By Rupy Cheema
Performing due diligence on any significant investment is important, but because of the immigration aspects of an EB-5 investment, it is critical.
So what is due diligence?
Due diligence is an investigation of an investment prior to signing a contract. It contributes significantly to informed decision making and enables investors to better understand the terms of the deal and the risks involved.
What’s included in a due diligence review?
It begins with a thorough analysis of the Private Placement Memorandum (PPM), the document that defines the deal. The PPM tells you what you are getting and what you are giving. It outlines your rights as an investor and the terms of the deal, including the capital structure (what other entities are investing in this project), the exit strategy (when and how the developer plans to repay you), the job creation potential and the risks involved.
A review of the offering documents typically consumes 20% of my time and the rest I spend verifying the claims made. Here are 12 steps to complete a thorough due diligence review on any EB-5 project.
- Review the Economic Impact Analysis.
Regional center investments rely on an economic model that predicts the number of jobs that will be created, based on capital investment or revenue. If projections come up short, investors may not get their green card. Reviewing the economic study is technical work and you may want to outsource this to a professional EB-5 economist (I do).
Review the project description, budgets and business plan for reasonableness and consistency. Confirm that construction inputs are modeled correctly, are reasonable and align with the investor’s timeline. Inputs from operations should also be reasonable and appropriately deflated before applying multipliers. Review both operations and construction calculations to ensure they were performed properly and are consistent with economic theory.
- Reduce Risks Associated with Construction Completion.
Confirm site control and property entitlements are finalized. Has the developer negotiated a maximum price contract with the contractor and is there a completion guarantee?
If for any reason construction can not be completed, you could lose your money and your visa so confirm the capital stack commitments are in place.
- Protection of Investor Funds.
Use of third-parties should include an escrow account, a fund administrator to oversee transfers of investor funds, construction monitoring to ensure transfers are only made based on construction progress.
Some issuers provide an online portal for real-time transparency as a protection against fraudulent activities going unnoticed. You want protections similar to those of a bank.
- Insurance on the General Partner or Manager.
Directors & Officers (D&O) insurance, asset-related insurance or a fidelity bond mitigate your risk. Also make sure there is a succession plan in place in case something happens to the General Partner or Manager.
- Corporate Governance.
Investor rights are critical and should be outlined in the NCE’s operating agreement. You should know the following:
What is necessary to replace the Manager? What is the form and frequency of reporting to investors? Is the NCE required to have an annual audit? What triggers liquidation of the NCE? How well is reinvestment defined and is a Registered Investment Advisor identified?
Review the management fees and expenses and the priority of management payments. Be clear of any conflicts of interest, especially between the manager (lender) and the developer (borrower).
- Regional Center Review.
Regional centers should oversee the EB-5 investments they sponsor, so I suggest asking them for the written policies and procedures they use to monitor their projects. Also review their designation letter to confirm it is in good standing and review their current I-924A form, which is filed each year with USCIS.
Confirm their designated geographic area to ensure consistency with the impact areas and review the regional center’s history of I-526 and I-829 approvals and denials.
- Financial Conditions of the New Commercial Enterprise.
Determine the financial condition of the entity you’re investing in. While it is a ‘new’ commercial enterprise and manages only one asset, it is still important to establish the expenses and net operating income so you can assess the viability of the NCE and likely preservation of your investment.
- Security Interest and Default Conditions.
Deals sometimes fail! Be sure to know that you have assets as collateral. While all EB-5 investments must be ‘at-risk’, there is no reason to take any more risk then necessary. Good security interests do not affect your ‘at-risk’ requirement.
Who will enforce a default if the NCE and JCE are related? Does the NCE get an opportunity to cure a default to the senior lender in order to continue creating jobs?
- Project Feasibility.
The project’s prospects be spelled out in the market feasibility study. This report should be developed by an experienced firm who understands the industry.
Review the inputs that make up the projections because if these projections come up short, the job creation estimates could also come up short.
Review the business’ financial projections in order to judge by how much the plan needs to go astray before the EB-5 investors are impacted.
- Investor refund policy.
What are the refund conditions in case of I-526 denial and will cash be available to fulfill the commitments made to investors?
- Visit the Site
When you tour the site, arrange to meet with management of both the developer and the new commercial enterprise. Use this opportunity to ask questions from your review of the offering documents.
A site visit helps you learn about the expertise, operations, and staffing of these entities and allows for viewing the current condition of the property as well as developments in the area.
- Background Checks on the Control People
Be sure to look at the employment history, past litigations, bankruptcies, regulatory violations of the people in charge. Background checks are a private investigation into someone’s life and should be performed by a reputable firm. Investigate every person that has access to your money. The backgrounds should not surprise you.
Confidence in your Investment Decision
Selecting the right EB-5 investment is the most important decision an EB-5 investor makes. A good investment is well run, will have better policies and procedures, better investor protections, more justifiable projections, more experienced management and offers investors more transparency throughout the life of the investment.
All of this will improve the chances that you will get what you expect, your permanent green card and the return of your funds in a timely manner.