Before you start
NII and distribution coverage: match the income, denominator and period, PIK income: distinguish the contract, the accounting and the cash, Incentive fees: model the hurdle and catch-up before adjusting NII, BDC distributions, RIC tax status and spillover: keep three records separate
- Reconstruct competing income definitions without double adjustments.
- Separate a run-rate judgment from a historical cash claim.
- Trace every coverage output to an input and a scenario assumption.
Freeze the analytical contract before calculating
Use one invented annual period in USD millions, with a constant 50 million common shares and total common distributions of 115. Reported NII is 120 and already includes all reported expenses, including stock compensation of 10. It also includes 10 of accelerated fee income and 18 of recognized PIK. A fictional adjusted measure adds back the compensation, yielding 130. These assumptions are supplied for this workshop, not copied from a company. Define the research question narrowly: what comparison results if compensation is retained as an ownership cost and the accelerated fee income is excluded from a chosen run-rate view?
Make every adjustment reversible and distinct from a cash reconciliation
Start from adjusted income of 130. Reverse the compensation add-back by subtracting 10, returning to reported NII of 120; do not subtract that expense again from reported NII. Then remove the 10 accelerated fee income from the analytical run-rate view to obtain 110. Historical reported NII remains 120. Excluding income from a future run-rate comparison does not undo cash already received or imply that its original recognition was wrong. Similarly, retaining stock compensation expense is one policy for recognizing an ownership cost, not a statement that the expense was paid in cash this period.
Add a PIK assumption without relabeling it cash earnings
Take the normalized analytical 110 and deduct 50% of the stated PIK of 18, giving 101. If an additional recurring expense assumption is 2, the selected downside amount is 99. This branch holds fees, taxes and all other items unchanged. A separate contract-based alternative might reduce an income incentive fee if the fee base actually declines. For illustration only, assume a 20% marginal participation rate applies fully across the removed 9 with no hurdle transition, cap or other limitation: the fee reduction would be 1.8, producing 102.8 before the extra expense, not 101 plus an unrelated dividend adjustment. Keep that alternative in a separate column.
Write the evidence that could overturn the normalization
An issuer might argue that accelerated fees recur often enough across the portfolio to be part of normal economics; an analyst might instead identify a pattern of one-off exits that is unlikely to repeat. A compensation adjustment also needs a stated objective and cannot be called objectively correct merely because it lowers income. To resolve the dispute, inspect the fee-recognition note, origination and repayment history, compensation policy and actual incentive-fee agreement. Preserve the period, source location and disclosed definition for each real input. The workshop's arithmetic is reproducible, but whether its normalization fits a real issuer remains an evidence question.
Synthetic: reproduce the per-share and total comparisons
At 50 million unchanged shares, reported NII per share is 120/50 = 2.40, normalized analytical income is 110/50 = 2.20 and total distributions per share are 115/50 = 2.30. The selected downside is 99/50 = 1.98 per share. Dividing total or per-share values gives the same coverage because the assumed share bases are identical. The separate fee alternative is 101 + 1.8 = 102.8 before the extra 2 expense. Neither branch is a measured cash result, a tax distribution base or a prediction of what the board will pay.
Scroll horizontally to see all columns. With the table focused, use the left and right arrow keys.
| Synthetic income bridge | USD million | Coverage versus 115 distributions |
|---|---|---|
| Issuer-adjusted measure | 130 | 1.130435× |
| Reported NII: reverse compensation add-back | 120 | 1.043478× |
| Analytical run-rate: exclude accelerated fee income | 110 | 0.956522× |
| Frozen-fee 50% PIK deduction | 101 | 0.878261× |
| Add extra recurring expense of 2 | 99 | 0.860870× |
| Separate marginal-fee alternative, before extra expense | 102.8 | 0.893913× |
Test your reasoning
Use the normalized 110 but deduct only 25% of PIK and hold all expenses fixed. What income and coverage result before the extra 2 expense?
Reveal the worked answer
The deduction is 18 × 25% = 4.5. Income is 105.5 and coverage is 105.5/115 = 0.917391×. This is a separate frozen-expense branch, not a weighted expected result.
Check your understanding
A common mistake
Subtracting compensation twice, treating a run-rate exclusion as a historical cash reversal, or mixing frozen-fee and contract-sensitive branches.
What to check in the disclosures
- Reconcile adjusted income back to reported NII first.
- State why a recurring or nonrecurring classification is justified.
- List the items held fixed in every sensitivity.
- Check whether the fee branch crosses a hurdle or catch-up interval.
Sources & scope
US BDC education. Examples are hypothetical unless expressly attributed. Filing dates, contractual definitions and tax rules matter. An issuer source describes that issuer; it is not evidence that every BDC uses the same policy.
- Ares Capital original 2025 Form 10-K: historical definitions, not current issuer data; check amendments and later filings ↗
- Ares Capital March 2026 results: statement and reconciliation format — not example data ↗
- Main Street September 2025 Form 10-Q: PIK and non-accrual accounting policies — historical definitions ↗
Educational material, not a recommendation or personalized investment advice. Source and correction policy.