Welcome back to our special series on Southeast Regional Center, LLC (“SRC”).  In the previous article, we explored certain aspects of many failed projects over the years, particularly those projects that were funded prior to the Reform and Integrity Act of 2022.

What can we learn from those projects?  More importantly, how can we apply those lessons to try and avoid similar negative outcomes in the future?

In this article, we describe a risk management framework that we have used with success over time as a Regional Center.  We recognize that risk management is a dynamic process and can always be improved, but we hope that our fundamental framework provides a useful starting point for investors considering different EB-5 investment projects.

Features of Projects that Help Protect Capital

Before we explore how to mitigate risk, we need to remember that the priority of investment objectives for EB-5 investors is unique and different than traditional investors.  EB-5 investors must preserve and hopefully grow their financial capital, but they must also secure their green card. Therefore, it only makes sense that the most attractive projects are those that limit the financial downside to the greatest extent possible.  

Investors must ask themselves: why take any unnecessary financial risk if I will not be compensated for doing so?

That is why the best EB-5 projects are prepared to handle unexpected business events, prolonged periods of underperformance or missed revenue forecasts.  These types of projects are ready for a “rainy day”.

Having adequate cash reserves at the project level is a first line of defense that investors should monitor.  But the analysis must go deeper. If investors are interested in protecting the safety of their capital, then the ideal project will have several types of downside protection beyond working capital.  

Important examples include:

Real Estate Provided as Collateral for the EB-5 Investment

Virtually every business needs some physical location in which to house at least part or all of its operations.  In fact, one of the uses of EB-5 investment may involve acquiring the real estate or building space necessary to locate the project, its staff, its equipment and more.  Investors are well-protected when the developer pledges the project’s real estate as security for the EB-5 investment.  

– In the United States, such a pledge usually takes the form of a “mortgage,” a “security deed” or “deed of trust” depending on the state in which the project is located.

– The US court system is very well developed and is based on the idea of individual rights, including property rights that are granted when borrowers pledge their property to a lender under a mortgage instrument or similar security instrument. 

– This type of physical, court-protected collateral can greatly enhance the downside protection for an investment

Equipment Provided as Collateral for the EB-5 Investment

Similar to real estate, most businesses also require some sort of equipment or means of production to be successful.  This can take on my forms, but a great example is a factory that uses heavy equipment during its manufacturing process.

Without the equipment, the factory cannot produce, which makes the equipment very valuable.  

– In the United States, if the project developer is willing to provide its equipment as collateral, the instrument that is used is called a UCC Filing.  UCC stands for “Uniform Commercial Code”.

– Just like mortgages, the Uniform Commercial Code and UCC Filings represent a fundamental aspect of property rights that is very well-protected legally by the US court system.

Corporate and Personal Guarantees Provided as Collateral for the EB-5 investment

Investors need to see if the project provides guarantees beyond the physical assets of the business, such as real estate and equipment.  One common type of guarantee is a repayment guarantee, which generally says that under certain conditions, the project will pay back the capital it originally received from the special-purpose entity (the “New Commercial Enterprise”) that funded the project.

– It is extremely important that investors pay careful attention to both the legal wording of the guarantee and the financial health of the person or entity issuing the guarantee.  Almost every guarantee is unique across one or both of those characteristics.

– Strong projects offer multiple guaranties on several levels. For example, if a project is a subsidiary of a larger corporation, then the corporate parent would ideally sign a financial guarantee that promises to protect and return outside investors’ capital if the project fails.

– It is even better if there are executives at the corporate or project level that personally sign the guarantee.  This is sometime rare because, in doing so, that person is staking their individual financial situation on the success of the project by offering their own personal assets to pay back investors if the project fails!

The Golden Ticket:  Diversified Guarantees

The best projects will offer investors guarantees backed by the project’s real estate, the project’s equipment, and by the project’s senior executives that are responsible for the venture’s overall success.  The projects currently sponsored by Southeast Regional Center enjoy all three types of guarantees and therefore provide an enhanced level of financial downside protection. 

EB-5 Investment Due Diligence from Third Parties

Placing USD 800,000 or more in a single investment requires careful consideration, especially if the purpose of the investment is broader than financial return.  That is the exact case with EB-5, and it is why many investors engage third-party due diligence firms to generate a written, well-researched report about a prospective investment’s strengths and weaknesses.  

How do investors go about selecting a third-party due diligence provider?  They need to align themselves with a firm that has their best interests in mind.  Often, this could be an attorney, a CPA or a trusted financial advisor that is already serving the investor in some way. Many times, investors find that such a professional may already be helping on a related EB-5 matter, and in that way the choice can be even more straightforward as long as there are no conflicts of interest involved.

It is important for investors to recognize they may not have to bear the cost of third-party due diligence on their own.  Investors should first ask whether a due-diligence report from a third-party has been generated already.  If so, it is likely that the investor can access that existing report at a cost that is much lower than if they commission a report on their own.  

They might even be able to receive a free copy if the report was commissioned by an agency or firm that represents many investors.  Either way, in this moment in the industry, there are very few good opportunities that do not have an accompanying third-party due diligence report.  And for those deals that do not have one, the question investors should ask, is why?

Southeast Regional Center, LLC works with investors and agents of all sizes from many countries and has always worked to ensure that third party due diligence providers have proper access to the Developer client in order to independently assess the prospects of the project.  Besides providing factual information, SRC is not involved in the composition of the report and the report writers attest to their independence within the report.  Just like a CPA audit, the third-party due diligence report must be free from any impression that the Developer or sponsor has exerted any influence over its findings.  In this way, investors can gain an additional level of assurance in their determination of the project’s merits.

More to Come

To be certain, there does not exist a way to eliminate all sources of financial risk and Developers cannot guarantee with 100% certainty against the risk of loss.  But there are substantial protections that can be provided if the developer is willing to do so.  Investors should be aware that Developers get to choose what they offer in terms of guarantees.  The most successful and safe projects often involve Developers that offer a generous and diversified package of protections. 

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The information provided here is not investment, tax or legal advice. You should consult with a licensed professional for advice concerning your specific situation. 

This article is educational and informational, and items including policy, program structures, financial models, feasibility studies, and other documentation may change without notification. 

Information prepared on electronic media such as PowerPoint, websites, blogs, WeChat, or other methods of delivery are often truncated and summarized to improve readability; details of any financial, tax or legal nature should only be addressed with a trusted licensed professional.