INTERNET FILM OFFERINGS
By John W. Cones
It is important to understand that for purposes of raising money from investors, the Internet is nothing more than a new form of communication. The technological creation of a new way to communicate with prospective investors does not in and of itself change long established federal and state rules and regulations that apply to investor financing of film or other entertainment projects. Thus, it is extremely important in analyzing whether funds for the acquisition, development, production and/or distribution of a feature film project can be raised via the Internet, that we understand clearly whether or not a security is involved, and therefore, whether the federal and state securities laws and regulations will apply to the transaction.
To simplify, a security is being offered or sold if the investors are going to be "passive". If, on the other hand, the investors are somewhat knowledgeable in the industry being invested in and are going to be regularly involved in helping the film's producer make important decisions, such investors may be considered "active" (i.e., non-passive), and under such circumstances, it is not likely that a security offering is being conducted, although again, this is an over-simplification and each case should be considered on its specific facts. There are, of course, very good reasons in a creative endeavor like film production not to want to raise money from "active" investors, whose opinions you have to deal with in putting your vision on the screen.
Next, we must recognize that any communication put on the Internet for the purpose of raising money from passive investors will be properly characterized as an "advertisement" or "general solicitation" by the federal and state securities regulatory authorities. As a general rule, the advertising or conduct of a general solicitation relating to a security is prohibited unless the security is registered with the Securities and Exchange Commission (SEC) at the federal level, and with the appropriate state regulatory authority in each state in which the security is being offered, prior to the start of the offering.
Low budget filmmakers may consider the use of the Regulation A public/registered offering (combined with state registration in each selected state) for amounts below $5 million. Another possibility is the SCOR offering (a state level public offering of corporate stock for up to $1 million, combined with the federal Regulation D, Rule 504 exemption from federal registration).
A third possibility that is even more complex than these other two involves securities offers being made over the Internet to a pre-screened and qualified group of accredited or sophisticated investors in the form of a private placement (i.e., a non-public offering that is exempt from the securities registration requirements because all conditions and limitations imposed on the use of the exemption have been complied with). In this scenario, the required pre-existing relationship already exists between the prospective investors and an online service, that has created an investor list through an online questionnaire designed to permit both the securities firm and any potential issuer to reasonably believe that the individual is an accredited or sophisticated investor for purposes of a Regulation D or other private placement offering. Qualified investors receive a password allowing access to a web page listing these private and other offerings. An SEC no-action letter sent to such a company essentially permits Internet solicitation of pre-qualified investors similar to solicitation by brokerage firms of pre-cleared customer lists. On the other hand, just because such companies exist online and their investors are pre-screened, that does not mean they are any more inclined to invest in a high risk investment such as independent film as any other group of prospective investors. And, the online service usually charges a fee upfront to permit access to their investors.
Another use of the Internet involves the posting of a generic business plan (or an executive summary of such a business plan) on the Internet and designing the business plan specifically for the limited purpose of attracting one or just a few "active" and sophisticated investors only. Under the right circumstances, such a business plan is not considered a security, thus the securities rules noted above are not involved. Such business plans can be communicated to anyone (i.e., a general solicitation via the Internet is perfectly permissible with an active investor business plan).
However, a business plan, by itself is not an investment vehicle. If the response to the business plan is positive, the producer may then choose to structure the investment as an investor financing agreement or a joint venture, and possibly as an initial incorporation or an active-investor (member-managed) limited liability company (all possible non-securities investment vehicles). If, on the other hand, the business plan attracts significant interest from investors, but they do not have sufficient means to finance the amount of money needed on a true active-investor basis, then it is still possible to stop the use of the generic business plan seeking active investors, wait a period of time (3-4 weeks is the suggested guideline by the SEC) and start a traditional (non-Internet) private placement securities offering (i.e., conduct a corporate stock offering, a limited partnership offering or a passive-investor limited liability company offering) making offers to these same prospective investors with whom the securities issuer/film producer now has established a pre-existing relationship for purposes of this subsequent securities offering. In other words, the required pre-existing relationship needed for purposes of conducting a private placement offering was established by means of the earlier general solicitation conducted through the use of the generic business plan seeking active investors. Of course, the pre-existing relationships with prospective investors of registered SEC/NASD securities broker/dealer firms can also be relied on for these purposes, if the film producer can interest such firms in film offerings.
Before any film producers expend a considerable amount of money seeking state approval for a SCOR or Regulation A offering and creating a Web site for marketing such offerings on the Internet, however, it would be wise to determine as much as possible just how successful these offerings have been. Film offerings of any kind are considered highly risky investments for investors. Merely putting them on the Internet will not reduce the risk to investors, thus, this new form of communication, may, in effect, merely be shifting producer monies to the pockets of Internet service providers, without creating a favorable track record for success in raising funds. Just as with all other film financing schemes, the producer must exercise reasonable caution.
For more information see:
California Department of Corporations Release No. 100-C "Offers of Securities Made on the Internet", November 5, 1996.
"Direct Public Offerings/Raising Equity Capital via the Internet", Internet Equity Consultants, at http://www.internetequity.com/intro.html.
"Financing on the Internet" by Dr. Jeffrey J. Moffie at http://www.ipoexchange.com/ipo-art2.htm.
43 Ways to Finance Your Feature Film, John W. Cones, Southern Illinois University Press (800/346-2680).
"Film Finance and Distribution--A Dictionary of Terms, by John W. Cones, Silman-James Press, 800/822-8669.
IPONet SEC No Action Letter re "Electronically Transmitted Indications of Interest and Posting of Notices of Private Offerings on Password-Protected Page", July 23, 1996.
"The Internet and Financial Markets", written by James E. Grand and Gary Lloyd for Upside Magazine" at http://www.ipoexchange.com/ipo-art.htm.
"SCOR Registration" by Mark J. Astarita, at http://www.e-ipoet.com/scorlaw.htm.SEC Release No. 33-7289 "Use of Electronic Media for Delivery Purposes", October 6, 1995.