Hercules: Value in Venture Capital

05/21/2015 7:00 am EST

Focus: STOCKS

Tim Plaehn

Investment Research Analyst, Investors Alley

Business development companies (BDCs) operate under special tax rules that allow them to not pay corporate income taxes, explains Tim Plaehn, editor of The Dividend Hunter.

BDCs provide loans and equity investments for smaller companies and at least 90% of a BDC's net income must be paid out as dividends to shareholders.

Hercules Technology Growth Capital (HTGC) is one of the oldest BDCs. It was founded in 2003 and came public in 2005.

What sets HTGC apart from its peers is its client focus, various types of technology companies. Hercules works with venture capital and private equity firms to provide funding for companies that are pre-IPO or being groomed for merger or acquisition.

HTGC makes only senior debt loans with maturities of three to three and a half years. About 90% of Hercules' assets are loans with 10% as equity positions that can pay off very well when a client goes public or is acquired.

The company's relationships with over 500 venture capital-type firms have allowed HTGC to steadily grow its book of business and also steadily increase its annual dividend. Since 2010, the annual dividend has increased from $0.80 per share to $1.24 paid in 2014.

In 2014, $900 million in new loan commitments were turned into new assets, continuing the growth trajectory.

The fact that such as significant portion of the portfolio paid off last year, means that in 2015 Hercules will not receive as much profit benefit from the payoff of loans and equity positions.

As a result, the dividend rate may not start growing again until the asset portfolio reloads and the historic cash flow growth profile can resume.

At the same time, the share price has leveled off, and even declined, so far, this year, allowing us to buy in at a near 9% yield. We are adding HTGC to our model portfolio.

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