Business Plans vs. Securities Offering Disclosure Documentation (John Cones Series: Part 4 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 4 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 4: Business Plans vs. Securities Offering Disclosure Documentation

By John W. Cones, Attorney 

Based on numerous conversations with independent feature film producers, there appears to be a considerable amount of misunderstanding and/or misinformation in this community regarding when to use a business plan as opposed to a securities disclosure document if seeking to raise money from investors to develop, produce or distribute one or more independent feature films, or to raise the equity component of a film’s financial plan. First, we have to understand what a business plan is and how it differs from a securities disclosure document. We have to recognize that although there may be similarities (i.e., some overlap), these two documents are not the same things. The differences are based on both the contents of these two documents as well as in the appropriate uses of the documents.

What's a Business Plan?

A business plan is a written statement that describes and analyzes a business (in this particular case, a proposed independently produced feature¬length movie) and gives detailed projections about the future of that business. A business plan is not an investment vehicle. You cannot sell shares in a business plan. Nobody can invest in a business plan. If a business plan is used to actually raise money, it must be used in the proper circumstances and must be combined with an appropriate investment vehicle.
Thus, a business plan, combined with an appropriate investment vehicle, can be used to raise money, but only in limited circumstances. What are those circumstances? A business plan can be used to raise money from one, two or a few active investors. A business plan cannot be appropriately used to actually raise money from a larger group of passive investors.

What's an Active Investor?

So, what’s the difference between an active and a passive investor? An active investor is someone who is regularly involved in helping you the filmmaker make important decisions with respect to your film. In the context of a film, that means helping to select the script, making changes in the script, selecting the director and lead actors, choosing the line producer and director of photography, helping to solve problems that come up during production, helping to make decisions with respect to critical questions relating to distribution and so forth. These one, two or a few active investors need to be capable of making valuable contributions on these important questions (i.e., they need to have some knowledge of and experience in the film industry that is relevant to what you are doing) and be actively involved in helping to make such decisions on a regular basis. For case law guidance as to what constitutes an active investor see Williamson v. Tucker, 645 F.2d 404, 5th Cir. 1981 and 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.

That does not mean the active investor(s) should have veto power, although some investors who put in most of the money to produce a film, for example, may insist on such control, and in that instance, it may become a problem for a producer. In addition, unless an entity is created to provide limited liability, active investors may also not have the limited liability protection offered by an entity, and, of course, most people with enough money to invest a substantial amount in a high¬risk venture like an independent film, will most likely prefer to enjoy limited liability protection. That’s just another factor to consider when determining whether to use a business plan and seek financing from one, two or a few active investors.

What's a Passive Investor?

On the other hand, a passive investor is someone who is not an active investor (i.e., someone who is not regularly involved in helping to make those important decisions). This is an important distinction, because it represents the essence of the difference between a non-securities offering and a securities offering. Essentially, anytime you are seeking to raise money from one or more passive investors, you are selling a security, no matter what you call it. So, the producer’s decision to raise money from active or passive investors has important implications and consequences.

Enlisting Both Active and Passive Investors?

If you are really trying to raise money from one, two or a few active investors, who are both capable of being regularly involved in helping to make important decisions and willing to be so involved, you can use a business plan combined with an appropriate investment vehicle to provide them with the information on which to base their decision. But, if you are raising money from one or more passive investors, you are required by law to provide those investors with a properly prepared securities disclosure document (not a business plan) prior to their investment.

Active Investment Documentation: The Business Plan

In addition, that business plan should not suggest in any way that you are really seeking to raise money from passive investors. In other words, either leave out the discussion about the specific financial arrangements or at the very least, avoid references to interests in limited partnerships, or units of a manager¬managed (passive¬investor) limited liability company (“LLC”). Further, the language in a business plan should not suggest or imply that the investor will not be permitted to be regularly involved in helping to make important decisions, since that is at the very heart of what makes him or her an active investor. It may be the better practice to actually state that the business plan is being used in conjunction one of those specific but appropriate investment vehicles for the purpose of raising funds from one, two or a few active investors. In any case, absolutely do not include language that you either plan to or may later create a limited partnership or manager¬managed LLC, because that language clearly indicates that you are planning a securities offering. Also, do not suggest by the language in the business plan that you intend to raise money from more than one, two or a few active investors, because at some undefined point, it is no longer possible to keep a large number of investors “actively” involved in a business venture in a meaningful way.

Active Investment: Investment Vehicles

Now, what are those investment vehicles that can appropriately be used in conjunction with a business plan for seeking funds from one, two or a few active investors? As discussed in more detail in my book “43 Ways to Finance Your Feature Film”, the four vehicles are: (1) the investor financing agreement (a copy of which appears in the book “Film Industry Contracts”--available at the Samuel French Bookshop in Hollywood), (2) the joint venture agreement (a sample of which also appears in the “Film Industry Contracts” book), (3) the initial incorporation (see discussion in “43 Ways to Finance Your Feature Film”) and (4) a member-managed (active-investor) LLC (which, in addition to the filing with Secretary of State, must also have an LLC operating agreement to be properly formed).

So, recognizing that there are some obvious disadvantages to seeking funds from active investors
(1) they may interfere with your creative control, (2) the investment vehicle chosen may not offer any limited liability protection to your investors and (3) it may be more difficult to find prospective investors who are both capable of and willing to be a lead investor in a high-risk investment like independent film, it is also important to recognize that by seeking active investor financing, you are eliminating at least two of the advantages of a securities offering (i.e., spreading the risk amongst a larger group of passive investors, none of whom will typically be hurt too badly if they don’t get their money back or make a profit, and, of course, passive investors don’t interfere with your creative control.

Passive Investment Documentation: S.E.C. Disclosure Offering

Now, a quick note about terminology. The securities disclosure document is a broad term that applies to the required written information that must be provided to prospective investors before they invest in all securities offerings. The terms “prospectus” and “offering circular” are used to describe the securities disclosure documents associated with various types of public/registered offerings. These securities offerings are usually too expensive, complicated and time¬consuming to be of much interest to low-budget independent filmmakers. On the other hand, the private placement offering memorandum or “PPM” is the term used to describe the securities disclosure document associated with an exempt / private offering (most commonly used by low-budget indie filmmakers).

Specific rules promulgated by the federal Securities and Exchange Commission and, in some instances, state securities regulatory authorities, provide guidance on what information must be disclosed in these securities disclosure documents and how that information must be presented. There are no such rules for business plans, and that’s why there is both such a wide disparity in the content of business plans and why the contents of business plans are always different in some respects from the contents of a securities disclosure document, even though some elements of the two are the same or similar.

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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.