THAT PESKY EQUITY COMPONENT OF INDEPENDENT FILM FINANCE PLANS
By John W. Cones, Attorney
Recently, I went online and conducted a search for “film finance blogs”, to see what information was being offered to filmmakers regarding this somewhat difficult but necessary aspect of independent filmmaking. Most of the articles agreed that many independent films will find it necessary to cobble together financing from 4 to 5 different sources, and that a so-called “finance plan” needs to be created to guide the independent filmmaker through the process. This approach is not necessary, however, for many ultra-low budget and low budget independent films because they can rely either on crowd funding, investor equity or a combination of the two. In any case, these finance plans might indicate that varying percentages of a proposed film’s budget would come from sources such as crowd funding, equity investors, federal, state or international tax incentives, foreign pre-sales and possibly a small percentage from GAP financing.
There is actually no limit to the combinations of the forms of film finance involved in a film finance plan, after all, my own book “43 Ways to Finance Your Feature Film” discusses in some detail, at least 43 different ways of financing a feature or documentary film, and at last count some 62 different ways in the book’s third edition (additional information on the book can be found at http://www.filmfinanceattorney.com in the “Film Finance Books”. These online articles, however, all seemed to agree that the largest component of such a film finance plan is the so-called equity (investor) portion or component. None of the articles provided much information, however, about what is involved in this largest part of the independent film’s finance plan. So, let me sketch out something about one of the most important starting points in equity financing.
First, we have to organize our thinking to recognize that there are two different kinds of investors (i.e., the folks that provide equity financing). There are active investors and then there are passive investors. As a general rule, this distinction marks the critical difference between a non-securities offering and a securities offering. At first blush, most filmmakers would naturally like to avoid the cost and complications of a securities offering, so they may initially want to opt for the active investor route. Sometimes these active investors are referred to as “angel investors”. They may also call themselves “venture capitalists”, although as a general rule, independent film is typically too risky for most of the organized venture capital firms.
Unfortunately, the definition of an active investor is not as loosey-goosey as some filmmakers and their advisors would like for us to believe. The term has been carefully defined by several federal appellate courts in cases that dealt with the questions relating to what is a security and who can be an active investor. I discuss these definitions of a security and the active investor in some detail in my article published in the May 2010 Los Angeles Lawyer magazine, a copy of which appears at my above-cited website in the “Film Finance Articles” section under the title “Contingent Promissory Notes as a Film Finance Method – Are Filmmakers Being Misled?” In addition, the actual sources of the law on this issue are cited in this article.
Generally speaking, active investors must (1) have knowledge and experience in the relevant industry; (2) they must be regularly involved in helping to make the important decisions relating to the project, and (3) the filmmaker’s written agreement with them must clearly authorize them to be actively involved in that decision making. If these requirements are not met and the question goes to a court, the judge will consider the investment a security, and if the filmmaker made no attempt to comply with the federal and state securities laws, he or she may be guilty of selling an unregistered security, which of all the inconveniences, is a felony.
Of course, it would be great, if a filmmaker could easily find one, two or three active investors who would put up all of the money needed to produce the filmmaker’s film or meet the needs of the equity component of the film’s finance plan. But, several very important disadvantages of relying on active investors confront any filmmaker: (1) In the real world, there is a much smaller population of investors who are willing to or capable of investing large sums in a risky venture such as independent film. (2) There are fewer still who have “knowledge and experience” in the film industry, as required by law. (3) There is always the risk that someone who puts up a lot of money to produce a motion picture will start throwing their weight around and insist on different creative decisions than the filmmaker originally envisioned.
Quite often, filmmakers are attracted to active investor financing because it seems simpler -- theoretically the filmmakers would be pitching their projects to fewer prospective investors, the business plan is the only document needed to provide information to the prospective investors, and although ultimately some form of investment vehicle will be needed (after all, a business plan is not an investment vehicle), many business plan consultants encourage the filmmakers to defer the decision relating to choice of investment vehicle until negotiations are underway with a serious investor prospect. It seems that few such advisors reveal to filmmakers that it is always difficult to determine whether a prospective investor is serious, and the filmmaker won’t know that for sure until an appropriate document is put in front of the prospective investor to sign (i.e., the kind of document typically associated with an active investor investment vehicle). Of course, if the filmmaker is not actually obtaining the prospective investor’s funds at the time of signing, there is always the possibility that the prospective investor will back out of the deal, and as noted in one of the online articles mentioned above, the filmmaker’s remedies in such a case are quite limited (for help in determining which informational document to present to prospective investors, see my article “Business Plans or Securities Disclosure Document” at my website.
An alternative to the active investor scenarios is to seek to raise money from a larger group of passive investors. The advantage is that passive investors do not interfere with the filmmakers’ creative decision-making. They are prohibited by law from doing so. A further advantage is that the filmmaker is asking each prospective investor to invest a smaller sum, thus it may be easier to convince an individual to part with a small amount of money. A third advantage is that there are a lot more small investors out there than there are large investors. One disadvantage is that the filmmaker will have to pitch the project to a larger number of prospective investors and a second perceived disadvantage is that the federal and state securities laws do apply, and compliance with those laws is difficult.
On the other hand, the filmmaker’s decision to hire a knowledgeable securities attorney who has specialized expertise with film offerings can significantly reduce the complexity of a securities offering, and that decision is not so different from hiring many other specialists who are brought on by the filmmaker to help in the development, financing, production and/or distribution of a feature film. The decision to hire the securities attorney just comes at an earlier point in the life of the project, when most independent filmmakers have limited funds (for tips on how to deal with such a situation see the article “Financing a Feature Film From the Ground Up”).
Thus, as stated in my book “43 Ways” there is no easy way to finance a feature or documentary film and each form of film finance has its own associated advantages and disadvantages. Just be careful. When someone starts aggressively pushing you toward the use of a business plan and the active investor approach to raising the equity component for your film’s finance plan, be sure to consider all of the advantages and disadvantages before using that approach. It may not be appropriate for your specific circumstances.
This article is limited to the important threshold question relating to whether a security is being sold. Additional information relating to this and other associated issues appears in the 16 articles posted on my website (http://www.filmfinanceattorney.com), in my six books about film finance (described at the website) and in the “Finance Forum” where I’ve been answering the questions of independent filmmakers regarding investor financing of independent film for more than fifteen years (see “Finance Archives”).
Good luck and be thorough in your investigation.
John Cones, Attorney, Author, Lecturer
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