By Marta Lillo
Current trends in the structure of EB-5 investments mix traditional equity and debt with innovative project financing approaches. Sophisticated investors, stringent regulations, and high-quality projects also drive the change.
EB-5 investors no longer rely on meeting the minimum 10 jobs requirement or the two-year mandatory period to stay in business to choose a project. They are also assessing the structure of the capital stack for repayments and potential profits.
Understanding the structure helps applicants know beforehand how their investment will perform, which is crucial to making an informed decision.
Phuong Le, a founding member and partner at KLD LLP, explains that “folks raising EB-5 money treat the underwriting and project analysis as seriously as their counterparts in other industries do simply because the investors have become more sophisticated with analyzing the right issues and on the flip side, the competition in EB-5 has greatly increased where each offering has to hold its own against the quality of their competitors or else they’ll get picked apart.”
The equity layer that makes up the EB-5 capital stack
Equity and debt are the fundamental components of this structure. The proportion of each component will vary based on financing requirements and specific needs. The New Commercial Enterprise (NCE) is responsible for structuring and managing this capital stack. The NCE can enter into several agreements with the Job Creating Entity (JCE) to provide financing.
The capital EB-5 investors provide is the primary source of common equity for the project’s capital structure. It has the highest reward potential but also the highest risk. Although applicants have a share in the project’s profits, they usually receive returns last.
Preferred equity is another type of equity in the capital structure. It has a higher priority in the project’s cash flow than common equity and receives favored treatment in terms of distributions.
Ronald Fieldstone, an EB-5 securities attorney and partner of law firm Saul Ewing LLP, says the “preferred equity model where the NCE funds the JCE and gets a preferred return” is commonly used. He adds that this model benefits EB-5 investors with a higher return and profit participation.
Likewise, Le says that understanding the project’s fundamentals and valuations also makes “more savvy investors comfortable with seeking preferred equity and even common equity positions in projects. We see that spill over into offerings itself.”
Two types of EB-5 debt options for different objectives
Developers of EB-5 projects and investors also often prefer senior debt from traditional lenders like banks. This option is attractive because it reduces non-payment risk; holders are paid first in case of losses or default. However, the return on investment for senior debt is limited to the agreed-upon interest rate and does not allow for any additional profit beyond that.
There’s also mezzanine debt, a hybrid type of financing that can be converted into equity in case of default.
Current capital stack structure options continue involving a mixture of senior and mezzanine debt at different levels, says Fieldstone. “The typical transaction still has a senior loan, and EB-5 comes in as second-tier mezzanine financing secured by a pledge. Given the increase in the TEA/Rural investment amount of $800,000, the job count enables a 60% increase in the amount that can be funded. Therefore, in certain situations where the land value is high based upon an appraisal/market study […] the EB-5 loan can be in a first lien position.”
The attorney points out this model’s benefits include the “ability to obtain portfolio loan exemption under Section 871(H) of the IRC [Internal Revenue Code] whereby the interest to investors is exempt; fixed obligation to pay within a time frame – like 5 years; priority over equity [in payment]; more control over the disbursement of funds, and inter-creditor rights with senior lender.”
In addition, since the passing of the EB-5 Reform and Integrity Act of 2022 (RIA) in March 2022, the proportions of equity and debt have changed. “Clearly, the financing markets have tightened, and accordingly, the EB-5 industry requires more equity than prior to the RIA. However, as noted above, the appraised can be used to increase the deemed equity,” Fieldstone adds. “The equity should be at least 20% and up to 35% of the capital stack. The senior debt is much easier to obtain if the amount is 50% of the total capital stack and the rate may even be lower.”
Regarding the mezzanine options available in the EB-5 industry, securities attorney Shae Armstrong, partner at Bradley Arant Boult Cummings LLP, explains that the convertible note model between the NCE and JCE is a new structure being used because it “affords the sponsor flexibility as the capital stack is formalized.”
Armstrong, who specializes in project financing for EB-5 developers, notes that this model is used mainly for larger deals with more complex capital stacks. “A convertible note between NCE and JCE allows flexibility for the developer in the event that their senior lender dictates how EB-5 capital should be treated. The convertible note is structured so that whether it is loan proceeds or equity, the EB-5 proceeds have the same economics as the sponsor and the EB-5 investors.”
The lawyer adds that EB-5 investors also prefer this model “because it may be able to attract more competent senior counsel that will better underwrite the project and hold the developer accountable.”
The quality of EB-5 projects and the availability of financing can impact the capital stack
Phuong Le explains much has changed in the past five years regarding project financing for EB-5. “The easiest way I can illustrate this is five years or a decade ago, when analyzing the capital stack of projects, so much energy would be spent explaining and debating what percentage of a pie chart the developer should contribute to, what amount would be safe for EB-5 investors to fund, the various proportions, and etc. Which is understandable, but even a quick glance at today’s offerings illustrates how the quality of projects have grown.”
Today, EB-5 investors must ask if their chosen project is fully financed, Le cautions. “This is because the biggest problem plaguing projects that have failed throughout the years is they simply didn’t have the financing to finish in the first place.”
The EB-5 attorney says that today’s successful projects are fully financed, well underway, and have an exit strategy and a guarantee of completion. “[It] doesn’t mean that it’s guaranteed to be successful, but most of us understand this avoids the majority of headaches that people will run into.”
The importance of a clear exit strategy has also risen, given the U.S. Citizenship and Immigration Services’ (USCIS) new rules on the two-year sustainment period.
Fieldstone adds that current competition is larger, given the number of quality projects in the marketplace. “Therefore, the track record of the developer in prior EB-5 transactions is critical.”
Right now, the supply of products exceeds the demand by the EB-5 industry, he points out. “The increased filing fees have accelerated the pace of filing I-956 and I-956F petitions. Furthermore, the new release on sustainment period commencement has stimulated a shorter-term payback to the investor.”
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