By Echo Meisheng King
Although the lion’s share of EB-5 projects are comprised of hotels, shopping malls, apartments, office buildings and other integrated construction projects, some investors have started to express interest in restaurants, especially chain restaurants. Restaurant projects can be divided into two categories: regional center projects and direct equity participation investment projects (“direct investment restaurant projects”). This article focuses on EB-5 direct investment restaurant projects, and touches upon the advantages and disadvantages of this type of project compared to other construction projects. Important matters in direct investment restaurant projects in non-regional centers are also discussed.
Advantages of using EB-5 direct investment in restaurant projects
Restaurant projects are unique compared to other projects and are more advantageous in many ways. Some advantages are listed below:
- Short construction time. Land purchasing, project planning, design engineering, and licensing for many large-scale projects are incredibly time-consuming processes. Depending on the location of the project, the preparation time normally starts a year or even three years before the actual construction can begin. The construction itself is a long process, and generally takes two years to complete. In a restaurant project, the general investment for each restaurant is under $2 million, and many only require as little as $10,000 in total. In comparison with hundred million-dollar construction projects, restaurants are definitely smaller in scale. Preparation time is shorter, and construction can be completed in as little as six months. And, since construction time is greatly reduced, there are fewer uncertainties that arise during the construction process.
- Substantial cash flow. Sufficient cash flow provides at least two advantages to the EB-5 investors: repayment time and return on capital. Normally, the majority of the investor’s capital comes from joint venture company loans given to developers for large-scale construction projects within general regional centers. In reality, each investor's return on capital is only 0.5 percent to 1 percent per annum or less, so cash flow of the project does not have a direct impact on the investor’s return on capital. In fact, if there is a good amount of cash flow for a project, it could bring gains to the principal amount invested upon the maturity of the loans. Regardless of whether the cash flow aids the developer in repaying the loan, or if the developer chooses to refinance from a bank or third party developers to repay the loan, adequate cash flow in essence is an assurance of repayment. Large-scale construction projects require long preparation and construction times, and the operating revenue for such projects rely heavily upon mall rentals, hotel guests, apartment rentals, or other revenue sources. Cash flow will not start generating for several years. Therefore, restaurant businesses that can start to operate within a year after construction will have fewer delayed cash flow issues. Investors involved in direct restaurant investment projects anticipate a return on investment within the first year. Take this hypothetical case: Mr. Zhang and Mr. Lee invest in the ABC Hamburger chain restaurant, and each store involves a total investment of $1.2 million. Mr. Zhang and Mr. Lee each invest $500,000, and developers invest $200,000. The three parties collaborate for the development of the hamburger chain, while the developer conducts management of operations. Hypothetically, Mr. Zhang and Mr. Lee each hold a 10 percent stake in the restaurant, and if the restaurant’s net profit margin is 25 percent then the two investors are expected to achieve annual revenues of $30,000 respectively. If their investment period is seven years, minus the first year of preparation and opening, each of them is still expected to reach $180,000 in return on capital within the investment period. This type of return would not be possible in regional center-related projects.
- No priority/senior loans from the bank. Restaurants are generally a joint venture by the developers and investors, with no interventions from a bank. In the case of liquidation, investors generally enjoy preferential rights in project assets that guarantee the return on their principal capital. Since there is no confusion related to subprime lending or mezzanine loans, it is much easier for investors to review the capital structure of the project. Naturally, there is another way of looking at the presence or absence of senior loans. Banks that provide senior loans for EB-5 projects conduct rigorous investigations on projects, so investors can have increased confidence for the project.
- Sufficient employment. Whether it is direct investment or a restaurant project within a regional center, restaurants can create enough employment opportunities to satisfy the requirements of the EB-5 project. Since restaurant projects are labor-intensive, there is a need to hire a large staff, and other jobs generated by developers. Many projects can easily fulfill the $500,000 investment requirement and generate 10 direct jobs (full-time employees or positions). Therefore, the projects do not have to calculate indirect employment or be located in a regional center. Using the previous example again, Mr. Zhang and Mr. Lee each invest $500,000 in the ABC hamburger restaurant and the developers invest $200,000. If the restaurant can reach a combined total of 26 full-time employees, then the two investors will each have 13 direct jobs. The two investors will also share the jobs created by the $200,000 investment from the developer. Additionally, There are also employment advantages for restaurant projects in regional centers. When using the same investment amount, due to the relatively high employment multiplier in restaurant projects for calculating indirect employment, calculating the employee amount within the restaurant business is much simpler than in construction projects.
