43 Ways To Finance Your Feature Film

43Ways to
Finance Your
Feature Film
A Comprehensive Analysis of
Film Finance
Third Edition
John W. Cones
43Ways to Finance Your Feature Film
Cones Frontmatter.indd 1 12/20/07 1:46:36 PM
43
Ways to Finance
Your Feature Film
A Comprehensive
Analysis of
Film Finance
Third Edition
John W. Cones
Southern Illinois University Press
Carbondale
Copyright 2008 by John W. Cones
All rights reserved. First edition 1995
Third edition 2008
Printed in the United States of America
11 10 09 08 4 3 2 1
Library of Congress Cataloging-in-Publication Data
Cones, John W.
43 ways to nance your feature lm : a
comprehensive analysis of lm nance / John W.
Cones.3rd ed.
p. cm.
Includes bibliographical references and index.
ISBN-13: 978-0-8093-2693-8 (pbk. : alk. paper)
ISBN-10: 0-8093-2693-0 (pbk. : alk. paper)
1. Motion picture industryFinance. I. Title. II.
Title: Forty-three ways to nance your feature lm.
PN1993.5.A1C64 2007
384'.83dc22 2007016176
Printed on recycled paper.
The paper used in this publication meets
the minimum requirements of American
National Standard for Information Sciences
Permanence of Paper for Printed Library
Materials, ansi z39.48-1992.
To Donna, without whose support, encouragement and
cooperation this book could not have been completed
Contents
Preface xi
Introduction: No Single Best Way
PART ONE. Subsidies 9
1 Gifts and Grants 11
2 Domestic Government Subsidies and Tax Incentives 21
PART TWO. Investor Financing 39
active investor vehicles 47
3 The Investor-Financing Agreement 49
4 General Partnerships and Joint Ventures 52
5 The Initial Incorporation 59
6 The Member-Managed LLC 64
passive investor vehicles 67
7 The Manager-Managed LLC 71
8 Limited Partnerships 74
9 Corporate Finance 80
securities compliance 95
private (exempt) offerings
10 Statutory Exemptions of the 1933 Securities Act, Section 4 96
11 Intrastate Offering Exemption 103
12 Regulation D 105
public/private (hybrid) exemptions
13 Public/Private (Hybrid) Exemptions 115
vii
public (registered) offerings
14 Small Corporate Offering Registration 128
15 Regulation A 131
16 Regulation S-B 135
17 S-1 Public Offerings 138
18 Over-the-Counter, NASDAQ and Stock Exchanges 141
PART THREE. Lender Financing 147
19 Lender Financing without Distributor Contracts 149
20 Negative Pickups and the Articial Version 157
21 Presale Financing 166
22 Gap and Supergap Financing 177
23 Insurance-Backed Schemes 184
24 Securitization 188
PART FOUR. Studio/Industry Financing 193
25 Studio Development and In-House Production 195
26 Studio Production-Financing/Distribution Agreements 199
27 Studio-Based Production Companies 204
28 Independent Distributors 207
29 Domestic Studio Facilities 210
30 Film Laboratories 213
31 Talent Agencies 215
32 Actor Financing 217
33 Product Placements 221
34 End Users 225
35 Completion Funds 227
PART FIVE. International Finance Options 231
36 Foreign Equity 233
37 International Coproductions 244
viii
Contents
38 Foreign Tax Shelters and Tax Incentives 256
39 Blocked Currency or Blocked Funds 275
40 Foreign Currency 279
41 Foreign Below-the-Line or Facilities Deals 281
42 Foreign Government Subsidies 283
43 Foreign Debt Capitalization Programs 289
Conclusion: The Broader Film Finance Environment 291

Appendix A: Finding Investors 297
Appendix B: Limited-Use Business Plans 299
Appendix C: Financial Projections 304
Appendix D: Securities Marketing Considerations 307
Sources and Further Reading 331
Index 359
ix
Contents
xi
Preface
This book is published with the understanding that the author is not
herein engaged in rendering legal, accounting or other professional ser-
vices. For those readers seeking legal advice or other expert assistance,
the services of a professional should be engaged for that specic purpose.
All opinions expressed in this book are those of the author.
The earliest drafts of this book were used as texts and as a basis for
discussion in the authors Independent Feature Film Financing and
Distribution class in the graduate-level Independent Producers Pro-
gram at the University of California at Los Angeles and in a lecture on
lm nance and distribution for the University of Southern California
School of Cinema-TV. Other parts of this book evolved from seminar
handouts developed for lectures sponsored by the American Film Insti-
tute, UCLA Extension, IFP/West, American University (Washington,
D.C.), the Nashville Bar Association, the Cal Western School of Law, the
University of Texas Entertainment Law Institute, the Semester in Los
Angeles program of Columbia College Chicago, the North Carolina
School of the Arts and other lm industry organizations. I am grate-
ful for the useful comments I received from many of the graduate and
undergraduate students in those schools writing, directing, producing,
business and law programs as well as others who attended my seminar
presentationsan aggregate audience of more than 5,000that included
certain lmmakers, attorneys, accountants, broker/dealers, lm com-
missioners, lm students, government ofcials and others. I have truly
beneted from their participation.
43Ways to Finance Your Feature Film
1
Introduction: No Single Best Way
This book has been written to meet a need within the American lm
industry for a balanced and objective overview of information relating to
the numerous lm-nancing options and their respective advantages and
disadvantages. The book is for those people, whether they are producers,
executive producers, attorneys, screenwriters, investors or others, who are
thinking about developing, producing, distributing or even investing in
one or more feature or documentary lms and trying to determine the
best way to go about nancing the costs of their project or projects.
The need exists for several reasons: (1) Each year in the United States,
thousands of lmmakers are confronted with the question, how can
I nance the costs of producing my feature (or documentary) lm?
(2) None of the currently available books, articles, or seminar presenta-
tions provides a comprehensive overview of the subject. (3) Much of the
information presented through books, articles, or seminars is biased in
one way or another. (4) And, unfortunately, some of the information
available is simply inaccurate.
