FINANCING OF INDEPENDENT FILMS: OVERVIEW OF PRODUCTION COMPANY BUSINESS FORMATION AND
Firm. We are answering the question: How to form an independent film production company?
WHAT IS AN INDEPENDENT FILM PRODUCTION COMPANY
To be taken serious in the entertainment industry, a filmmaker will want to form a production
company to create their projects and pitch to investors and Hollywood executives. An
independent film production company is a business that creates independent feature films. Technically
speaking, an independent feature film is any film not made by any of the major Hollywood
studios - Warner Bros., NBC Universal (which includes the Comcast Corporation), The Walt
Disney Company, Paramount, Viacom, CBS Corporation, News Corporation, Fox, or Sony (which includes
Columbia Pictures, MGM, and United Artists). What is a major studio? Essentially, a major
studio differs from an independent production company in that it has all of the following:
(1) Its own production capacity; (2) Its own studio lot;
(3) Its own financing capabilities; and (4) Its own distribution and marketing capabilities.
Generally, with independent film production the filmmaker retains artistic and budget
decisions concerning the film. However, if the film obtains studio distribution, the
major decisions in the production will be subject to the approval of the studio.
The form of the business structure for the independent film production company should
take into consideration the objectives of the filmmaker - is this going to be simply
a one film project, or is this going to be a career and make multiple films? It must
be decided whether this is a business that will require ongoing investor relations and
whether the filmmaker intends a slate of multiple projects (in which one project should always
be in pre-production, one in production, and a third in distribution).
The filmmaker will also have to decide whether the operating production company is kept separate
from the investment vehicle for financing of the filmmaker's individual projects. An
investment vehicle is in itself a separate business entity. In essence, one business
form will be for the production company and another business form will be used to raise
funds for a particular project in which the company is producing. In order to provide
the most protection, it is preferred to have separate business entities for the production
company and the individual film projects. An investment vehicle is a separate business
entity in which investors can contribute funding capital for the film project. In doing so,
if the individual film project ends up being a failure, only the capital contributed to
the investment vehicle is at risk and not the capital in the production company itself.
This enables the production company to continue business and make up for any losses with other
projects.
BUSINESS FORMS
The business formation that the production company takes may give an opportunity for
a first level of startup investment capital. A subsequent second business entity which
the production company takes an active part in can be utilized as a financing vehicle
to attract additional investor capital. There are four applicable business forms:
I. SOLE PROPRIETORSHIP II. PARTNERSHIP
III. CORPORATION IV. LIMITED LIABILITY COMPANY (LLC)
When choosing the proper business structure, there are four main areas of concern:
(1) Control - The filmmaker's creative control of the project;
(2) Financing - Financing capabilities and funding of the production company and the
individual film projects; (3) Liability - Exposure for contractual obligations
and tort liability (which is the duty to pay compensation for accidents or intentional
misconduct); and (4) Taxes - Federal and State tax obligations
owed and whether the tax can be shifted to the company or its owners.
Each business entity form offers advantages and disadvantages regarding the four main
areas of concerns. There is no one size fits all, as each production company and each individual
film project has its own circumstances to be considered when forming the business or
the investment vehicle to raise funds.
INDEPENDENT FILM PRODUCTION FINANCING
The filmmaker should utilize a combination of financing. A filmmaker should not try to
finance a film alone. The old saying is the filmmaker should use "OPM" - Other People's
Money. However, that is not totally accurate. Nowadays, the filmmaker is likely to put in
some of his or her own funds toward the financing. This shows faith in the success of the production
company and the film project.
DEBT FINANCING
Debt financing must be repaid. This type of financing consists of credit cards, personal
loans, and promissory notes. Debt financing can be secured by collateral or unsecured.
If the filmmaker defaults on a secured loan, the lender can take over the property that
was put up as collateral. If it was an unsecured loan, the lender must file a lawsuit against
the debtor to recover the money.
