This is Part 2 of a two-part blog post addressing the intense debate which was waged on many LinkedIn groups recently. If you are relatively new to EB-5s and need to understand the exact difference between Direct EB-5s and Regional Center EB-5s, please read Part I first.
The following are my thoughts on the arguments for Direct EB-5s and against Regional Center EB-5s that were posted on the LinkedIn EB-5 groups. (Italics are from this post).
1. Argument re: Loss of Capital: “It is almost unheard of that an investor in a Direct Investment has seen a loss of capital. In cases of Regional Centers, it is quite common for investors to experience capital erosion of between 5 to 100%.”
As a starting point, I would like to point out that there is no way anyone can get accurate data to make the above claims. Because the USCIS only started systematically collecting Regional Center data at the end of FY2011, the public has no access to the I-526/I-829 approval or deny records of any Regional Center. As to investment return track record, it is anybody’s guess. So when Regional Centers boast a 100% track record, you have to kind of take them at their word.
In addition, the bulk of Regional Centers were formed beginning 2008/2009. Currently there are over 200 Regional Centers, while as of June 2010 (which is the oldest USCIS statistic I can find right now), there were 94. Considering that Regional Center investments are not returned for five to six years, even if the first round of new Regional Centers established in 2008 flooded the market with projects as soon as they were approved (which they didn’t), that was only 4 years ago, so it is pretty early to be making sweeping (“quite common”) and weirdly specific (“5 to 100%”) statements about the return of capital.
As for Direct Investments never losing capital, that again, is a statistic nobody keeps. But that statement doesn’t sound too accurate as it implies new businesses never fail or lose money. I wouldn’t be surprised, however, that EB-5 Direct investments as a group have better success rates than generally established new businesses, as the owners probably manage them very conservatively, so as not to lose the opportunity to get the conditions removed on their greencards. (Assuming it is the investor owner that is managing the company. There seems to be a slow but steady emergence of “institutionalized Direct EB5s” (I made up that term) where entities are acting as intermediaries, similar to regional centers, and connecting investors with Direct EB-5 opportunities. Or, the investor may simply be taking a minority stake in a company managed by someone else.)
2. Argument re: Dividends: “Most regional centers do not pay out dividends. and those that do pay dividends are usually in the low single digits in RC’s, while investors usually get double digit returns for Direct Investments. This means that at the very least, investors in direct investments get between 2 to 8 times higher profits when compared to Regional Centers.”
It is true that Regional Centers pay little, if any, distributions to its members. (I assume that the writer meant distribution as regional centers are not corporations.) And in the case of loan products, the interest rates are very low as well. (To understand the difference between equity based and loan based EB-5 projects, see here.) Whether investors who invest in direct projects “usually” get double digit returns, is up for debate.
3. Argument re: Exit Strategies: “It is quite easy to sell a business on the open market or even take it public. It is quite hard to sell shares in a regional center, and most regional centers require the investors to use their affiliates to sell their shares, which means an added cost of 3-10% when exiting.”
Off the bat, let me just say taking a business public is a very rare and expensive endeavor. (You don’t have to be a former securities lawyer like me to know that.) Whether an investor can sell their EB-5 business quite easily depends on how well the business is doing and what the market conditions are at that point in time.
I agree it is quite hard to sell a regional center interest (not shares, again, because regional centers are not corporations and what the investor is obtaining through the investment is interest in a fund (either a limited partnership or limited liability company). Regional center interests are restricted securities, meaning that there are heavy transfer restrictions. In addition, there is no market for these securities because, in a way, the main “return” on the investments come in the form of a greencard. Regional Centers EB-5s have evolved from the equity model to the loan model to address this issue. (Again, see link in #2 above for a discussion on the difference between the two.)
4. Argument re: Loss of Certification: “It is quite common for regional centers to lose certification, and quite unusual for direct investments to lose certification.”
As of today, there is only one regional center that has lost its certification. (Which is not to say, more will not in the future if managed badly.) Direct investments are not certified in any form by the USCIS. You either create the jobs or you don’t. Mismanagement of the business will result in the investor not obtaining the permanent greencard.
5. Argument re: Fraud: “Many cases have surfaced where regional centers were found to have defrauded investors. As a matter of fact, the NYTimes.com article below clearly says EB-5 programs are rife with fraud and corruption. http://www.nytimes.com/2012/04/16/opinion/reform-the-eb-5-program.html”
There is no doubt that the EB-5 program needs better supervision. At the very least, it needs some sort of an EDGAR-like system where potential foreign investors can gain access to relevant data points. And I am sure there are misstatements galore and even instances of fraud involved. But to say that because there is fraud in regional center projects, all people working in regional center projects must be frauds (which is the gist of the accusations hurled around on LinkedIn) is like saying there are securities fraud on the stock market so anyone involved in public companies are guilty of fraud.
(I must admit that I’m a bit disappointed in my beloved New York Times publishing such a lazy opinion piece. The opinion piece that makes claims that the EB-5 program is “rife with fraud and corruption” without any supporting evidence (although I am the first to admit that there is no place to obtain such evidence; but the writer could at least have made the effort to have one egregious case study of an individual investor or bad-behaving regional center!) with a poorly crafted conclusion to just “fix it”.)
For the interest of full disclosure, I would like to state that I have a regional center application pending (in the USCIS’s RFE blackhole) while I earn a living filing petitions for immigrant investors that want to obtain a greencard through Regional Center EB-5 investments. I also work with businesses that are interested in establishing regional centers or working with existing regional centers. That said, I also assist investors with their Direct EB-5 petitions who want to run their own business (or invest in a Direct EB-5 by taking an equity stake in somebody else’s business). In fact, I am going to a construction site next week to take pictures of a restaurant that is being built that my client is investing in. (I could have asked for the pictures to be send via email, but I wanted to see it for myself and also talk to the owners who are receiving the investment.) I’m also going to Korea at the end of this month on be
half of a client who is receiving Direct EB-5 investments so that I can meet his investors and explain the EB-5 process.
So which is better? I will have to give the quintessential lawyer’s answer, which is: IT DEPENDS. Then what does it depend on? That will be the topic of my next few posts.