I recently read a good article highlighting the reasons for investing in business-development companies (BDCs). It correctly pointed out that since these businesses borrow at relatively low rates of interest and then lend out those funds at much higher rates, the net interest income distributed to investors (registered investment corporations must pay out at least 90%) often results in 10%-plus yields. Though they're awfully enticing, these higher-risk, higher-reward investments come with a huge caveat. I'll look at five currently paying double-digit yields.
IN PICTURES: 6 Major Credit Card Mistakes

High-Yield BDCs

Company Yield Discount/Premium YTD Return
Prospect Capital (Nasdaq:PSEC) 15.6% 103.5% -11.6%
BlackRock Kelso (Nasdaq:BKCC) 12.2% 106.3% 22.0%
Triangle Capital (Nasdaq:TCAP) 11.1% 135.5% 21.8%
PennantPark Investment (Nasdaq:PNNT) 10.3% 88.5% 9.9%
Apollo Investment (Nasdaq:AINV) 10.0% 106.0% 15.5%

Prospect Capital
To give you an idea of how risky some of these investments can be, I looked at a list of current and previous Prospect investees on its website. It lists Houston-based drilling services firm Deep Down (OTCBB:DPDW) in its portfolio. On August 1, 2007, it lent the company $6 million to grow and recapitalize its business. The loan was a senior secured note at 12.5% with a 3% payment-in-kind repayable over four years. The interest rate sounds fantastic until you look at Deep Down's income statement and realize that the company has made money in just one of the last six years. This gives you an idea what type of risk is taken by BDCs to get these returns. It isn't for the faint of heart.

BlackRock Kelso Capital
If you do invest in a BDC, I highly recommend that you go through its portfolio of loans to get an idea what type of opportunities it generally invests in. There weren't too many names I recognized as I went through BlackRock's list of investments. One I did know was Water Pik, the electric toothbrush company. I didn't even know this company still around, but apparently it is. BlackRock's lent them $30 million at 5.75% - one of the more generous rates to appear on its schedule. Virginia's Retirement Plan must like what BlackRock's doing, it owns 33.5% of the company. Credit strategies, of which BlackRock is a part, represent 10% of the assets held in Virginia's retirement system and those assets have beaten their benchmark in the latest one, three and five-year periods. This speaks volumes about the quality of BlackRock's assets in my opinion.

Triangle Capital
On May 11, Triangle announced that the Small Business Administration had granted the company a second license for $75 million on top of its first license that provides $150 million in government-backed SBA debentures. These debentures carry a current interest rate of 6% giving it an excellent spread on loans to its lower-middle-market customer. The transaction size generally is between $5 million and $15 million and its target are companies with annual revenues between $20 million and $75 million. In the first quarter, its average annual yield on its debt outstanding was 14.7%, leading to a 15% increase in its total investment income in the quarter. More will follow with this additional license.

PennantPark Investment
The company had a good first quarter ended March 31 with net investment income increasing 34% to $7.1 million from $5.3 million. During the quarter, Pennant made $68 million in new investments and so far the second quarter is turning out to be equally as busy. This should lead to further increases in its income levels. The company currently has investments in 47 companies at average of $12.5 million per investment. Ninety-five percent of its $600 million in assets are debt investments with the remainder in equity. If nothing else, you have to love the company's name.

Apollo Investment
At the end of April Apollo announced it was selling 17.25 million shares to the public, increasing the number of shares outstanding by 10%. Once the offering is finalized, the company will be sitting on $731 million in cash and cash equivalents - money that will be necessary to rebuild its portfolio because of some non-performing investments including a potential Innkeepers USA bankruptcy. Those in the know question whether it can continue to pay the $1.12 annual dividend given $600 million in realized losses in 2009. While it is one of the biggest BDCs out there, I have to wonder if current issues will slow earnings and ultimately affect the dividend payout.

Bottom Line
I've written about three BDCs in the past. If you can live with the higher risk, they are an excellent way for investors to generate a little additional income. However, don't bet the farm. (For more stock analysis, take a look at Three ETFs Looking For A Bounce.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.