Business owners throughout the United States are still finding it difficult to finance development and expansion of their business, almost three years after the start of the Great Recession in September 2008, and weak job creation continues to be a major factor holding back the economic recovery. U.S. business owners are looking for new sources of financing, at the same time as the U.S. government is looking for ways to promote new jobs.
Meanwhile, on the other side of the world, more Chinese and other Asian investors are seeking to emigrate to the United States. As a result, a little known immigrant investor program, designated as Employment-Based Visa Category 5, or “EB-5,” by the United States Immigration and Citizenship Services (“USCIS”), is gaining increasing interest among U.S. business owners as a potential new source of financing. It has been estimated that the EB-5 visa program could result in a total of $1.25 billion in new financing to U.S. businesses in 2011, and even greater amounts in future years.
According to the 2011 China Private Wealth Study issued by China Merchant bank and global management consulting firm Bain & Company on April 19, 2011, the number of Chinese with investable assets of more than $1,500,000 is projected to rise to 585,000 in 2011. The same study indicates that 60% of China’s multimillionaires are considering becoming or have already become immigrant investors.
These two factors – the lack of investment in the U.S. and the demand for U.S. visas in China – have combined to create a recent surge in U.S. business owners seeking financing from Chinese investors through the EB-5 investment program.
This article provides some background information regarding the EB-5 visa program, with a focus on the information most relevant to business owners seeking financing, followed by an explanation of the basic requirements necessary for a business owner to qualify to receive financing through the EB-5 investment program, and a discussion of some of the key legal issues that apply to business owners who raise financing through the EB-5 investment program.
Background Information on the EB-5 Immigrant Investor Program
Creation of EB-5 Program. The EB-5 visa category was originally created in 1990 for foreign nationals who invest in a new commercial enterprise that will benefit the U.S. economy and create at least 10 full-time jobs. Congress set aside 10,000 immigrant visas annually for investors and their immediate family members under Section 203(b)(5) of the Immigration and Nationality Act (“INA”) (8 U.S.C. 1153(b)(5). The EB-5 program thus generates capital investment in the U.S. for businesses that will generate new jobs.
Statutory Requirements for EB-5 Visa Eligibility. Sec 203(b)(5)(C) of the INA provides that in order to qualify for a visa, an immigrant investor must invest a minimum of $1,000,000, except that, in areas designated as “targeted employment areas” the minimum investment is $500,000. Federal regulations defined a “targeted employment area” as a rural area or an area that has experienced an unemployment rate of at least 150% of the national average rate (8 C.F.R. 204.6(e)). Since most EB-5 investors prefer to invest at the $500,000 level, most projects funded through the EB-5 program are located in targeted employment areas.
Historic and Potential Growth of EB-5 Capital Investment. If all 10,000 immigrant visas available under the EB-5 program were issued annually at the minimum investment level of $500,000 per visa, it would generate additional investment capital in the U.S. of $5 Billion. However, only a fraction of the available visas have been issued each year since the program began in 1990. According to statistics published by the USCIS on June 30, 2011, a total of 1, 955 EB-5 visas were applied for and 1,369 visas were issued under the EB-5 program in 2010, the highest number by far compared to all prior years. For the first two quarters of 2011, 1,601 EB-5 visas have been applied for and 407 EB-5 visas have been issued. The IIUSA, a trade group for the EB-5 investment program (which we will talk about more below), estimates that the EB-5 program could generate $1.25 Billion in capital investment in the U.S. in 2011, and even greater amounts in future years.
Requirements for Businesses to Access EB-5 Financing
There are four basic elements required for an EB-5 investment: (1) an investment of capital, (2) in a new commercial enterprise, (3) in which the investor is either engaged in management or a limited partner; that (4) creates at least 10 new, permanent full time jobs in the U.S. These three elements are further described below:
Investment of Capital. An investment of capital may include cash and cash equivalents, equipment, inventory, and other tangible property, but generally, a business owner will prefer that the investment is made in cash. The capital invested by the EB-5 investor must be “at risk” in the enterprise, and the most typical way that the investment is made is through the purchase of a limited partnership interest in a limited partnership formed for the purpose of aggregating EB-5 investments in a single entity to be used for a single project. The investor cannot be guaranteed a return of capital, or that the investor will receive some value regardless of the success of the enterprise, according to a precedent decision, Matter of Izummi 22 I&N 169 (Assoc. Comm’r, Examinations 1998). The same precedent decision held that the entire minimum capital investment (i.e., the entire $500,000 in a targeted employment area or $1,000,000 outside of a targeted employment area) must be invested in the enterprise, and cannot be used for administrative expenses or to fund reserve accounts for the enterprise.
