How to Make 14% Dividends from Small Businesses

Trent Lindmark is the billboard king of the Gulf Coast. Trent operates billboard advertising next to highways in Kansas, Texas, Oklahoma, Mississippi, and Alabama. He makes the structures in a large warehouse, with a team of 30 welders. He prints the advertisements with his own digital printing business. He manages the billboards once they're up next to the highway.

Trent has been in the billboard industry all his life. He started when he was 12 years old, working for his grandfather. In 1999 – at the age of 20 – Trent split from his grandfather and started his own business with $1,500.
 
Trent was the most aggressive competitor in the industry. He had the best customer service, the lowest pricing, the best locations, and he made the strongest billboards. For example, two of his billboards were in Hurricane Katrina's path. After the storm, he went to inspect the damage. "There was seaweed on the tops of them," he said to the reporter. "But they were still fine. The IHOP next door was gone, however."

By 2007, Trent's business owned 900 billboards. That's when Trent decided to go on a shopping spree. He bought four of his local competitors... and doubled his billboard ownership from 900 to 1,800. He bought a new state-of-the-art digital printer. Then he bought a 105,000 square foot warehouse in Purcell, Oklahoma. He's turning this warehouse into a billboard factory.

Here's the thing: Entrepreneurs take a big risk when they decide to grow. Most people don't know about this risk, even though it's probably the No. 1 killer of small businesses. In business school, they call this risk "undercapitalization."

When entrepreneurs find a profitable business, they assume they should grow it as fast as possible to maximize profits. They don't realize that growth consumes large quantities of cash. One day, they wake up and realize they've spent all their money manufacturing thousands of new widgets and can't pay the electric bill.

To prevent a cash crunch, these small businesses must borrow money... and they're usually desperate to get it. But who will to lend it to them? Not banks. Loans to high-growth small businesses are too risky for banks. Most banking charters prohibit these loans. The capital markets are not an option. It costs millions of dollars to meet the regulatory requirements and pay the fees to go public. Small companies can't afford the costs of public financing.

BDCs are the solution. BDC stands for Business Development Company. A BDC is a very simple business. Think of it as a pool of capital managed for the benefit of shareholders. The managers of the BDC use the pool of capital to make loans to very small businesses, like Lindmark Outdoor Advertising.

Lending money to small private companies is an excellent business.

First, tiny companies grow the fastest... and as we saw with Trent's business, not only are small companies the most desperate companies in the market for cash, but they have the most to gain from a loan. So they'll pay any price to get it... sometimes as much as 20% in annual interest payments, plus a piece of the ownership in their company.

Secondly, by financing only small companies, BDCs can spread their portfolios over a large number of companies, sectors, industries, and geographical locations. Collecting loans and bundling them all together is one of the secrets to finance. Diversification eliminates the risk without hurting the return.

Finally, taxes are the best reason for investing in small companies. The U.S. government thinks small businesses are vital to the economy and gives huge tax breaks to companies that lend money to them. BDCs never have to pay tax on their profits as long as they distribute their profits to shareholders in dividends.

In this case, a BDC lent Trent the $10 million he needed to pay for his expansion. Trent says he'll have 2,800 billboard advertisements by the end of 2008, making Lindmark Outdoor Advertising one of the largest outdoor advertising companies in America. It was a great deal for Trent Lindmark. And it was a great deal for the BDC, which earns a 16% return for its shareholders on the loan.

There are 19 publicly traded BDCs on the stock market. The largest is Allied Capital (ALD). It has a dividend yield of 14%. It's been in business for 50 years and has never cut its dividend.

Good investing,

Tom