EQUITY FINANCING
Equity financing represents investments that are ownership interests in the business. This
type of financing includes shares in a Corporation, units in a Limited Partnership, or membership
interest in a Limited Liability Company. As opposed to debt financing, there is no obligation
to repay the money invested as capital when dealing with equity financing, which can be
very attractive to filmmakers.
Rather, the investors share in the risks and rewards of the business. However, in dealing
with such financing, the filmmaker must comply with State and Federal security laws. If the
filmmaker offers membership interests in a Limited Liability Company, units in a Limited
Partnership, or shares in a Corporation to potential investors in exchange for money,
the filmmaker is conducting an "offering" pursuant to State and Federal security laws,
and if the filmmaker does not comply with all the disclosures and legalities, they may
find themselves civilly or even criminally liable.
THE DISTINCTION BETWEEN ACTIVE INVESTORS AND PASSIVE INVESTORS
The biggest factor determining whether the filmmaker must comply with security laws and
provide detailed disclosures to investors is whether such investors will be active or
passive in the business.
If an investor participates in the management of the business, then the investor is considered
to be an active investor. Members of a member-managed Limited Liability Company, shareholders who
are also officers or directors of a Corporation, and general partners in a Partnership are
considered to be active participants in the business. These investors not only invest
their money, but they also take active control on the success of the business. Active investors
take on a regular involvement and help the filmmaker-producer make important decisions
in managing the production company or the individual film project.
Whereas, if an investor does not take part in the management of the business, the investor
is considered to be a passive investor. A passive investor is one who is not involved
in the active participation of a business and does not have immediate control over the
activity that produces income. The business investment is considered a security because
it involves the investment of money in a common enterprise with the expectation of profits
from the efforts of others. Members of a manager-managed Limited Liability Company, shareholders who
are not also officers or directors of a Corporation, and limited partners in a Limited Partnership
are considered to be passive participants in the business. The passive investor provides
money, but does not run the business. This type of investor is more attractive to the
independent filmmaker-producer because it allows them to maintain the sole creative
control of the direction of the production company and the individual film projects.
SECURITY LAWS
Passive investments are subject to compliance with State and Federal security laws. A passive
investment of money for an equity ownership in a business is considered a sale or offer
of a security.
The United States Securities and Exchange Commission defines a security very broadly
as: "Any note, stock, treasury stock, bond, debenture, certificate of interest or participation
in any profit-sharing agreement..., any collateral trust certificate, preorganization certificate
or subscription, transferable share, investment contract..."
Moreover, pursuant to the Howey Test created by the United States Supreme Court in 1946,
an investment contract is subject to security laws if it contains the following elements:
(1) An investment of money in a common enterprise; (2) An expectation of profits by the investor;
and (3) The profits are derived solely by the
efforts of others.
See SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
The purpose of the test is to protect the investing public against fraud. The laws regulating
securities are designed to promote full public disclosure. Generally, most issues of securities
are offered in interstate commerce - that is, the issuer of the security uses the mail
or the internet. Therefore, the securities must be registered with the Securities and
Exchange Commission, unless an exemption from registration applies. When dealing with securities,
it is important to have the counsel of an Attorney.
COMBINATION OF FINANCING
In most cases, the filmmaker will use a combination of different kinds of financing. A common
example of the financing combination that may be utilized includes:
(1) Gifts; (2) Grants;
(3) Investment in a start-up production company (capital contributions provided by active
investors in a C Corporation, S Corporation, or member-managed Limited Liability Company,
and the investment of the intellectual property written, acquired, or optioned by the filmmaker-producer);
(3) Financing of development and packaging funds or a portion of production funds raised
by a passive investment vehicle compliant with security laws;
(4) Crowdfunding; (5) Product placement; and/or
(6) Domestic or international negative pickup deal, foreign presales, or tax incentives.
Now that we've covered the general overview of the independent film production company
and the investment vehicle, you can be more aware of the legal issues involved in forming
the business and the basics of financing an independent film. However, again, this only
provides a general overview. Many of the terms referenced in this video need more explanation.
Please refer to the additional videos discussing each of the topics in more detail.
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