By Lili Wang and Yannan Wang
The EB-5 market has seen unprecedented demand from Chinese investors in recent years, particularly with the closing of the Canadian program. Additionally, there is an ever-increasing number of projects seeking EB-5 capital in the United States as the program gains more publicity. With so many projects seeking EB-5 capital, and new players entering the market constantly, investors often face difficulty in selecting sound projects. Because the EB-5 industry lacks quality standards for both projects and intermediaries, investors can encounter unsound projects that do not protect the investor’s ability to obtain permanent residency or capital repayment. Too often, EB-5 is a single-sided deal where investors must take what is given, like a bargaining table where project sponsors dictate all the terms and investors cannot even show up.
We have compiled three of the most frequently voiced questions and concerns from investors and agents. We hope that by delving deeper into the issues that can affect investors and agents, we can empower both to be more successful in the EB-5 marketplace.
Q: I have reviewed a project’s job creation, capital structure, and exit strategy. They seem okay. What can blindside me?
Thorough due diligence should provide evidence of the project’s claims, delineate the risks involved, verify risk mitigation mechanisms and provide transparency to the project’s operations.
Evidence of claims may extend beyond just the project documents. For instance, a project’s feasibility could be severely impacted by industry trends, market changes, and demographic shifts. It is helpful to ask the project sponsor or representative to present evidence beyond project documents. If an agent or investor could obtain third party, independent reports it would be even better. The project sponsor should work with the third party to respond to inquiries and produce reports. When selecting such third parties to work with, agent/investors may want to look for formal qualifications and experiences in due-diligence work. US Financial Industry Regulatory Authority (FINRA) licensed broker-dealers with Series 79 qualification and experiences in M&A deals or security underwriting are ideal candidates in this arena.
Typically, a project’s legal documents contain the finer points of investor rights, but are not fully discussed. To validate a project’s claims, it is important to home in on the sections of the legal documents that corroborate such claims. It is recommended to ask the project to point out exactly where, in the contracts, are the relevant clauses that support investor rights and provide investor recourse. If resource permits, the agent and / or investor can engage independent attorneys who are familiar with US securities and corporate law to verify such clauses.
Additionally, the Risk section of the private placement memo contains valuable disclosures that can substantially affect an investor’s success. We recommend fully understanding these sections and asking the project about how to mitigate such risks.
Q: What are some positive signs of project safety?
Other than sound capital stack, good project fundamentals, thorough feasibility study, and solid exit strategy, experience and expertise also increase the chance of success. Typically a project sponsor who has a track record of solid projects is a positive indication. It is important to examine the sponsor’s operating history – how are its existing operations performing? Has there been any financial or legal trouble? Also, the sponsor, personally, should present a clean record. Of course, previous I-526 and I-829 approvals and investor repayments are positive signs, but a new regional center or project sponsor could also bring excellent project to the market. Therefore, investors and agents should always examine a project on its own merits.
The engagement of a broker-dealer in a project is another positive sign. Broker dealers are institutions regulated by the US Securities Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), and are held to high degrees of transparency. Broker dealers work with projects to ensure compliance with US securities regulations. These institution usually have financial industry experts who have experience with due diligence. They should have conducted thorough due diligence prior to becoming engaged in a project, and would be able to make that information available to agents and investors. Additionally, broker-dealers are required to disclose material information about the project, making sure that investors understand the risks. This goes beyond simply handing investors the project documents and provides an added transparency to a project.
A broker dealer’s credentials and operating history can be easily verified on FINRA’s website.
Q: If something goes wrong with a project, how can I find recourse for my investors?
We recommend that investors work with projects whose sponsors have “skin-in-the-game,” a solid track record, and a willingness to be open with investors regarding questions and inquiries. Sponsors whose incentives are aligned with investors would be more motivated to work with investors to find solutions. For example, if a project’s non-EB-5 financing falls through, a sponsor who has equity in the project will actively seek out alternative financing to enable a project to proceed. Also, a sponsor who is willing to share information and provide updates is more likely to be responsive and responsible to investors when things go wrong unexpectedly.
Additionally, it is important to read the project’s legal documents carefully, in their original language, to understand the finer points. Push whomever is presenting the project to point out where the legal documents specify protection for the rights of investors and the claims of the project. In a downside scenario, where in the legal contracts, are there paths to recourse for the investor. For example, if the general partner of the New Commercial Enterprise misappropriates investors’ funds, can the limited partners vote him or her out of power? Or, if EB-5 capital has claims on certain collateral, what are the scenarios where those claims prove ineffective? Where in the legal documents are investor claims protected? It may be helpful to work with a qualified bi-lingual securities attorney to navigate the legal documents. For an agent with numerous investors this may be a beneficial investment.
In summary, the EB-5 marketplace provides a wonderful opportunity for foreign investors to obtain the American dream. To ensure the integrity and success of projects, agents and investors should demand a higher level of service and transparency from their project partners. Investors and migration agents should demand sound structures, comprehensive due diligence, and professional monitoring. They should also demand vehicles to advocate for investor rights. Third party marketers and intermediates should have relevant licenses and necessary experiences to provide investors with adequate level of protection. It is time that investors and agents finally come to the negotiating table and demand protection for their rights.
Lili Wang is a Managing Partner of New City Advisors. She began her investment career at Goldman Sachs; before starting her own practices, she managed a $300 million Global Financials and Emerging Markets portfolio at Seneca Capital. She currently serves as the chair at IIUSA Investor Markets Committee.
Yannan Wang is a Managing Partner of New City Advisors. He has years of experiences in banking risk management and start-up business management.