By Elizabeth Peng and Cletus Weber
Due diligence is the term used to describe a business transaction in which would-be investors and stakeholders thoroughly investigate and evaluate a business opportunity before signing onto it.
Standard due diligence components of an investment opportunity involve a review of the type of business, proposed capital stack, financial projections, anticipated rates of return—and, of course, the experience and track record of the principals responsible for carrying out the business itself.
In the context of EB-5 investments, where obtaining a long-term green card is an investor’s top priority (in addition to the return of capital and return on investment), due diligence must include review of additional factors that could jeopardize an investor’s chance of obtaining a green card.
The single biggest factor affecting green card eligibility under the EB-5 category is job creation. Put simply, an EB-5 investor must prove job creation in two phases. To qualify for an initial two-year conditional green card, an investor must first submit to the U.S. Citizenship and Immigration Services (“USCIS”) a Form I-526 (Immigrant Petition by Alien Entrepreneur) showing that the investment will create 10 full-time jobs for U.S. workers.
Thereafter, to convert from the two-year conditional green card to a permanent one, the investor must submit to USCIS a Form I-829 (Petition by Alien Entrepreneur to Remove Conditions) typically showing that the investment has created 10 full-time jobs for U.S. workers (or, in some cases, can be expected to create the 10 jobs within a reasonable time).
Job Creation Due Diligence
Practically speaking, the job-creation-related risks with any particular project are that: it might never get started (no jobs created); it might get started but not be completed (barely any jobs created); it might be completed but underperform (not enough jobs created to cover all EB-5 investors); or it might be completed and perform well, but only after a major delay (jobs not created in time). Therefore, to assess these risks, robust due diligence in job creation is critical in reviewing potential investment opportunities. In the context of an EB-5 project sponsored by a USCIS-designated regional center, job creation must be demonstrated by an economic impact report showing that activity generated by the project will create sufficient jobs to cover the total number of EB-5 investors investing in the project.
Accordingly, an investor should always ask whether the project is supported by an economic impact report prepared by a qualified professional, and whether the total job count stated in the report is adequate (preferably with a “cushion”) to cover the maximum number of EB-5 investors sought. This should merely be the start of the inquiry, however.
Truly meaningful due diligence concerning job creation (in the regional center project context) requires an investor to ask additional substantive questions, including the following:
- What are the financial assumptions (or “inputs”) underpinning the job calculations in the economic impact report?
Most EB-5 economic impact reports predict job creation using an “input-output” model such as RIMS II, IMPLAN, or REDYN. These input-output models typically use projected expenditures or revenues as the financial assumptions (“inputs”) that are entered into the model to calculate the estimated employment impacts of the project.
For example, an economic impact report for a real estate development project would typically project jobs based on both the estimated construction expenditures and the projected operations revenues of the completed facility. The key issue is whether the expenditure and/or revenue projections used in the economic impact report are credible.
Do the economic impact report and other project documents provide a clearly articulated and reasonable basis for the figures? In other words, are the projections realistic and therefore more likely than not to come true? If not, then it does not matter how experienced the economist is, how substantial and polished the report looks, or how substantial the job estimates are; the jobs may only ever exist on paper.
- Are the project’s performance claims supported by a comprehensive market study from a credible independent third party?
Prospective investors must keep in mind that an EB-5 “comprehensive business plan” prepared for a project is essentially a marketing document. It focuses on the best case scenario and makes the case for the ideal outcome. Therefore, although the business plan provides objective facts about a project’s scope, structure, management, and relevant market, it should not be treated as a perfectly objective information source.
Instead, prospective investors should seek out well-substantiated market studies from third parties unrelated to the project, to validate the reasonableness of the performance (and thus job creation) predictions made for a project based on its type, location, market size, etc.
In addition, if the project has been implicitly underwritten by a bank, investment advisor, or underwriting department of a reputable migration agency, prospective investors might have a reasonable basis for increased confidence in the project—although someone else’s due diligence should not be a substitute for the investor’s own thorough due diligence process.
- What is the objectively verifiable track record of the individuals or entities managing the project?
Again, the business plan prepared by a project is largely a marketing document. The management biographies contained in a business plan may be accurate, but they are typically drafted in a condensed format that highlights limited aspects of an individual’s or entity’s background in relatively general terms using buzz words and generic track record descriptions. The point of management biographies is not to give the reader a comprehensive education about all of the parties at the helm of a project but, rather, to give the reader an overall picture that reasonably inspires confidence in the project. It is important, therefore, for prospective investors to independently research the experience, track record, and backgrounds of the managing individuals and entities involved in a project. Do the facts truly inspire confidence that the project will successfully create jobs as planned?
- What progress has the project made to date?
With an EB-5 investment, the timing of job creation is critical. Jobs connected to an EB-5 investor’s investment must typically be created within the investor’s two-year conditional residence period (with certain exceptions).
Therefore, the further along a project is at the time it is seeking EB-5 investor capital, the greater the likelihood that the anticipated project will be completed according to the timeline predicted in the project’s business plan. For example, a real estate development project requires the completion of numerous steps—land acquisition, design, permitting, etc.—before building construction can even begin, and each step is vulnerable to unanticipated delays. If the project has not begun any of these necessary steps, there is a high risk of project delay and untimely job creation. Further, lack of progress frequently reflects a capital shortage, so investors should also ask whether the project has non-EB-5 capital sources that can see it through to completion even if the target amount of EB-5 capital is not raised.
- Does the project realistically have alternate funding sources if it fails to raise the expected level of EB-5 funding or bank financing, or if project costs unexpectedly increase?
To create jobs, a project must have enough capital to cover its costs. Prospective EB-5 investors should examine the capital stack for a project and ask whether the majority of capital needed for the project is already in place. If a project is heavily reliant on EB-5 capital that it hasn’t yet raised, the project may not be viable.
If, on the other hand, developer or owner equity is a significant part of the capital stack, the project can show that other funding sources are in place, and the non-EB-5 funding sources could be adjusted to cover any shortfall in the EB-5 capital raise (e.g., the project has a completion guaranty from a strong partner), the project is more likely to reach completion, meaning that the jobs are more likely to be created.
Why Investors Themselves Must Ultimately Accept Responsibility for Successful EB-5 Due Diligence
Although no amount of due diligence can fully eliminate risk, investors who ask the right questions—and insist on objective and verifiable answers—about job creation will be in a much better position to attain the ultimate goal of a long-term green card.
Most investors are reluctant to pay additional money to qualified EB-5 experts to conduct truly independent due diligence on projects. Also, physical distance, language barriers, cultural differences, and other challenges normally make it difficult for EB-5 investors to conduct project-related due diligence on their own.
At the end of the day, however, only investors themselves control whether to invest their funds in a particular project. Savvy investors therefore leverage that pocketbook control into solid due diligence. They ask migration agents very specific questions about why the agent is recommending this project, what specific due diligence materials the agent is relying on, who conducted the due diligence, and who paid for the due diligence research.
In response to these questions—and in response to the increasing number of project-related failures and other problems—a growing number of migration agents take due diligence very seriously and hire truly independent EB-5 experts to objectively analyze deals before they recommend them to any investors. More and more investors concerned about job creation and other key aspects of projects are also seeking out migration agents who require solid independent due diligence before promoting a project.