- Simple subscription and less risk if the project launch fails.The monetary amount required to open a restaurant is generally less than $2 million. Because project developers also partially contribute funds for the project, each restaurant only requires one or two investors. In comparison, large-scale construction projects require a large sum of funds, which often results in a great number of investors offering to purchase, or subscribe, the location before the project begins. This type of subscription could potentially increase the likelihood that the project will fail to launch. Subscriptions for restaurant projects can be divided into three models, using the previous example to demonstrate:
- Direct investment for a single restaurant. The ABC hamburger restaurant investment is $1.2 million, which only requires Mr. Zhang and Mr. Li, the two investors to invest in order for the restaurant to open and operate.
- Fund structure through a regional center. Fund companies provide up to 20 investors, offering loans to developers to construct up to 10 ABC hamburger restaurants. Every restaurant needs $1.2 million and two investors; if they end up having four investors, then they can only open two burger stores. Using fund companies, the investors do not need to recruit 20 people for the project to launch. There is less risk because there is no scramble to find more investors.
- Direct investment funds structure. The ABC hamburger restaurant developers anticipate and the need for 20 investors to build 10 ABC restaurants. This business model is similar the regional center model in terms of recruitment and structure, except that each restaurant must be a wholly-owned subsidiary of the funds company. Therefore, the fund managers must be the developers. Another difference is the employment calculation between direct investment fund structure and the regional fund structure. The former can only calculate direct employment, whereas the latter can calculate indirect employment and the creation of more employment. Regardless of the type of restaurant project, the subscription model is always simple. Taking the ABC hamburger restaurant as an example, only two investors are needed to build a restaurant. Therefore, the possibility of having insufficient investors for the project is very small.
- The economic climate has little impact on restaurant projects. Restaurants are not very affected by the general economic climate. Even when the economy is slow, the restaurant business is still relatively stable. On April 15, 2015, the news organization Bloomberg published an article stating that according to the data provided by the U.S. Department of Commerce, in March 2015 Americans consumed more in restaurants and bars than in supermarkets for the first time in history. On the other hand, if the U.S. economy experiences a downturn, high-end hotels and office building projects will suffer. As the commercial and tourist population falls, there will be a large reduction in the hotel occupancy rate, and there will be difficulties in renting offices.
- Demonstrating employment is simple. According to relevant laws, regulations and EB-5 immigration memorandums, each EB-5 investment must create at least 10 jobs and a direct investment must lead to direct employment. Regional center projects calculate direct and indirect employment as well as job creation. The jobs must be fully created within the two years after a conditional green card is obtained. Under some circumstances, USCIS also approves employment generated outside this two-year time span, as long as the job creation is completed within a "reasonable timeframe.” The business plan for direct investment restaurant projects is even more straightforward. Employment in such projects is based on the number of workers directly employed, rather than those in regional centers where job creation is based on economists’ prediction using a variety of complex numbers and formulas. The painless method of calculation in direct investment restaurant projects is easy to understand for both the investors and USCIS. It’s reasonable to assume that the approval process would be easier with the USCIS, especially with many successful examples in the chain restaurant model. However, approval is never completely guaranteed.
Disadvantages of using EB-5 direct investment in restaurant projects
Now that we’ve explored advantages of using the restaurant project type, let’s look at the disadvantages of direct investment in restaurant projects.