New Commercial Enterprise. Section 203(b)(5) of the INA requires that capital be invested in a “new commercial enterprise,” but Regulation 204.6(e) defines “new” as any business formed after November 29, 1990. Even businesses formed before that date can qualify for the EB-5 investment program if they can demonstrate substantial reorganization or restructuring, according to a precedent administrative decision entitled Matter of Soffici, 22 I&N 158 (Assoc. Comm’r, Examinations 1998). Beyond this precedent decision, however, there is very little authority regarding what would qualify as a substantial reorganization or restructuring, which means that businesses formed before November 29, 1990 would need to do some further analysis to determine if they might be able to demonstrate a sufficient level of reorganization or restructuring after that date to meet the requirement of being a “new” commercial enterprise.
Management or Limited Partner Requirement. Regulation 204.6 requires that an investor demonstrate that he or she is or will be engaged in the management of the new commercial enterprise, either through the exercise of day-to-day managerial control or through policy formulation, as opposed to maintaining a purely passive role. The one exception to this requirement is if the investor is a limited partner and the limited partnership agreement provides the investor with certain rights, powers, and duties normally granted to limited partners under the Uniform Limited Partnership Act. Most EB-5 projects use a limited partnership or limited liability company model, rather than giving management rights to the EB-5 investors.
New Permanent, Full-Time Jobs. From a business owner’s perspective, the most important requirement for EB-5 financing is that every EB-5 investment must generate at least 10 new, permanent, full-time jobs, as required by Section 203(b)(5) of the INA. In other words, for every $500,000 invested in a project located in targeted employment area, or $1,000,000 invested in a project outside a targeted employment area, at least 10 new jobs must be created as a result of the investment. The key elements necessary to meet this requirement are as follows:
New Jobs. For an investment to qualify under EB-5, the capital invested by every EB-5 investor in the project has to create jobs that did not already exist in the enterprise. This means that capital cannot be used for purposes that don’t create new jobs, such as buying an existing business without adding new employees, buying equipment, or paying off an existing loan on a business. New jobs typically require that there be a new business created, or a new building built, in order to show that new jobs are created. There is one exception to this requirement, which applies to an investment in a “troubled business,” defined in Regulation 204.6 as a business that has been in existence for at least two years, and that has incurred a net loss for accounting purposes (determined on the basis of generally accepted accounting principles) during a twelve or twenty-four month period, where the loss is at least equal to 20% of the troubled business’s net worth prior to the loss. An investment in a troubled business is required to show that 10 jobs were “saved” (as opposed to created) for every EB-5 investment.
Qualifying Full Time Jobs. As defined under Regulation 204.6, an EB-5 project must create jobs for United States citizens, lawfully admitted permanent residents, or other immigrants lawfully authorized to be employed in the United States. This does not include the alien entrepreneur or his or her spouse, sons, or daughters, or any nonimmigrant alien. In addition, ever job must be a full time job, defined as a minimum 35 hours per week. Job sharing is permitted, but combinations of part time jobs do not qualify.
Permanent Jobs. Although not specifically required by the statute or regulations, the USCIS takes the position that the jobs created by EB-5 financing must be permanent, rather than temporary or seasonal jobs. For this reason, construction jobs are typically not counted by the USCIS as qualifying jobs. For example, the U.S. District Court for the Eastern District of California held that the administrative officer did not abuse his discretion in construing full-time employment to mean continuous, permanent employment. Spencer Enterprises, Inc. v. United States, 229 F. Supp. 2d 1025, 1039 (E.D. Calif. 2001) aff’d 345 F.3d 683 (9th Cir. 2003).