This book seeks to provide an overview of lm nance and is dedicated
to the proposition that
there are a variety of ways to nance one or more feature lms;
often a combination of methods may have to be used;
there is no single best form of lm nance for all motion pictures at
all times;
there are advantages and disadvantages associated with each form of
lm nance; and
one of the most important responsibilities of the producer or some-
one on the producers team is to be generally aware of the advantages
and disadvantages of each form of lm nance so that the method or
methods chosen for a particular project are more likely to succeed in
raising the money needed.
Cones Intro.indd 1 12/20/07 1:46:25 PM
Introduction
2
Thus, the focus of this book is on lm nance, primarily for feature
lms and documentaries, as opposed to short lms, videos and other
types of entertainment or informational projects, although much of the
information presented may be useful in nancing those kinds of proj-
ects as well. The emphasis is on nancing the production of such lms,
although, again, some of the nancing techniques discussed here can be
applied to the development and distribution phases. These three major
phases in the life of a lm (development, production and distribution)
can be nanced separately.
Film Finance versus Distribution
As a practical matter, it is pointless, and even misleading, to attempt
to discuss lm nance without also discussing certain aspects of lm
distribution; namely, those aspects that help to determine how revenues
generated from the exploitation of a motion picture in all markets and
media ow back to the owners, contingent-compensation participants,
nanciers and investors. Nevertheless, this book will strive to emphasize
as much as possible the front side of the transaction (lm nance) instead
of the back side (nancial aspects of lm distribution) and keep refer-
ences to distribution to a minimum. (For additional information relating
to lm distribution, see The Feature Film Distribution Deal: A Critical
Analysis of the Single Most Important Film Industry Agreement.)
An Overview
This book also does not attempt to provide an in-depth discussion of
each of the forms of lm nance covered. If in-depth coverage were the
goal, a series of books would be needed to adequately cover the main ar-
eas of lm nance: (1) gifts, grants, subsidies and tax incentive programs;
(2) investor nancing; (3) lender nancing; (4) studio and industry
nancing; and (5) international nancing options. For that reason, the
Sources and Further Reading in the back of the book provides numerous
suggestions for readers interested in a particular form of lm nance to
nd additional and more complete information on that topic.
New Additions and Order of Presentation
The contents of this new edition of the book have been expanded sub-
stantially to include the following new topics: gifts and grants; foreign
and domestic state subsidies; the manager-managed LLC (limited li-
ability company); public-private hybrid exemptions; securitization;
product placement; gap and supergap nancing; and insurance-backed
schemes. In addition, the order of presentation has been reversed from
Introduction
3
that used in the previous edition: instead of starting with a discussion
of studio and industry nancing (the least likely to be accessible to the
rst-time producer) and then proceeding to lender nancing, investor
nancing and foreign nancing options, this new edition starts with
those forms of lm nance that may, of necessity, have to be considered
rst by a U.S.-based independent feature lm producer because they are
likely to be more accessible, even if they offer the least amount of funds.
The book then proceeds to discuss other forms of lm nance that may
provide a greater amount of money or that may become available as the
producers career matures. Thus, the new order of the topics covered
is (1) gifts, grants, subsidies and tax incentive programs; (2) investor
nancing; (3) lender nancing; (4) studio and industry nancing; and
(5) international nancing. For many lm producers, the natural order
of progression for the last two broad categories may be reversed; after all,
there is no law requiring that lmmakers proceed in this fashion. They
are free to pursue whatever nancing is available for a particular project
at any given time. Some forms of lm nance simply make more sense
for particular lmmakers at a given stage in their career.
Independent Film Finance
With the exception of the section relating to studio lm nance, most of
the lm-nancing methods presented in this book are considered more
appropriate for the production of independent feature lms and docu-
mentaries. But just what is an independent lm? The Independent Film
and Television Alliance (IFTA, formerly known as the American Film
Marketing Association, or AFMA), a trade association for the indepen-
dent lm and television industry, sets forth an easily applied denition.
Most important for the purposes of this book, the IFTA denition focuses
on how the lm is nanced: It states that a lm should be considered an
independent lm if more than fty percent of its nancing comes from
sources other than the . . . major U.S. studios. The IFTA denition goes
on to indicate that independent productions cover all budget ranges and
genres and are aimed at wide, as well as niche, audiences.
Another industry association, not so directly tied to lm nance and
production, uses a less objective and more difcult to apply denition.
The Film Independent group (FINDformerly IFP/West or IFP/LA)
takes the position that an independent lm is one that exhibits unique-
ness of vision; contains original, provocative subject matter; was produced
using an economy of means (with particular attention paid to total pro-
duction cost and individual compensation); and derived some unstated
percentage of its nancing from independent sources. That means that,
Introduction
4
at the discretion of FIND, lms nanced by the major studios or their
subsidiaries can compete for FIND awards, which may be the purpose of
such a vague denition: It allows FIND to include more well-known stars
in their annual awards ceremony, thus making the organization appear
more glamorous. In the process, however, FIND is literally inviting the
major studio/distributors to gobble up even more of the attention and
market share desperately needed by independent lmmakers. Thus, as
an organization, FIND can hardly be said to effectively represent the
interests of independent lmmakers.
To some extent, both of these denitions seem to be succumbing to
the power of the Hollywood major studio/distributors. After all, if a lm
is 50 percent nanced by a major studio/distributor or one of its afli-
ates, it is most likely also going to be released, at least in the domestic
marketplace, by a major studio/distributor or afliate, which will have
exerted a considerable amount of inuence over both the production and
the distribution; thus, for all practical purposes, it is not an independent
lm, in the ordinary sense of the word. When major studios put up half
of the production nancing for a lm, they tend to have a say in how the
lm is made.
