Positions in the Capital Stack

Understanding the funding structure of an EB-5 project is crucial to assessing investment risk. The capital stack acts as a visual representation of the share of funding provided by each investing party and allows us to understand repayment priority. While there are many shades and variations of each stack, a generic capital stack typically consists of 4 sources of funding (numbered in repayment priority order):

1. Senior Debt
2. Mezzanine Debt
3. Preferred Equity
4. Developer/Common Equity

The sources are “stacked” on top of each other to fund a project. Here’s an easy way to visualize it:

Senior Position

The first party to be repaid in a capital stack holds the senior position, meaning their loan to the project has the highest priority for repayment. No other parties will be repaid before the lender holding a senior position. This position is usually occupied by institutional lenders, such as commercial banks, but in some cases can be occupied by EB-5 NCEs.

Senior loans are always repaid first and are often secured by the project’s assets which can be liquidated if the project is unable to repay loans or interest to senior lenders. When a senior loan is not current or not repaid and a property is foreclosed, the senior lender will extract their original loan amount from the liquidated funds and pass on any remaining funds to the mezzanine lender or to the next position below the senior lender.

Mezzanine Position

Typically, the next position in the capital stack is the mezzanine position. Mezzanine lenders will only be repaid after the senior lender has been paid back in full, with interest. This position is also called mezzanine debt, mezzanine loan, or subordinated debt/loan.

Preferred Equity

Following that, Preferred Equity is the third position in the repayment hierarchy and will be repaid after all loans from senior and mezzanine positions have already been repaid. Because this position does not hold debt in the project, preferred equity investors receive profits made by the project, sometimes even before the project is completed. This also means financial return is dependent on the project returning a profit unlike a loan where interest is earned regardless of project completion or performance. In preferred equity position, there is no finite “maturity date”, meaning that investors in this position are not required to be repaid by a certain time. Insecurity from lack of maturity date is what makes preferred equity much riskier than senior or mezzanine debt. Additionally, if a project goes into bankruptcy and liquidation, the preferred equity stands third in line claiming the liquidation value, behind senior and mezzanine loans and other priority creditors. In these cases, the senior lender decides a project’s liquidation value which can be catastrophic for equity investors who may not be repaid with the remaining liquidation funds.

Common Equity

Common equity position has the highest return on investment due to having the highest risk of all contributors to the capital stack. Because this position is last in the repayment hierarchy, it holds the largest risk for no repayment at all.

Additionally, if a project declares bankruptcy or is liquidated, the preferred and common equity positions claim residual liquidation value after senior and mezzanine positions. Additionally, the  liquidation value set by the senior lender can be bad or equity investors, who may not be repaid with the remaining liquidation funds.