By Hermione Krumm, Esq.
Real estate technology or PropTech is the new wave in the real estate industry. In 2017 alone, venture investors deployed over $12 billion globally in PropTech start-ups. Some companies, such as Zillow, have long ago taken advantage of combining the real estate market with technology, while others are finding new ways to ride the trend. The recently announced (however cancelled) IPO of WeWork has once again brought this exploding area into the center of public attention.
Whilst the tech sector has become the talk of the town, keen entrepreneurs and venture capitalists are seeing a new kid on the block, joining them in investments. Attracted by the volatile market with the appeal of potential exponential growth, EB-5 investors are studying this innovative industry segment with googly eyes. Tech startups can also make good use of EB-5 investments as the former tends to have immense pressure to raise money quickly but may have limited operating history securing traditional financing or lack access to capital markets. One might even argue that by funding entrepreneurial projects in tech startups, the companies and the associated EB-5 investors are returning to the original intention of the Congress when setting up the EB-5 Immigrant Investor Program.
A key difference between an angel or venture capital (VC) investor and an EB-5 investor, however, lies in their prospect of return on investment (ROI). To satisfy the EB-5 requirement, the investors must have a chance of gain from the investment. Unlike angel funding or VC funding, EB-5 investors also have immigration benefits in mind – an alternative form of ROI that is not traditional and cannot be quantified yet all the well mighty.
Here, the focus should be really who your customer is. Although we are seeing EB-5 investors inquiring more about their potential ROI and expect higher ROI due to the increasing processing time or visa backlog, which will most certainly be the norm post November 21, 2019 after enforcement of the higher EB-5 minimum investment amount, the EB-5 investors’ priority, at least currently, is still with getting a green card. When structuring a deal, developers and project attorneys must be mindful of the EB-5 repercussions and not categorize it as another angel or VC deal.
Although the law and regulations dictate EB-5 investment as an “at-risk” investment, a well-structured deal with sufficient disclosure can potentially reduce the risk to a certain extent or at least prompt an investor to make an informed decision before commitment. In the case of tech startup investments that involve EB-5, one thing investors should pay attention to is the exit strategy as it has profound financial and immigration impact.
An investment vehicle that is usually favored by tech deals is a convertible note. A convertible note is a debt instrument that later converts into equity when triggered by a future round of financing or milestone. It has practical benefits to a startup that may wish to delay establishing a valuation as there might not be much to base a valuation on; and investors, who, instead of a return in the form of principal plus interest in cash, receive equity in the company at a discounted rate (usually) to compensate themselves for the additional risks they bore by investing early on. In effect, convertible notes can quickly deliver much needed capital to startups and potentially large returns to investors.
Although there are benefits to their use, convertible notes do have drawbacks of which investors should be wary. One typical and legitimate concern is that convertible noteholders are often at the mercy of others, with little power to sway the outcome of their investments. This is especially important in the EB-5 context where most deals are not negotiated at arm’s length. The interests of the issuer (the Job Creating Entity or the Project Company) and the noteholder (the New Commercial Enterprise where the investors pool their investments) may not be aligned when it comes to valuation and a future round of financing might never happen. If future equity rounds are not completed, the convertible note will remain debt and thus require redemption (Investors beware: some convertible notes also do not have automatic conversion on maturity), pushing the potentially still-fragile Project Company into bankruptcy or being acquired for a nominal amount. For EB-5 investors, this means potential financial loss and/or forfeiture of immigration benefits if, amongst others, the jobs were not created beforehand.
Given the backdrop of the booming PropTech industry, and the well capitalized nature of its industry segment, one can predict the marketability of a PropTech project. Whether a particular project is feasible and profitable, however, depends heavily on the project specifics. EB-5 investors should look at the Project Company’s past history and prospective usage of funds for guidance. Is the Project Company a brand-new startup with only ideas and a conceptual model or does it generate net income already? Is there strategic partnership formed? Is there diversification of product portfolio to weather economic downturns, should they happen? And most importantly, how is capital used to generate revenue to pay back the investors?
In the end, what is really important and where the risk really lies is with the management team’s experience in the relevant field. EB-5 investors, like unicorn (a term for startups valued at $1 billion or more) investors, who place a lot of trust in the founders of dynamic and expanding startups, are also relying on or placing bets on the key personnel of the company developing the project. It is therefore crucial for investors to conduct due diligence and thoroughly read the Private Placement Memorandum (PPM) of the project (if the project offers one) before commitment. After all, whether a tech company will continue, whether a project can succeed or fail, depends on the people managing and developing it more than anything.
Please see the link below for access to the EB-5 Investment Voice podcast episode where the author and Mona Shah, Esq. are joined by Dr. Umesh Harigopal, CEO of PropTech company PropMix.io LLC, to discuss how EB-5 can be utilized by a tech startup: http://mshahlaw.com/prop-tech-projects-for-eb-5-with-umesh-harigopal-of-propmix-episode-84/.
About the Author:
Hermione Krumm, Esq. is an associate attorney with Mona Shah and Associates Global. Hermione’s practice focuses on corporate and securities matters for issuers and developers seeking financing under the EB-5 program. She offers clients significant experience in corporate law, advising on SEC and EB-5 compliance, deal structuring, integrity measures, corporate finance, and mergers and acquisitions (M&A). Hermione writes and comments frequently on current corporate and immigration issues. Her articles have been published by LexisNexis, ILW, EB-5info, EB-5 Supermarket, etc. and she has also been interviewed by mainstream news channels, featured in international newspapers and quoted. Hermione received her LL.B. (Hons) from the University of Manchester School of Law (UK), and obtained her LL.M. from Cornell Law School. Hermione speaks fluent English, Mandarin and Cantonese.