Direct Jobs Versus Indirect Jobs. A key concept for business owners seeking EB-5 financing is to understand that, unless the financing is done through a “Regional Center” (of which there is more explanation below), the entity in which the EB-5 investment is made must directly employ all of the employees in the project. Regulation 204.6 defines an employee as ” an individual who provides services or labor for the new commercial enterprise and who receives wages or other remuneration directly from the new commercial enterprise. Independent contractors are specifically not counted as employees under this definition. However, when an EB-5 financing is done through a Regional Center, Regulation 204.6 defines an employee as an individual who provides services or labor in a job which has been created indirectly through investment in the new commercial enterprise. For example, if a shopping center is built with a direct investment of EB-5 financing, only the direct employees of the entity in which the EB-5 financing is invested will be counted – not the employees of all of the tenants in the shopping center. However, when the EB-5 financing is made through a Regional Center, then all of the employees of the tenants in the shopping center can be counted, along with any other employees who provide goods and services to the shopping center. Therefore, the use of a Regional Center has a multiplier effect on the number of jobs that can be counted for purposes of EB-5 financing.
Requirement to Prove that Jobs Were Created. Business owners need to understand that the EB-5 investors who invest in their projects will be required to prove to the USCIS that the projected number of jobs were actually created by the project. Every EB-5 investor is required to file an application, two years after the investor receives a conditional visa, to have the conditions removed. At that time, the investor must file documentary evidence with the USCIS that at least 10 new jobs were created for every EB-5 visa issued to an investor in a project. Unless the investment is done through a Regional Center (which is further discussed below), every investor will need to provide relevant tax records, Forms I-9, or other similar documents for at least ten (10) qualifying employees who is then employed at the project.
Regional Centers – the Preferred EB-5 Financing Vehicle
In 1993, the U.S. Congress adopted a pilot program that set aside 3,000 of the 10,000 visas under the EB-5 visa category for issuance to investors in so called “Regional Centers,” The pilot program was established as a temporary program, and is currently set to expire on September 30, 2012, although there are bills currently pending to make the pilot program a permanent part of the EB-5 investment program. Most importantly, the Regional Center allows the counting of indirect jobs created through EB-5 investment, which dramatically increases the amount of capital that can be raised through an EB-5 financing. Regional Centers have become the dominant form of EB-5 financing, according to statistics compiled by the USCIS, which show that between 90% and 95% of all EB-5 visa applications are filed through a project sponsored by a Regional Center.
What a Regional Center Is. A Regional Center is any entity, public or private, that, according to Regulation 204.6, is formed for the purpose of promoting economic growth to a specific geographic region through increased export sales, improved regional productivity, job creation, and increased domestic capital investment. There are currently almost 150 approved Regional Centers in 39 states, and approximately 80 applications for new Regional Centers pending. Anyone can create a Regional Center, even in an area where one or more Regional Centers already exist. The geographic area covered by a Regional Center can be a city, county, or group of contiguous cities or counties, and in a few cases, an entire state. A business owner could form his or her own Regional Center to raise financing for one or more projects within a defined, contiguous area, but the processing time for Regional Center approval from USCIS is approximately 9 to 10 months, so many business owners prefer to negotiate with an existing Regional Center to sponsor their project.
How a Regional Center is Formed and Approved. A Regional Center is required to file an I-924 application with the USCIS, and to provide detailed evidence showing v how jobs will be created indirectly through increased exports, the amount and source of capital which has been committed to the regional center, as well as a description of the promotional efforts taken and planned by the sponsors of the regional center, and a detailed prediction regarding the manner in which the regional center will have a positive impact on the regional or national economy in general as reflected by such factors as increased household earnings, greater demand for business services, utilities, maintenance and repair, and construction both within and without the regional center. In practice, a Regional Center files a detailed business plan describing the industries and specific projects that the Regional Center intends to pursue through EB-5 financing, and a economic report showing the numbers of new jobs that the projects will create in the designated region.
How Regional Centers Count Jobs. Regulation 204.6 allows a Regional Center to use economically or statistically valid forecasting tools, including, feasibility studies, analyses of foreign and domestic markets for the goods or services to be exported, and/or multiplier tables. There are several different input/output models accepted by the USCIS, but the two major ones are IMPLAN and RIMS II. Either of these methods can be used, and a Regional Center will typically have the model prepared by an economic consulting firm.
How Regional Centers Prove Jobs Were Created. Regional Centers are required to present proof that they fulfilled their business plan, but the type of proof is significantly different than would be presented for an EB-5 financing without a Regional Center, where the only proof required and accepted is tax records of direct employees. A Regional Center, on the other hand, is required to show that the project was consistent with the inputs used to create the model. In a model that uses the RIMS II model, for example, the Regional Center would be required to prove that the actual construction expenditures, and the actual total amount of gross (top-line) revenues used to create the projected number of jobs, have actually been achieved.
