Two Types of Equity-Based Film Funding Sources (John Cones Series: Part 2 of 6)

I had the pleasure of sharing a panel at the Hollywood Black Film Festival with John Cones - entertainment attorney who's worked extensively with independent producers and filmmakers.  While I emphasized the importance of audience-building and the role of fans as a contribution-based funding source, John focused on the role of passive and active investors as an equity-based funding source.  Together, both are complementary sources.

Filmmakers rarely raise money from one source.  Debt, equity, grants, fan funding, tax credits, rebates, and more are all sources filmmakers can tap at once.  Check out the "Show Me The Money Forum" to discuss the hybrid approach with IndieGoGo members. 

What follows is Part 2 of a Special 6-Part Weekly Series in the DIWO Download on equity-based film finance sources from John Cones.

• Part 1: Five Most Common Film Finance/Distribution Scenarios
• Part 2: Two Types of Equity-Based Film Funding Sources
• Part 3: How Filmmakers Can Avoid the Business Plan Scam
• Part 4: Business Plans vs. Securities Offering Disclosure Documentation
• Part 5: Securities Offering Disclosure Checklist & Fee Schedule
• Part 6: 12 Motivations for Investing in Film

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Part 2: Two Types of Equity-Based Film Funding Sources

By John W. Cones, Attorney 

If we step back and analyze the world of equity-based film finance sources, for purposes of determining which is the appropriate initial documentation with which to approach such sources, we can divide that world into two broad categories:

1. Industry Sources
2. Investor Financing

Each category has their own type of documentation.

1. Industry Sources
Industry sources would include the in-house development/production deal, the production-financing / distribution deal (P-F/D) and co-productions (joint ventures), along with the various forms of third-party lender financing for production costs (i.e., worldwide negative pickups, domestic negative pickups, international negative pickups, split rights deals, foreign pre¬sales, gap financing and super gap). (See Part 1 for details)

Producer’s Package    
All of these industry sources, with the exception of the in-house development/production deal, can only be accessed with a producer’s package (i.e., at minimum a completed script, a budget and evidence of key attachments). The in-house development/production deal is accessed through pitching an idea for a film, typically before the script is even completed and a package assembled. It would not be appropriate to approach such industry sources with a business plan.

2. Investor Financing
The world of investor financing can be further divided into active versus passive investors.

Securities Disclosure Document
All offerings to passive investors involve the sale of a security (typically, units in a limited partnership or manager¬managed LLC or shares in an existing corporation). The securities disclosure document associated with a public/registered offering is called a “prospectus”. The securities disclosure document associated with a private/exempt offering is called a “private placement offering memorandum” or “PPM”.

Business Plan
Generally speaking, active investors (investors who are regularly involved in helping make the important decisions associated with the project--not necessarily a good idea for a creative venture like film) can be approached with a business plan. Of course, a business plan is not an investment vehicle, thus, it must be associated with a suitable active investor investment vehicle (e.g., investor financing agreement, joint venture agreement, initial incorporation or member-managed LLC). Unfortunately, federal appellate courts construing securities regulations have narrowed this field of active investors who may be approached with a business plan even further. This line of cases (see case citations below) require that not only must the active investor be regularly involved in helping to make the important decisions, but all documentation of the deal between the investors and the production company must make it clear that these investors have the authority to participate in such decision-making and most important, they must be capable of participating at a meaningful level (i.e., they must have “knowledge and experience” in the relevant industry – the film industry for purposes of our analysis here).

Upon reflection, we have to admit that these court-imposed limitations relating to the world of active investors (from outside the film industry) with whom a film producer might choose to and be willing to work and that have knowledge and experience in the film industry is very limited indeed. This effectively means that contrary to the misinformation routinely being provided to filmmakers by business plan consultants and others, the business plan is of very little use in seeking to raise film production funds from investors. 

Sources and Additional Reading:

• Consolidated Management Group, LLC versus the California Department of Corporations, 162 CA4th 598, 75 CR3d 795, 2008 (as reported in the California Business Law Reporter in its July 2008 issue.
• Dictionary of Film Finance and Distribution – A Guide for Filmmakers, John W. Cones, Marquette Books, 2007.
• Forty-Three Ways to Finance Your Feature Film, Third Edition, John W. Cones, Southern Illinois University Press, 2007.
• Williamson v. Tucker, 645 F.2d 404, 5th Cir. 1981.

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About John Cones

John Cones is a securities/entertainment attorney who has practiced in Los Angeles and area for nineteen years advising independent feature film producers and others on matters relating to investor financing of feature film and other entertainment projects. He has prepared or participated in the preparation of business plans and/or the required securities disclosure documents, along with Blue Sky compliance for more than 250 such offerings during this period, including public and private production¬money offerings for feature films, television pilots, documentaries, music projects, infomercials, live stage plays and Internet companies. Some 50 feature and documentary films have been produced by his clients with securities offering materials he has prepared. Other such offerings have been conducted for development, packaging, completion and distribution funding. In a broader sense, Mr. Cones also works with entrepreneurs on investor financing of business startups. 

Mr. Cones has lectured more than 300 times to an aggregate audience of approximately 5,400 on topics relating to film finance and distribution for the American Film Institute, the UCLA graduate level Independent Producers Program, UCLA Extension, The USC Cinema/TV School, the USC Cinema/TV Alumni Association, IFP/West, American University (Washington, D.C.), the Nashville Bar Association, Cal Western School of Law, The University of Texas Entertainment Law Institute, North Carolina School of the Arts, California Lawyers for the Arts and other film industry organizations. He has also published several books and articles on those same topics including Film Finance and Distribution¬¬A Dictionary of Terms, Film Industry Contracts, 43 Ways to Finance Your Film, The Feature Film Distribution Deal and How the Movie Wars Were Won. He also hosts a Q&A Internet site about investor financing of entertainment projects at http://www/mecfilms.com/guide4.htm and maintains a web site at http://www.mecfilms.com/coneslaw. 

John is a member of the California and Texas bar associations and the Independent Feature Project/West.  He can be reached at jwc6774 at roadrunner dot com.