To be more precise in determining whether a given lm is an inde-
pendent lm, it may be relevant to determine which of the three phases
in the life of a lm have been nanced without the aid of any of the
so-called major studio/distributors. In other words, if an independent
producer has been responsible for raising the funds to develop, produce
and distribute a motion picture, that is clearly an independent lm. If, on
the other hand, an independent producer has nanced the development
phase but has used the assistance of a major studio/distributor or one of
its subsidiaries in nancing the production phase in addition to the dis-
tribution of the lm, it would not be accurate to call that an independent
lm. Still further, if an independent producer raised the nancing for the
development and production phases and then merely looked to a major
studio/distributor or to an afliate or subsidiary of one to release the
picture (i.e., the distributor was only responsible for the costs of distribu-
tion and acquired the rights to distribute the lm as a pure acquisition),
that may be considered an independently produced lm that was merely
released by a major studio/distributor, afliate or subsidiary.
The Internet
In this new era of the Internet, a book also has to be written in a way
that complements the information available online. Thus, the extensive
bibliography (i.e., Sources and Further Reading) appearing at the end of
Introduction
5
the book not only includes articles and books but also online sources.
Readers must recognize, however, that websites tend to come and go. In
addition, since anyone can put up a website or post an article, the qual-
ity of the information relating to lm nance appearing online is not
consistent, and some of it may not be reliable. Thus, readers are advised
to proceed cautiously. Never rely on any single source for lm-nancing
information. Learn from as many different sources as possible. And dont
hesitate to check out the credibility of sources. If you nd that someone is
pushing too hard for your acceptance of their point of view, consider their
motives. Many lm nance practitioners do not even know what a conict
of interest is, much less how to appropriately handle such a situation.
Bad Advice
A new feature added to this revised and updated edition of the book is
entitled Bad Advice. Independent lmmakers are often given misinfor-
mation about lm nance, and some of that bad advice has been noted
here so that future lmmakers can recognize and avoid it.
Why Forty-Three?
The choice of forty-three as the number of ways to nance a lm is some-
what arbitrary, but it is based on an early analysis of the question and
an estimate of the number of possible solutions. A number smaller or
larger could have been chosen. In fact, by one count, as many as sixty-two
distinct types of nancing methods are explored in this presentation,
and an even greater number of combinations could be used on a given
lm. Thus, the various forms of lm nance could have been presented
as the Major Types of Film Finance. Certain forms of lm nance that
were covered as separate chapters in the earlier edition (e.g., the three
exemptions under Regulation D) are now covered in one chapter. It just
so happens that forty-three was my original estimate of the number of
forms of lm nance that could be reasonably discussed in a book of this
naturea number not so large as to be overwhelming, but large enough
to suggest the great range of lm-nancing optionsand although dur-
ing the actual writing of the book, various editorial decisions were made,
splitting, combining, adding or omitting chapters, forty-three stayed on
as a comfortable, if not catchy, number.
Availability Analysis
Finally, a book that focuses on providing an analysis of the advantages
and disadvantages of various forms of lm nance, as this one does,
will overlook one of the most important advantages or disadvantages,
Introduction
6
as the case may be, if it does not discuss the availability of such forms
of lm nance; that is, whether a particular form of lm nance would
realistically be available in the marketplace for a particular lmmaker on
a particular project at a given time, regardless of what other advantages
might attract the lmmaker to that form of lm nance. Different forms
of lm nance may be more, or less, available to some people than others,
depending on the specic project, its budget and other lm elements,
along with the relationships and other resources that such persons bring
to the table, and so forth. In addition, reliable availability information
is difcult to come by in the lm industry, if for no other reason than
there is no organization that routinely develops and makes objective,
comprehensive lm-nancing information available to those who need
it (another missed opportunity for the professional associations purport-
edly representing the interests of independent producers). Thus, before
a producer ultimately determines which form of lm nance is best for
a particular lm project at a given time, it is important to objectively
analyze whether that form of lm nance is realistically available for
that person and that project at that particular moment.
Overview and Order of Use
In the normal course of events, a lmmaker might start off as a sole
proprietor and might choose to operate the sole proprietorship under a
ctitious name (or dbadoing business as). The lmmaker may next
choose to bring some start-up funds into the business by seeking gifts,
grants or investment funds through an investor-nancing agreement
or a joint venture agreement. Eventually, the lmmaker may choose to
create an entity to serve as the production company, either a corpora-
tion (so-called regular C corporation or S corp) or a member-managed
limited liability company (LLC). In either case, the creation of such an
entity will provide another opportunity for the lmmaker to raise some
additional start-up funding for the production companys operations.
The next level of nance might come from a privately placed securities
offering of corporate stock (long-term corporate nance) or a privately
placed securities offering through a manager-managed LLC or a limited
partnership (project nancing). Such project nancing may be for a
single motion picture project or a series of lms. It may be combined
with other forms of lm nance, such as gifts, grants, coproductions
(joint ventures), lender nancing, or state, federal and foreign subsidies
and tax incentives.
In the alternative, the lmmaker may want to conduct a public (regis-
tered) securities offering for LP or LLC units. If the venture continues to
Introduction
7
be successful, the lmmaker may choose to take the production company
public as a corporation by conducting a public (registered) offering of
corporate stock. Eventually, the publicly held corporation may want to
offer its shares over-the-counter, on the NASDAQ exchange or on one of
the other stock exchanges. All of these options are treated here.
A Collaborative Process
A lm producer should not try to nance a feature lm alone, unless his
or her intention is simply to produce a home movie. Just as in producing
the lm, the nancing part is also a collaborative venture, and it is very
common these days for producers to use several different forms of lm
nance to fund the production of a single motion picturean arrange-
ment sometimes referred to as combo-nancing. Thus, it makes sense
to utilize the services and expertise of individual associates, executive
producers, attorneys or consultants who know the terrain for each spe-
cialized form of lm nance because it is highly unlikely that any one
individual adviser will have bona de expertise with respect to all the
forms of lm nance.
As examples only, here are several suggested combinations of forms
of lm nance for putting together the needed nancing for an inde-
pendent lm:
Get someone to make a start-up gift of $10,000 (see chapter 1).
Get a grant for another small amount of money (see chapter 1).