How a Business Owner Raises Capital Through an EB-5 Financing
A business owner seeking to raise capital for a business project will generally take the following steps to obtain EB-5 financing:
1. Determine if the project has the necessary characteristics to successfully raise financing through the EB-5 program. This will require an analysis of the project to determine that it will generate the necessary new jobs to qualify for EB-5 financing, and a determination of whether the project is in a targeted employment area.
2. Contact one or more Regional Centers. The business owner should contact one or more of the Regional Centers that are already approved in the geographic area where the project is located, and discuss the terms upon which the Regional Center would agree to sponsor the project. Terms are subject to negotiation and vary widely among Regional Centers. Also, it is prudent to perform a background on the individuals sponsoring the Regional Center, to determine their experience and reputation in the EB-5 investment community.
3. Contact one or more Marketing Agents in China. Some Regional Centers provide marketing as part of their sponsorship of an EB-5 financing, but that is not always the case. Even if the Regional Center does offer to provide marketing, depending upon the size of the project, it may be in the business owner’s best interests to market through several agents in China. The business owner will need to discuss the fees that will be payable to the marketing agents, as well as when the fees will be paid. In general, marketing agents are not paid until the business owner receives financing from the EB-5 investors.
4. Prepare offering documents for the EB-5 financing. Since most EB-5 financings are done through limited partnerships or limited liability companies, EB-5 financings involve the sale of securities, and must meet the same requirements as other offerings of securities. In general, EB-5 offerings are made in reliance upon Securities and Exchange Commission Regulation D (for private offerings of securities) and Regulation S (for offshore offerings of securities outside the U.S.). The business owner typically prepares a private placement memorandum, limited partnership or limited liability agreement, and subscription agreement for the EB-5 offering.
5. Negotiate with any other financing source any conditions that will apply to the EB-5 portion of the funds. This could require negotiation with the business owner’s bank or equity sources. Typical issues include conditions of repayment of the EB-5 financing, security for the EB-5 financing and guarantees of repayment.
6. Prepare the offering for sale in China. The Regional Center or lead marketing agent will generally assist the business owner with translation of the offering documents into the Chinese language.
7. Market the project in China. The marketing agents will coordinate with licensed emigration agents in China to market the offering to Chinese investors. This process can take from two to six months, depending upon the size and characteristics of the offering.
8. Obtain subscriptions for the limited partnership or limited liability company interests and commence the EB-5 visa process for each investor. Each EB-5 investor will generally sign a subscription agreement, place the full amount of their investment in escrow, and commence the immigration process by filing an I-526 visa application through a U.S. immigration attorney. Although not required, it is typical that the investor funds will remain in escrow until the investor obtains approval for the I-526 visa, which may take approximately five months. The I-526 visa is a conditional visa that is good for two years, after which each investor must file for a permanent visa.
9. After the project is completed, provide the documentation for investors to obtain permanent visas. Every EB-5 investor will be required to file an I-829 visa application for removal of conditions within two years of the date that the investor obtained a conditional visa. At that time, the investor will be required to prove that the conditions under which the project was approved as an EB-5 investment have been met. That will require that the business owner provide evidence that all material terms of the business plan used to demonstrate the creation of new jobs were met. If the conditions were met, the investors should then obtain permanent visas. If the business plan was not materially completed for any reason, the investors will lose their conditional visas, and will be forced to leave the U.S. With this penalty for investors, it is easy to understand why EB-5 investors want to receive as much assurance as possible that the business owner has the means and a demonstrated track record of completing projects before they agree to invest in the project.
The EB-5 financing program may provide some business owners with an alternative source of financing for projects that will create new jobs in the United States. Not every project will qualify, or have the characteristics necessary to appeal to EB-5 investors, but business owners should consider whether their project will qualify. The potential amount of financing available through the program, particularly from Chinese investors, makes the EB-5 financing program one that every business owner will want to consider.
Catherine DeBono Holmes is the chair of JMBM’s Investment Capital Law Group, and has practiced law at JMBM for over 30 years. She specializes in EB-5 immigrant investment offerings and hotel and real estate transactions made by Chinese investors in the U.S. Within the Investment Capital Law Group, Cathy focuses on business formations for entrepreneurs, private securities offerings, structuring and offering of private investment funds, and business and regulatory matters for investment bankers, investment advisers, securities broker-dealers and real estate/mortgage brokers. Contact Cathy at CHolmes@jmbm.com or 310.201.3553.