- Can employment continue to the I-829 stage. Immigration laws state that the employment created by the investment should be completed "within a reasonable timeframe.” In May 2013, a USCIS memorandum explained that a "reasonable timeframe" is within two and a half years after the submission of the I-526, or within the last year of the investors’ conditional green card (within one year before the I-829 application). This memorandum was produced before there was a regression in immigration visas in China, and when the I-526 approval time was roughly six months. This is the reason for the stipulated two-year and two-and-a-half year timeframe. The latest immigration draft memorandum issued in August 2015 was aware of the previous memorandum’s limitations, but due to the uncertainty of whether the regression would improve, the newly drafted memorandum did not make changes in regards to this issue. What influence does this employment time have on the project? Real estate development projects in some regional centers can satisfy all (or most) of the employment needs relying solely on the amount of project expenditures, as long as the expenditure budget is in accordance with the original business plan. Therefore, the employment during I-829 phase and the operations of the project should not be the focal point of the assessment. Thus the visa regression or reasonable time calculation should have no effect on such projects. A restaurant must hire all of its employees straightaway before they can open, (the manager, chef, kitchen helper, dishwasher, waiter, etc.); therefore the required staff must remain employed from the opening of the restaurant to within one year of submitting their I-829. The standards for operating a restaurant are much higher now because the I-829 visa is prolonged in China due to regression. The USCIS draft memorandum in August 2015 liberally interpreted this point, claiming that if employment is considered to be permanent at the beginning, even if the job does not last two years, it will still be counted as permanent employment. But how this should be analyzed in direct investment restaurant projects is awaiting further discussion.
- In EB-5 direct investment restaurant projects, the company constitutes a general equity rather than the loans. In many restaurant projects, the company consists of investors that fulfill the EB-5 investment requirements, and each will buy a stake in the restaurant, participate in dividends, and become limited investor members. Then after five or seven years, according to the agreement provisions and the subscription documentation, some investors may choose to retain investment in the equity of the project, whereas other company managers may buy back the shares at market price. In real estate development projects, the vast majority of loans are in the market system. A set of EB-5 investors and the general partners of a limited partnership will provide loans to developers, and developers will repay the company after five to seven years. This ensures the repayment of investors in the event of the dissolution of the company. Such loans are very popular among investors because the repayment period is clear, as is the repayment amount. In case of a direct investment in a restaurant, it is advisable to review the terms of the subscription carefully, ensuring that within the document the investor’s right to be priority for repayment during the liquidation is protected.
- Record of employment during the I-829 phase. For real estate development projects in regional centers, especially those that have already calculated expenditure employment, the information to submit during the I-829 phase is straightforward. All they need to prove is that the basic expenditure has been generated. But in direct investment restaurant projects, eligible employment payrolls and tax forms need to be provided in the I-829 stage. Recording all of this can be rather complicated, and it is important to urge developers to maintain good employee records.
- The power of the developer. Since opening a restaurant does not require a large amount of capital, some restaurant projects are not necessarily established by powerful developers. Under such circumstances, in addition to verifying the history and potential development of the food brands for the restaurant, the strength and experience of the developer needs to be considered. It is most ideal to choose experienced brands and a developer that can be a strong partner.
- Limited project sources. The majority of projects on the market are regional center projects, and there is an especially large amount in real estate development. For various reasons, intermediaries generally do not get involved in EB-5 direct investment projects and investors suffer limitations in the choice projects. According USCIS statistics, all direct investment projects account for only 10 percent to 15 percent of all EB-5 projects. Due to the fact that there is no large-scale publicity by intermediary agencies, the general direct investment restaurant projects are limited to family businesses in the United States. But family owned restaurants are not necessarily the best projects for EB-5 investors, and there is no guarantee the family members are qualified to partake in the business. Since there are only a few choices for investors, not many people choose direct investment because communication is ineffective. Due to the lack of marketing, many credible chain restaurants cannot recruit investors, and investors cannot get enough information on the restaurants. To remedy this, investors could get in touch with the U.S. Chamber of Commerce and law firms to better understand the options and channels available for them.
EB-5 direct investment restaurant projects in fact have many advantages, especially those with good reputations. If it has a good operating history, experienced developers, clear subscription documents and repayment terms, and complete record of employment, then these projects not only enjoy green card security, but the project generates a decent return. It may be a good choice for investors in addition to real estate development projects. Naturally, there are many limitations in executing restaurant projects. In direct investment projects, success is incumbent upon the independence and uniqueness of each restaurant. Even with successful branding of the chain restaurant, each restaurant’s operating experience and location will directly influence the success of the project. Investors must be cautious when choosing this type of investment.