Get several people to invest in a start-up production company organized
as a regular C corporation, or as an S corp, or as a member-managed
LLC (but only if the owners are people with whom the producer can
work harmoniously and effectively). The producer invests scripts he or
she has written, acquired or optioned, and the investors invest the pro-
duction companys start-up funds (see Choice of Investment Vehicles
and Entities in the introduction to part two).
Raise development and packaging funds or some portion of the pro-
duction funds through an investor offering to a large group of passive
investors to spread the risk (see part two, Investor Financing, Passive
Investor Vehicles and Securities Compliance).
Raise the balance needed with a domestic negative pickup deal, an in-
ternational negative pickup, foreign presales, state subsidies or interna-
tional tax incentives (see chapter 2, chapters 1924, and chapters 3643).
Again, the order in which a lmmaker moves through the various
available forms of lm nance is not set in stone. The choices will depend
on the lmmakers own background, resources and notions regarding
Introduction
8
the advantages and disadvantages of each form of nance as applied to
that lmmakers current circumstances. Also, somewhere along the way,
the lmmaker may choose to become vertically integrated and not only
engage in production but set up a subsidiary development company, or
an afliated distribution arm, and eventually, maybe even an exhibition
company. Thats what the major studio/distributors did. The company
may also expand horizontally, engaging not only in lm production but
the production of television shows and other media and entertainment
activities. Good luck with all of that!
PART ONE
Subsidies
This rst section of the book brings together several forms of lm nance
that are not generally considered stand-alone nancing methods, in the
sense that such methods are not likely to raise enough money to nance
the entire production of a single motion picture, unless the budget is in
the ultra-low-budget category. However, such lm-nancing methods
may work well in supplementing one or more of the other forms of lm
nance described in later parts of the book. In fact, the various domestic
tax incentive programs described in this part, by their very denition,
are generally used in conjunction with investor nancing techniques so
that investors may benet from the tax incentives.
Cones Pt1Ch1.indd 9 12/20/07 1:46:44 PM
11
1 Gifts and Grants
Financing Films through Gifts
Although it is not likely that a lmmaker will be able to successfully
solicit one or more gifts adequate to fund the entire budget of a feature
lm (unless the budget is extremely low), the lmmaker may want to
start his or her lm-nancing activities by soliciting one or more gifts.
After all, a gift is a voluntary transfer of cash, an asset or other property
made without consideration. In other words, nothing of value has to be
paid back to the donor in return for that transfer.
From a legal point of view, the essential elements of a valid completed
gift of personal property are
the donor is competent and understands the nature of the action taken;
the donors intent is to make a voluntary gift (i.e., donative intent);
either actual or symbolic delivery of the property occurs;
the property is accepted, either actually or imputedly;
the donor completely divests himself/herself of all control; and
there is no consideration for the gift.
It is important for the lmmaker seeking gifts to understand that such
a transfer of personal property may have tax consequences. For example,
receipt of a gift may be excluded from the gross income of the recipient
lmmaker, but the transferor (donor) may be subject to an estate or gift
tax. The relevant Internal Revenue Code provisions need to be consid-
ered, or alternatively, an accountant ought to be consulted. Note that
the federal estate tax has been reduced for the moment, but the issue is
politically active and thus the tax is subject to change.
Estate Tax
As just noted, the status of the federal estate tax is in ux for the mo-
ment and may continue that way for some years to come. In 2001 a tax
package was signed into law that included a repeal of the estate tax, but that
provision was not designed to start until the year 2010. In the meantime,
Subsidies
12
the size of estates eligible for the tax exemption increased from $675,000
in 2001 to $1 million in 2002 and 2003, $1.5 million in 2004 and 2005, $2
million in 2006 through 2008 and $3.5 million in 2009. When the year
2010 arrives, the estate tax is supposed to end. The heirs of people who
die in 2010 may be able to avoid the estate tax altogether. However, the
repeal is temporary. The legislation contained a so-called sunset provision
that would bring the current estate tax rules back in force in 2011. At that
time, the debate over the estate tax may resume. In the meantime, some
proponents of estate tax repeal have been advocating passage of a law that
would make such tax cuts permanent.
Gift Tax
As a general rule, in the United States a federal gift tax is imposed on
transfers of property by gift during the transferors lifetime (IRC Section
2501), but most states do not impose such a tax. The gift tax is imposed
on every gift except those subject to specic exclusions under the law. For
example, charitable gifts are excluded from the tax. On the other hand,
gifts to a spouse are not excluded but are entitled to a deduction that
results in there being no tax on gifts between citizen-spouses.
Generally, the gift tax rate ranges from 37 to 49 percent of the value
of the gift. However, there is a provision in the law that allows donors to
make gifts each year up to a certain amount to any person, and there is
no limit on the number of persons who can receive those gifts. Formerly
the limit was $10,000 each year per person, but the limit has now been
increased to $11,000. In other words, a donor can now make as many
$11,000 gifts as he or she desires each year without incurring any gift tax
obligation, as long as no one person receives more than $11,000 from the
same donor in any one calendar year. That means, of course, that a donor
could give a lmmaker $11,000 in late December and another $11,000 in
early January without being subject to the gift tax in either year.
By taking advantage of this annual exclusion provision in the law,
the federal gift tax law permits donors to reduce the size of their estates
by making $11,000 gifts each year to as many people as they wish. Such
gifts can be made to children, grandchildren, great grandchildren, other
relatives, friends or anyone elseincluding lmmakers. The relationship
between the donor and the recipient does not matter. The value of the
gift is the amount of money given away or the fair market value of any
property given away calculated as of the date of the gift. This technique of
making annual exclusion gifts can result in substantial savings of federal
estate taxes for the donors family, assuming the donors estate would be
subject to the estate tax.
Gifts and Grants
13
Filmmakers need to know that in addition to helping lmmakers get
started, making gifts can be an excellent way for donors to reduce taxes,
and tax reduction may be the motivation for such gifts. The basic principle
involved is that when donors give something away while they are alive, it
will not be a part of their estate when they die and therefore their heirs will
not have to pay taxes on it. On the other hand, if the estate tax is nally and
permanently abolished, this motivation to make gifts will disappear.
