Business development companies (BDCs) are very attractive for investors. It’s hard not to like steady dividend payments and high yields. However, there is a very large range of quality in the BDC space, with a corresponding range of total return results.  Many investors have been burned by chasing the BDCs with the highest yields, rather than looking for investor focused business operations and long term records of positive investment returns.

A business development company operates under the 1940 Investment Company Act, the same law that governs mutual funds and other types of investment funds. Additional laws governing this type of business require a BDC to provide capital to smaller, privately held corporations. This capital can be in the form of business loans or equity investments. A BDC can use leverage up to one times its equity, effectively doubling the money one of these companies has available to make small business investments. Typically, a BDC focuses on making business loans, and often will take a small piece of equity in a client company. The loans provide cash flow to pay the attractive dividends craved by investors. Equity investments can produce capital gains to be paid as special or bonus dividends. Business development companies are also required to pay out at least 90% of net income as dividends. This is a rule that ensures a high dividend rate and yield, but makes it a challenge for management to grow the business.

Out of the 40 or so publicly traded BDCs, the majority have produced less than stellar results. One report shows that since the start of 2011, 90% of the companies in the sector have lost share value, with some dropping  by more than they have paid in dividends to investors. To narrow down the pack, consider these three BDCs with above average investment potential. For comparison, the UBS ETRACS Wells Fargo Business Development Company ETN (NYSE:BDCS) exchange traded note that tracks the sector has a current yield of 9.05% after 0.85% in annual expenses.