“Loan Model” vs. “Equity Model” EB-5 Regional Center Investments
Foreign investors must make an “equity” investment into a qualifying EB-5 program as per the program’s regulations. Loans to a project with the guarantee of repayment do not suffice in the eyes of the U.S. government, a key detail that foreign investors need to know when applying for the EB-5 program.
However, in the scope of the EB-5 program, this has not always been the case. When the EB-5 program was first introduced in 1990, it was commonplace for foreign investors to invest with a “cash down” and a portion in the form of “promissory notes.” USCIS removed this aspect, and has since made it clear that a loan is not to be considered investment.
But it’s not uncommon for many Regional Center investment projects to be structured as a loan in this day and age. Clients who have read a lot of information online about the EB-5 program oftentimes find themselves confused: “If loans cannot be considered as an EB-5 investment, then how are the Regional Centers promising that their project will give them a 1% interest rate with the “loan” repaid in 5 years?”
The answer here is relatively straightforward. The foreign investor is not making a loan to the project, but is instead making an equity investment in a limited partnership created by the Regional Center. The Regional Center then makes a loan to the EB-5 project. Refer to the below graph for clarification.
The EB-5 investor is thus taking on an “equity position” in a debt fund. The EB-5 “loan” is then structured with the Regional Center Company in the above image (the lender) and the Project (the borrower) within the parameters of the EB-5 regulations. Typically this results in a 5-year secured term loan. The provided security is what the borrower can give to cover the EB-5 loan.
This can be related to the project itself, including in the form of the land or business that is being developed, or the expected cash flow from the project. Or it can be unrelated to the project, including as a guarantee by the owner, a parent company or even cross-guarantees. Some projects have even tried to introduce a “third party insurance” that covers the principal of the EB-5 loans.
An “Equity Model” investment has a completely different structure. In this case, the individual investor takes an equity position in the project itself. This is what an individual investor who makes an EB-5 investment into his or her own project in a so-called “direct EB-5” or “stand-alone EB-5,” (which basically means that Regional Center is involved) will be doing.
There are different advantages to both of these models. The reasons for this are rather simple: the investor knows with a certainty the mode and timing of the exit. In an equity-model, after the foreign investor successfully obtains permanent residency (green card), the exit will depend on market conditions.
If the market is on the up, you should sell. If not, you should hold. People who have invested in equity model EB-5s, who may have forgot about it were rewarded with a sizable profit after many years. almost doubling their principal. Some didn’t or couldn’t wait for the market to improve, so they sold early and as a result couldn’t recover the cost of their principal.
At the same time, loan-model investors can expect regular interest payments (generally starting at about 1%) and a specific timetable their principal will be returned. Both the loan-model and equity-models carry the same kind of business risk.
Imagine this: you have $500K and a friend is opening a business. She requires some capital and is offering you the option of 1) loaning her the money she with a promise to repay you in 5 years with some interest or 2) investing in her new company with a promise to repay your investment plus, any additional profits she can share when her company reaches that level. In both scenarios, the possibility of her business failing and her not being able to return the loan or your investment exists.
There are other possible situations you should run through. You have $500K. Your pal John is opening a clothing store and he wants you to lend to him money plus interest. Your friend Taylor is opening a deli and she wants you to invest the money. John is smart, but has no experience in the retail industry. Taylor however has successfully started a previous business and already has operated five delis in the recent past. Considering their experiences, going with Taylor is usually the better answer.
Or maybe John is? What if he already has a successful consulting business, and is eager to secure his loan with proceeds from his existing business? Meanwhile Taylor just liquidated all her assets and gave it all away to a charity, and is now starting on a fresh slate. You can think of an infinite amount of details that could complicate a decision like this. In short, the lawyer’s answer to which model is better, the loan-model or the equity-model, is “It depends.”