As is often the case, this area of the law is quite technical and may
change from year to year; thus, if a lmmaker is placing signicant reli-
ance on gifts for funding some of the development or production costs of
a lm, an attorney or accountant should be consulted for a review of the
current status of such laws. In any case, lmmakers may want to talk to
wealthy individuals about helping to nance their lm through gifts that
reduce the size of the donors estate and avoid any gift tax.
Advantages
No obligation to return or pay back. The recipient does not have to pay
a gift back to the donor.
Current enjoyment. Recipients can currently enjoy the benets of the
gift (i.e., use the gift to help produce a lm).
Tax advantages for donor. A donor may be able to avoid federal estate
tax on gifted property. The estate or inheritance tax on appreciation in
value after the date of the gift may also be avoided.
Tax advantages for recipient. Income from the gifted property may
be taxed at a lower income tax rate (assuming the recipients income is
substantially less than the donors).
Disadvantages
Loss of control. Donor loses control over the gifted property.
Loss of income. Donor cannot retain income from the gifted property.
No return. Donor cannot demand return of the gifted property.
Creditors claims. Gifted property may be subject to claims of the
recipients creditors.
Divorce proceedings. Gifted property may be subject to divorce pro-
ceedings of the recipient.
Medicaid eligibility. The donors eligibility for assistance from Medicaid
for nursing home expenses may be affected.
Financing Films with Grants
Grants for lmmakers may come from foundations, government agencies,
large corporations, lm festivals, arts organizations and other groups.
Subsidies
14
Grants may be intended to fund and encourage screenwriters, students,
women or minority directors, or the production of films relating to
certain subjects of interest to the grantor. They may be intended to fund
controversial or experimental lms or specic ideas or causes, such as
strengthening organizations that address poverty and injustice or promote
democratic values, international cooperation and human achievement.
They may be specically designed to cover the costs of development, pro-
duction or postproduction, or may be used as so-called nishing funds,
or even to cover the cost of distributor delivery items. They also may be
targeted at specic populations or residents of certain cities or states.
Most grants are cash awards, but some may be for materials or equip-
ment. Other sources may characterize their grants as so-called recoverable
grants, loans or loan guarantees. In some instances, the grant organiza-
tion may require the production company to match the grant with funds
from other sources. Some grant-making organizations require that activi-
ties supported by grants and program-related investments be charitable,
educational or scientic, as dened under the appropriate provisions of
the U.S. Internal Revenue Code and Treasury Department regulations.
Seeking one or more grants can be extremely competitive. Grant source
funds are limited in relation to the great number of worthwhile propos-
als received. Some grant-making organizations will receive as many as
40,000 grant requests in a given year.
Research Phase
Asking a foundation or any organization for money and actually get-
ting it may be more overwhelming for a lmmaker than actually produc-
ing the lm. The initial task is to identify one or more sources of grants
that may benet the planned production. That means going online, going
to the library or going to the bookstore to locate sources of information
on organizations that make grants.
Then the grant research portion of the project has to be narrowed to
grants relating to lms. That research has to be focused even more: to nd
organizations that make grants for the specic kind of lm the producer
intends to produce. Be encouraged by the fact that many foundations are
specically created for the purpose of giving away money. The producers
objective is to persuade one or more of these organizations to award that
money to a particular lm project instead of to competing projects.
Most experts in the eld recommend that this research phase be han-
dled very carefully, and that is why it is so time-consuming. It is essential
to learn which organizations may show serious interest in the subject
matter of the proposed lm. On the other hand, many foundations and
Gifts and Grants
15
other organizations do not have specic funding programs for lms, but
often they have mission statements that will provide useful guidance. A
producer seeking a grant must study the foundation, its grant program,
the programs guidelines, the organizations annual report and any other
information that will aid in the evaluation of how a proposed lm may
advance the mission of the organization.
The Grantsmart.org website, http://www.grantsmart.org, provides a
searchable database with more than 480,000 tax returns led by more
than 95,000 private foundations and charitable trusts. The data are sup-
plied to the site in raw form by the IRS and are updated on a continuing
basis. By law, these tax returns are public records, and they may prove
useful in the lmmakers search for a grant source.
Another valuable online resource may be found at the website for the
New York Foundation for the Arts, http://www.nyfa.org. The site provides
information on helpful articles, online resources, books, funder directo-
ries and writing guides. The resource page may be found at http://www.
nyfa.org/leve13.asp?id=209&d=1&sid=51.
Once such a match is identied, the producer may want to contact the
organization directly to gain more insight into the nature of its interest.
It may even become necessary to embark on a campaign to persuade the
organization that the proposed lm would be a good way to advance the
organizations mission statement. That sometimes means getting involved
with people in the organization. That is where the lmmakers social
skills and politics sometimes come in to play. This type of research and
personal involvement is all designed to help the lm producer develop
a tailor-made application for an available grant. Using the shotgun ap-
proach of sending out generic proposals to many possible grant sources
is not generally recommended.
It is important to review the grant organizations requirements regard-
ing rights to the results of a grant (i.e., so-called grant products) to make
sure that those rights are consistent with the producers planned use of the
lm production. Some programs will require an acknowledgment (e.g.,
screen credit) on all funded materials and products. The grant organiza-
tion may also reserve a royalty-free, nonexclusive and irrevocable right to
reproduce, publish or otherwise use a work produced with its funding.
Some may even want the grant money to be repaid if the project makes
a prot. It is important to know these requirements going in and to plan
for them. The process of seeking grants gets even more complicated if an
applicant is trying to obtain grant money from several sources. Then it
is necessary to make sure the rights requirements of each organization
are consistent with each other.
Subsidies
16
Some grant-making organizations limit their grant funds to orga-
nizations or restrict the number of grants made to individuals. So it is
important to note whether only individuals or only entities (or both) are
eligible for the grant; and if an individual, whether that individual must
be a U.S. citizen, must reside in a particular state or city and must have
resided in any particular place for a period of time prior to the applica-
tion being submitted.
