BDCs were established by Congress as part of the Small Business Incentive Act of 1980. Created specifically to finance privately held companies in the U.S., BDCs were set up as tax pass-through entities. While there is no double taxation on dividends, at least 90% of gross annual income must be distributed to shareholders. And at least 90% of gross annual income must come from dividends, interest and realized capital gains from the BDC's investment portfolio. That investment portfolio must also be diversified.
Despite all of these restrictions, or perhaps because of them, BDCs were devastated by the Great Recession.
The most egregious case was that of Allied Capital, which came under attack from hedge-fund manager David Einhorn. His book, Fooling Some of the People All the Time, details his campaign to alert the investing public to the dubious business practices of Allied Capital, especially in its accounting shop. The stock price of Allied Capital plunged, and it was sold to Ares Capital Management for $5 a share in 2010.
Since BDCs finance smaller entities, adverse economic conditions hit them hard; larger firms are more resilient because of their access to more resources. A BDC will never be a lender that is "too big to fail." Allied Capital was the oldest and, at times, the biggest BDC -- and it still went down. (Rightfully so, thanks to the efforts of Einhorn, who profited handsomely from his short position on the stock.) The entire sector was dragged down during the Great Recession.