Rupy Cheema: A primary question of due diligence is how the project is going to be funded and whether the capital stack is complete. If the project will be funded in part by developer equity, we look into how much equity is being committed to the deal. Most agents we speak to are looking for a minimum of 30% developer equity.
That begs the question “where is that equity coming from?" and “Is it a cash contribution or is it an asset contribution?” If the developer is contributing land, how are they arriving at the value of the land. Was there an appraisal done? Is the value assigned reasonable and thus is the developer really contributing 30% of the project cost? If the developer plans to contribute cash, at what stage will it be funded? Is the developer providing an additional equity commitment in case the project needs more money or if the EB5 funding does not come in as anticipated.
Part of the project costs may be funded through a secured loan from a bank. Having a senior lender in the deal brings both advantages and disadvantages to the NCE’s investment. The biggest disadvantage is that the NCE’s investment will likely have only junior or subordinate rights or perhaps no rights at all to the collateral and the biggest advantage is that the EB5 investors have an experienced party involved in the deal, one who is going to conduct its own due diligence. The senior lender will want to make sure that the construction budgets are reasonable and the environmental assessment is complete. They will also ensure that any conditions imposed have been satisfied prior to the disbursement of their loan.The senior lender may also have specific ratio requirements; for instance a debt-to-equity ratio would ensure that the developer can only borrow a certain amount of money. They might even have other kinds of debt service ratios that would require the company’s compliance. The NCE may be able to piggy back on the bank’s requirements and impose the same conditions.
With that in mind, EB5 investors should understand that a bank’s due diligence is, of course, for the benefit of the bank, to protect the bank’s funds and they're not looking out for the EB5 investors. If the senior lender is relying on a report, such as an environmental assessment, EB5 investors should ensure that the report protects the interests of NCE as well.
Additionally we review the NCE’s investment terms or loan agreement with the project regarding lockout periods and how they're going to ensure that the investment remains “at risk” throughout the conditional residency period. Does the agreement provide the developer an option to extend the investment term? What are the rates of return during the extension period.
We also like to review construction cash flow schedules and the cash flow model of the project beyond the construction phase. A construction cash flow model presents a projected timeline of the developer's sources and use of funds, which is important, especially if the developer isn’t well versed in raising EB5 funds. I've seen cases where a developer anticipates receiving EB-5 funds within three months of going to market and the construction timeline depends on it, which is typically unrealistic.
Cash flow models also tell us how the financing costs will be funded during the construction and the pre-stabilization phases. Typically an NCE requires the principal to be paid as a ballon payment on maturity, so we need to see if the project company plans to maintain cash reserves or whether net income is being distributed to equity holders.
If there's bridge financing being used, we look at whether it was identified early on and whether the bridge has been spent as anticipated in the business plan, as these items have immigration implications.
These are some of the items we look at regarding EB5 project financing and the capital stack.
Dawn Lurie: I assume that sometimes you have to go back and ask for more due diligence or follow-up, which I can only imagine must frustrate the parties involved. From my own client's perpective, I know they become very frustrated between the timing and the request for additional documents.
Rupy Cheema: That's one of the complications of performing due diligence on very large projects and often the NCE manager doesn't want to ruffle feathers of a reputable developer. This is especially true if we're doing due diligence on behalf of just one investor. The manager really doesn't want to bother busy people, so they ask themselves, "Is it really worth taking up the developer's time?"
Additionally the manager doesn’t want to alarm the developer who might assume there’s a problem. The manager has to manage their relationship with the developer so when we're asking for a lot of information, we can get pushback.
Dawn Lurie: Yeah, we run into that as well, because we represent individual investors. We represent regional centers and issuers, obviously never at the same time, but if we're coming at it straight from the immigration diligence perspective, we’re looking at the project in addition to other aspects. Of course, I know we're talking about the project’s due diligence, but there are all different types of due diligence.
From an investor's perspective, we need due diligence not only on the project, but on the regional center, the principals. We even want to look at the qualifications of the various service providers and vendors such as who the economist is, who wrote the business plan. I assume, Rupy, you are also looking at that and it's not just project due diligence?
Rupy Cheema: Right. We're looking at due diligence on two entities. One is the project and the other is the management of the fund, the NCE.