Application Process
Some grant programs will allow a prospective grant applicant to send
in a brief letter of inquiry before a request is made for a grant or program-
related investment. Through such a letter, the prospective grant applicant
may be able to determine whether the foundations present interests and
funds permit consideration of the request.
Such a letter may include
the purpose of the project for which funds are being requested;
problems and issues the proposed project intends to address;
information about the production company proposing to produce
the lm;
the estimated overall budget for the project;
the period of time for which funds are requested; and
the qualications of those who will be working on the lm.
Then after receiving the letter, the grant organizations staff members
may ask the grant seeker to submit a formal proposal, or point out why
there is not a good t between the two. Usually, grant organizations will
eventually require some form of more formal proposal or application. In
other cases, there are no grant application forms. A grant application may
have several components, including a cover sheet, narrative portion and
budget. Each grant program will provide special instructionsprogram
guidelineson how to prepare an application for their grants. These
should be reviewed carefully before beginning to prepare the applica-
tion. Look for information about the focus of the program, the eligibility
requirements and the types of funding offered. A lm producer needs
to make certain that he or she qualies for the particular grant, since a
considerable amount of time can be wasted if it is learned after the fact
that the lmmaker or project are not eligible and therefore could not
even be seriously considered for a particular grant.
Although each prospective grant source will have its own specic re-
quirements, grant proposals without application forms typically include
Gifts and Grants
17
the nancial status of the production company;
a description of the proposed lm and how and where it will be produced;
the names and biographical information for those attached to the lm;
a detailed lm production budget;
a description of the present means of support for the production company;
the status of applications to other possible funding sources; and
the legal and tax status of the lm production company seeking the
grant.
Unfortunately, there is no standard application form. So applications
will have to be customized for each potential grant. One of the primary
grant-writing skills is simply the ability to write effectively. If, as a lm-
maker, writing is not one of your strong points, then clearly you will want
the assistance of someone else who has those skills when applying for
grants. There are professional grant-writing consultants who may be able
to help in this process, but they also will either charge money up front, on
a monthly basis or at least take a percentage of the money raised. Bringing
someone with grant-writing expertise on board as a coproducer may be
the dream of the producer seeking grants, but that situation is likely to
be rare in the real world. Sometimes bringing on a more experienced lm
producer will enhance the strength of the grant application, regardless of
whether the person has grant-writing skills, and so will putting together
an experienced team of lmmakers to demonstrate that your group has
the capability of producing a quality lm. Others even suggest that a
lm producer should surround himself or herself with an experienced
board of advisers to both gain their good advice and help strengthen the
grant application.
Often the application itself will ask whether the applicant has received
other grants. Apparently many grant sources find the indication of
commitment by other grantors reassuring, particularly in cases where
they know that their own grant alone is not sufcient to complete the
proposed project.
Experienced grant writers advise that applications for grants need
to be studied carefully. Any particular grant application may be one
of hundreds or even thousands that are being submitted to a given
grant source during a single grant season. Answers that write around
a question or do not otherwise answer the question asked will reduce
the chances of the application being well received. The same is true for
incomplete applications. Grant consultants consider the following to
be some of the more common characteristics of grant applications that
are not very persuasive:
Subsidies
18
not really understanding the mission of the potential grant source;
providing information that is not consistent with the grants guidelines;
choosing to apply to a grant source that is not a good t for the lm;
failing to answer all of the questions or failing to provide adequate
information in response to one or more questions; and
signicantly underestimating the cost of making the lm, or grossly
overstating the lms budget.
Some grant providers are available to offer advice about preparing a
proposal, to supply examples of grant applications and even to review
preliminary drafts (for most programs, if they are submitted well before
the deadline). Producers should pay close attention to each programs
instructions on how to submit the application, whether by mail or online.
If the requirement is for mail, an online application is likely to be ignored.
Note also that even if formal applications cannot be accepted by email
or fax, a particular grantor may encourage the use of fax or email for
other kinds of correspondence, including inquiries, preliminary drafts,
recommendations or reports. To ensure that the application is processed
in a timely fashion, the envelope or package used to send the application
materials should prominently display the producers return address and
should not be covered with tape.
Each grant program will have its own deadline. If cutting it close,
double-check whether the deadline is based on receipt of the applica-
tion or its postmark.
Some grant organizations consider applications throughout the year. In
some instances, a grant applicant will have to wait seven to eight months
after the deadline to get a decision. On the other hand, applicants to some
grant organizations may at least receive within six weeks an indication
of whether their proposals are within the grant organizations program
interests and budget limitations.
Grant Monitoring
Most grant organizations engage in some form of monitoring activi-
ties that may consist of regular nancial and narrative reports submit-
ted by the grantee. During the course of a grant, some grant programs
send representatives out to actually visit with the grantee onsite. They
review the grantees periodic nancial and narrative reports and share
them with a grants administrator and occasionally an attorney who also
reviews them and provides comments. The grantee may be asked to at-
tend meetings the organization convenes to discuss current and future
program strategy. In other cases, the grant-making organization may hire
Gifts and Grants
19
consultants to help monitor groups of grants or a single grantees work.
Monitoring is designed to ensure that the funds are used for approved
and lawful purposes and to see whether those purposes are contributing
to the grant-making organizations larger goals.
Latino Public Broadcasting Grants
One example of a sponsored grant program for a specific type of
lm is that of the Latino Public Broadcasting (LPB) organization. The
group holds an annual open call for independent producers throughout
the United States in the rst week of June to apply for funding for the
development, production and distribution of television programming
that represents Latinos and their culture. Made-fortelevision movies
and documentaries are included. For four months before each years
open call, LPB executives travel around the country, holding workshops
to inform producers how to apply for funding.
Independent producers, who apply for funding from LPB may expect to
receive grants between $5,000 and $100,000 to help support their projects
at any phase of production. While the LPB program focuses primarily on
the promotion of Latino projects and subject matter, its target audience
is not strictly Latino. The idea is for the projects to have a broad appeal.
At the same time, the programming supported by LPB is noncommercial
and conveys educational and cultural messages. The organization reports
that it has seen a large increase in the number of proposals received at
open calls in recent years. It may see as many as 135 proposals in a given
year, from which only about 14 are selected for funding.
