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Funding for an independent feature production usually comes from a variety of sources. This post will introduce two that are most frequently used to raise the capital needed to produce a full-length motion picture: investor, or “equity”, financing and lender, or “debt” financing.
Equity financing for independent films
Funds for indie productions may be raised from one to a few “active” investors or a greater number of “passive” investors. The difference is extremely important because it generally determines whether the investment involves the sale of a “security“. Such sales are regulated by the U.S. Securities & Exchange Commission and federal and state laws that can impose severe penalties if violated.
Within these laws are several complex definitions of “security”, which can make it hard to understand whether compliance is required for an indie project. Generally, a security is “an investment of money in a common enterprise with profits to come solely from the efforts of others . . . .” SEC v. W. J. Howey Co., 328 U.S. 293, 299 (1946). As a very rough guide, the “solely from the efforts of others” aspect of that definition may be used to illustrate the basic difference between active and passive investors. Active investors put in their own efforts toward generating profits because they have experience and knowledge of film industry business affairs to contribute. They are regularly involved in helping to make important decisions for the production.
What are active investors?
It’s been said that every financial decision on a film is a creative decision. Because many producers of indie features prefer to control creative decision making, they will rely mostly on passive investors to fund their films. Passive investors also invest with the goal of making profit. But by doing so, they don’t expect to participate in the process of making the film. Instead, they may have other goals, such as supporting the filmmaker’s career or the project’s message, experiencing being behind-the-scenes on a real film set, or attending premieres and basking in the glamour of the movie business.
What are passive investors?
Passive investors purchase securities, which means that they should be provided detailed disclosure documents (a private placement memorandum and subscription agreement, along with a copy of the operating agreement or other documents drafted to start the film production company). Additional compliance with federal and state securities laws must also be ensured.
How are indie film investors repaid?
Perhaps the greatest difference between financing indie films through equity and debt is that unlike repayment of a loan, repayment of active or passive investors is usually not required unless a film is profitable. As a simplified description of a typical private film offering, if the film succeeds in earning income, or “gross receipts”, distributors deduct their fees and costs from these revenues. If the amount remaining, or “net proceeds”, exceeds all budgeted expenses (including any deferred compensation), then investors are paid first in the full amount of their investment, plus a premium, on a pro rata basis. Any remaining revenues are divided between the film producer and the investors, with talent participations, or “contingent compensation”, then paid out of the producer’s share. Investors then receive an additional “back end” payment out of the investors’ share, which is again proportional to their actual investment.
Debt financing for independent films
When, as is usually the case, the entire film budget cannot be raised through investors, indie producers may finance the balance through borrowing money. Typically, film projects able to access debt financing have completion bonds and total budgets between $1 million and $50 million. Banks or other lenders also require collateral.
Collateral for entertainment lending
Collateral in film lending generally means agreements in place for distribution, minimum guarantees, pre-sales, and federal or state tax credits. Once the mainstay of indie film finance, foreign pre-sales and minimum guarantees are commitments by foreign distributors to pay specified amounts on delivery of a completed film. Producers may then borrow against the amounts of these commitments. As they are now much less available, tax credits have become the principal basis for debt financing.
If you have questions about using investor financing, loans, or other film finance tools to fund an indie production of any size, contact DeepFocus Entertainment Law.