How should developers structure the capital stack of an EB-5 project? -

How should developers structure the capital stack of an EB-5 project? Staff

By Marta Lillo

Developers who are looking to attract EB-5 investors and ensure the success of their projects must keep the investors’ interests, market demand, and provide necessary details when developing the capital structure of their projects. This understanding is crucial in today’s evolving investment landscape, as highlighted by EB-5 project attorneys.

According to immigration attorney and FINRA representative, Irina Rostova, the financing structure plays a pivotal role in attracting the necessary capital. If the structure of the capital stack fails to appeal to investors, it’s unlikely to secure the required funds.

“You can structure our project in a way that works for you. But if it doesn’t appeal to investors, you won’t be able to attract EB5 capital,” Rostova says.

Understanding investor interest begins by knowing how their preferences as to equity and loan stand.

Rostova explains the choice of EB-5 financing has shifted towards debt over the past 15 years. “Back then, investors liked the idea of owning a part of the project, but with time, investors saw that when you go in as an equity investor, your risks are higher. But more importantly, you don’t know when you’re going to exit, and so if you’re lucky, maybe you will exit in five years,” she says.

Chris Foulger, president of HomeFed corporation, explains that the equity model was attractive for EB-5 developers because of its flexibility. “We were used to doing it with equity and we had equity on the balance sheet. We just bridged ourselves. We funded the project with equity, and the EB5 that came in, whether it was 10% or 100%, didn’t affect the timing of the project at all.”

Loans are now the preferred choice for both experienced developers and EB-5 investors, offering the latter clearer repayment options and interest rates.

“The majority of the investors want to put their money in the project and know exactly when they’re going to get it back. So that’s why the debt model is more popular. Investors are willing to sacrifice earnings, willing to go into a debt model where they’re interest rate is nominal versus going into an equity model where they may potentially earn 5% or 6%,” Rostova says.

This option provides developers with a more secure and predictable financing structure. “It makes them feel safe,” she adds. “If something is a senior loan, we can look at the documents to make sure that they have backup financing. If they’re plan A but there’s no Plan B, it’s much riskier than going into a project where you are in a second lien position, but where all the financing is in place.”

For Shae Armstrong, EB-5 securities attorney and partner at Bradley Arant Boult Cummings, another advantage for developers for having the EB-5 loan being the senior position is for prepayment purposes.” You don’t have to worry about breaching any of your senior debt covenants and there’s probably more flexibility for the project with EB-5 and the senior position like yours.”

What EB-5 project agreements should include about the capital structure

Developers who want to attract investors with their capital structure need to provide them with detailed and transparent documentation. “Unfortunately, I see a lot of EB-5 loan agreements that are very minimal,” Armstrong cautions.

According to Rostova, clarity is paramount as “sneaky provisions” could reduce the project’s appeal from a legal perspective. “It’s going to be a deterrent on the market if these investors are represented by a competent financial professional or if these investors are working with a good agent, they will catch on to those terms. Funky things are if your loan agreement has too many extensions if you’re marketing it as a 3-year project, but you have a 5-year extension that you are not even mentioning in your marketing material. That’s a red flag.

These agreement documents must also clarify the repayment terms to the developer from EB5 proceeds. “I have seen it in prior projects and the EB-5 space. The developer claims to have put down 25% equal to [the EB-5 investor], but they’re carving out provisions saying if they hit a certain amount in the race, they’re pulling some of that money out.
Try to avoid that. Your project should be such that when all the terms are summarized and it is clear that it’s still competitive with what is on the market.”

Is there an ideal EB-5 project capital structure for developers?

These EB-5 actors agree that the most efficient structure balances EB-5 capital with the sponsor or developer’s own funding.

Armstong explains that EB-5 investors will avoid projects that depend 100% on their capital because developers and sponsors are not leaving “skin in the game.”

Foulger suggests that the more money the developer puts in, the safer it is for the EB-5 investor.

Rostova illustrates: “I would say 50% EB-5 financing in senior loan position, 50% developer equity and a very strong backup option. If the EB-5 funds are not raised, so obviously very strong regional center that I know has the capacity to raise those funds in a good project overall, but a very strong backup option. So, which if the developer has put up 50% equity?

EB-5 project timing and seniority can influence the appeal of capital structure

The timing of an EB-5 project and the developer’s experience can affect the appeal of its capital structure.

According to Foulger, uncertainty raises concerns for developers and investors alike. “One of the biggest issues for developers who are thinking about using EB-5 and investors is how the project will be built if only part of the EB-5 funds are raised. If you’re a developer, how are you going to bridge that? Because timing is everything, and EB5 is anything but certain as far as when the money is going to,” he says.

For Rostova, the further along the project, the better. “We can actually check to see if the everything is moving along the way it should. If the construction is already started, if the financing is in place, that is an amazing time for the investor to come in. If the construction is near completion, then of course we’re reducing your construction risks. However, that’s just not the reality for the majority of projects, so they do need to attract financing.”

New developers entering the EB-5 scene offer more significant risks to investors despite having attractive capital stacks. “If it’s a new developer and they just have letters of intents or term sheets, but everything is contingent and EB5 financing, it’s just too risky. So we do want to see whether it’s backup equity or backup financing. We do definitely want to see that those documents have been executed,” Rostova says.

Foulger adds that EB-5 legal advisors to the investors will also look at the project sponsor experience when studying the structure. “Have they done this multiple times, and do they have the balance sheet to support it going forward?”

Developers must also know their competition and understand investor preferences to attract funding.

Rostov advises that they must offer comparable or better terms than other projects to be successful. “You may have the best ideas, but if it doesn’t compare to what other projects are doing and other projects can offer sometimes better terms, then you know you’re just not going to do as well raising those funds.”

Foulger concludes that developers must be realistic about what’s in the marketplace and what is marketable.

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