Latino Public Broadcasting was created in 1998 by Edward James
Olmos and Marlene Dernier and is part of the National Minority Con-
sortia, a division of the Corporation for Public Broadcasting (CPB). The
Minority Consortia includes ve divisions, each of which receives fund-
ing from the CPB to nance programs representative of their respective
minority communities.
Advantages
Only possible funding source. One or more grants may be the only avail-
able funding source for certain lm projects that are highly specialized
or targeted at small, specic groups and that are not expected to make
a prot.
No obligation to repay. Often, but not always, a lmmaker awarded a
grant is not expected to repay the money.
Combination nancing. Small grants might be combined with other
forms of lm nance to bring a movie to the screen.
Subsidies
20
Disadvantages
Grants too small. Relative to the cost of producing a feature lm or
even a documentary, grants are rarely large enough to play a signicant
role in funding a feature-length movie.
Lots of research involved. A considerable amount of research is gener-
ally required to identify potential grant sources and to determine more
specically whether an application relating to a specic lm project is
appropriate to any given grant source. Thorough grant research may
require the review of hundreds, if not thousands, of possibilities, some
from outside the subject area of lmmaking.
Challenge of grant writing. Properly completing or drafting the grant
application can be a tedious and time-consuming activity.
Professional assistance. The expert assistance of a grant consultant may
be required to reduce the time and effort involved in research and grant
writing, and such assistance may cost money.
Extremely competitive. Seeking grants for any purpose is generally a
very competitive eld and sometimes politicalgetting one or more
grants is usually a long shot at best.
Takes time. The passage of a considerable amount of time is usually
involved in obtaining grantsresearch time, writing of the grant applica-
tion, waiting for the decision and actually receiving the check.
Monitoring required. The way in which the funds are being spent is
likely to be monitored by the grant-making organization.
21
2 Domestic Government Subsidies and
Tax Incentives
It may not be quite accurate to consider tax incentives as a stand-alone
form of lm nance. In all fairness, tax incentives function more as a
supplement to investor nancing, in the sense that they provide additional
motivation for investors to invest. Many investors are partly motivated by
the opportunity to get tax deductions from their investments, whether in
lm production or otherwise. Recently in the United States, federal and
state governments have begun passing various forms of tax incentives to
encourage investment in U.S.-made lms, while also discouraging run-
away productions going to Canada and elsewhere. For the purposes of
this book, domestic tax incentives are discussed separately from investor
nancing here.
The Federal Approach
When Congress passed the American Jobs Creation Act of 2004 (contain-
ing special rules for certain lm and television productionsSection 244
of HR 4520) and the president signed the legislation into law in October
of that year (later codied as IRC Section 181), many in the Hollywood-
based U.S. lm industry cheered and predicted great things for the future
of lm production in the United States. At the time of this writing, it was
still too early to tell how much of an impact the legislation would have
on the nancing of lm production domestically, and more specically,
whether it would move signicant amounts of investor funds into lm
production as intended. In addition, as of the early months of 2005,
there were already reports of talk in Congress about the possible repeal
of some elements of the new tax incentives for lm. Such is the nature of
government-provided tax incentives.
To summarize, the Special Rules for Certain Film and Television
Productions found at Section 244 of the American Jobs Creation Act of
2004 apply to lms produced after October 22, 2004, and before January 1,
2009. The legislation would allow the investor members of an entity such
Cones Ch2.indd 21 12/20/07 1:46:54 PM
Subsidies
22
as a limited partnership or limited liability company that has acquired
the rights to produce a feature lm to elect to deduct their pro rata share
of 100 percent of the direct and indirect costs of producing the lm as
an expense for the taxable year in which the costs of production are rst
incurred, so long as the aggregate cost of the lm does not exceed $15
million and 75 percent of the total compensation paid to actors, directors,
producers and other relevant production personnel working on the lm
is paid for services performed in the United States.
More specically, the legislation provides that a taxpayer may elect
to treat the cost of any qualied lm (and in some instances, television
productions) as an expense that is not chargeable to a capital account
and to take such costs as allowable deductions. The deductions, however,
are limited in that they do not apply to any qualied lm or television
production the aggregate cost of which exceeds $15 million. However, in
the case of any qualied lm production the aggregate cost of which is
signicantly incurred in an area eligible for designation as either a speci-
ed low-income community or a specied distressed county or isolated
area of distress, the ceiling on the aggregate cost for which deductions
may be allowed can go as high as $20 million. Taxpayers making such
an election will not be allowed to use any other form of depreciation or
amortization deduction relating to the same expenses in that tax year.
The term qualied lm as used in the legislation means certain pro-
ductions, as further described in the law, in which 75 percent of the total
compensation of the production is qualied compensation. The term
qualied compensation means compensation for services performed in the
United States by actors, directors, producers and other relevant production
personnel. The term compensation does not include participations and
residuals. However, IRS temporary regulations (Internal Revenue Bulletin:
200712, March 19, 2007, T. D. 9312) provide that these P and R costs are
considered production costs for purposes of the production cost limit.
The taxpayers election to take this deduction needs to be made by the
due date (including extensions) for ling the tax return for the taxable
year in which costs of the production are rst incurred. In addition, such
an election cannot be revoked without the governments consent.
Thus, in effect, this legislation moves the date of deductibility for lm
production expenses forward from the date the lm is placed in com-
merce (the old rule), to the date in which the expense is incurred (the new
rule). This might mean the deduction is available to a taxpayer-investor
one or two years earlier in most instances. In addition, the legislation en-
larges the percentage of deductibility for a lms production expenses.
Cones Ch2.indd 22 12/20/07 1:46:54 PM
Domestic Government Subsidies and Tax Incentives
23
However, Variety ran a headline as early as January 18, 2005, suggesting
that Congress was likely to make some revisions to the new tax provi-
sions (see Congress Likely to Take Back Indie Pix Tax Break). Be sure
to review the latest developments in the tax law before relying on the
provisions in existence as of this writing.
