution to existing stockholders.

As we describe under “The Adviser”, pursuant to the investment management agreement with our adviser, subject to receipt of exemptive relief from the SEC, we have agreed to pay 50% of the net after-tax incentive fee in the form of shares of our stock at their then current market price. This may result in the issuance of shares to our adviser at a price that is below our then current NAV (if our market price is below our NAV on the issuance date of the shares). Any issuances below NAV may have a negative effect on our stock price. In addition, the interests of existing stockholders may be diluted. The extent of the dilution that may be incurred is not calculable.

The 1940 Act prohibits us from selling shares of our common stock at a price below the current NAV of such stock, with certain exceptions. One such exception would permit us to sell or otherwise issue shares of our common stock during the next year at a price below our then current NAV if our stockholders approve such a sale and our directors make certain determinations. At our next annual shareholders’ meeting, we will seek approval to continue this arrangement.

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