Right or Wrong Solution
The problem of so-called runaway production, referring to lm pro-
duction companies taking their operations out of the country to lower
their costs, is the supposed reason for asking both federal and state gov-
ernments to provide special tax incentives for the domestic production of
feature lms. But the problem is not necessarily caused solely by foreign
government subsidies; rather there are other contributing factors that
include the decisions made by U.S.-based lm company executives who
try to save money by seeking cheaper production costs, as opposed to
reducing the salaries of major star talent or their own executive salaries.
It is even possible that the practices of foreign governments offering lm
subsidies are not the real problem at all. Maybe the real culprits are the
Hollywood major studio/distributors who, for nearly one hundred years,
have used anticompetitive business practices to gain dominance over
lm distribution even in foreign countries (see 337 Reported Business
Practices of the Major Studio/Distributors; and Hollywood Wars: How
Insiders Gained and Maintain Illegitimate Control over the Film Industry).
When these other countries reacted to protect their own interests by
providing lm subsidies (i.e., when they hit us back), then the American
lm production community reacted to that by seeking government help.
Maybe the U.S. government is being asked for the wrong service. Instead
of trying to stop the foreign government subsidies or being drawn into
a never-ending spiral of competing subsidies, maybe our governments,
federal and state, should join with the governments of other countries
to investigate the business practices of the Hollywood-based major stu-
dio/distributors. That is the genesis of the problem.
Advantage
Faster deductions. The new U.S. tax law (HR 4520 or IRC Section 181)
allows production expenses to be deducted more quickly.
Disadvantages
Constantly changing. Just as other governments across the globe
manipulate tax incentives for political reasons, the U.S. government is
Cones Ch2.indd 23 12/20/07 1:46:54 PM
Subsidies
24
constantly changing the rules or even, in some instances, taking away or
threatening to take away the incentives altogether.
A fairness problem. Tax deductions provided to wealthy taxpayers to
support a particular industry, such as the lm industry, merely shift the
burden to other taxpayers, who pay more taxes to make up the lost rev-
enue. Many consider this sort of government activity to be inappropriate
and even unconstitutional.
State Tax Incentives
Most of the fty states offer some form of tax incentive to encourage
lm production in their state (some thirty or more states do this). These
sorts of tax incentives, provided to a particular industry over other in-
dustries, are often hotly debated in the state legislatures, and for good
reason. They provide examples of the quintessential special interest in
conict with the general publics welfare. After all, what small industry
wouldnt want a special government subsidy or tax incentive to help it
prosper?
The specic incentives change from time to time. Thus, any listing
of them will always be out of date in some respect. Some such listings
do appear online at several lm-related sites and can serve as a starting
point for researching available tax incentives in states of interest. The
better practice, however, is to contact the state lm commission in each
of the states being considered and obtain the most current information
directly from such ofces.
In addition to state lm commission ofces, some regions and cities
also fund and staff lm commissions that can provide helpful informa-
tion. There are approximately 350 lm commission ofces worldwide,
representing countries, regions and cities. The information that follows
provides some examples of the tax incentives offered by selected states
that may be available to lmmakers. It also provides a collection and re-
statement of the arguments often used on both sides of this lm industry
debate, along with a listing of advantages and disadvantages of state-level
tax incentives, as well as sources for additional information.
Florida Film Finance Incentives
Any company engaged in producing lmed entertainment in Florida
may submit an application to the Florida Ofce of Film and Entertain-
ment for the purpose of determining qualication for reimbursement on
a percentage of qualied expenditures.
Florida entertainment sales tax exemption. Qualied production com-
panies engaged in Florida in the production of motion pictures, made-
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25
for-television motion pictures, television series, commercial advertising,
music videos or sound recordings may be eligible for a sales-and-use tax
exemption on the purchase or lease of certain items used exclusively as
an integral part of the production activities in Florida.
Sales tax exemption at point-of-sale. Florida does not require the pay-
ment of sales taxes on the sale or lease of motion picture, television or
sound-recording equipment. This exemption takes place at the point of
sale. In order to be exempt from Floridas sales tax at the point of sale,
the production company must apply for a certicate of exemption to be
presented to a registered Florida sales-and-use tax dealer when making
purchases and rentals of qualied production equipment.
The form and instructions needed to apply for the Entertainment
Industry Qualied Production Company Certicate of Exemption (form
DR-230) can be viewed online and printed from http://www.lmin-
orida.com/i/incentives.asp. The certicate can be renewed for either
a 12-month or 90-day period.
Other Florida tax incentives. Florida does not require the payment of
any tax on artistic or copyright material on master tapes, master lms,
master records and master videotapes. Transactions involving masters are
taxed only on the value of the blank lm, tape or other tangible personal
property. The value of all the major cost components of making a master,
such as artistic services, processing, copyrights and royalties, is excluded
from taxation when the master is sold or leased.
Florida does not impose a tax on the rent or lease of real property
used as an integral part of a motion picture production. The renting of
studios, soundstages, lots, buildings or any other real estate is exempt.
This exemption applies to small, independent operations and to major
studio facilities.
In addition, Florida does not impose a tax on labor to produce a lm,
commercial or sound recording made for a companys own use. Also,
Florida is one of only seven states that have no personal income tax and
no tax on inventory or goods in transit.
Hawaiian Tax Incentives
The State of Hawaii offers two tax incentives that may be applied to
lm production in that state. One is an investment tax credit based on
Hawaiis 2001 Session Laws (Act 221). This provision allows the state to
grant 100 percent tax credits to local investors in movie productions that
qualify. The second Hawaiian tax incentive is the Motion Picture and
Film Production Income Tax Credit, which is a refundable tax credit for
lm productions that take place in Hawaii.
Cones Ch2.indd 25 12/20/07 1:46:55 PM
Subsidies
26
Investment tax credit. In order to take advantage of the Hawaiian in-
vestment tax credit, the business must employ individuals, own capital
or property or maintain an ofce in Hawaii and qualify under one of the
performing arts provisions of the law. The credit is nonrefundable but
is deductible from the Hawaiian investors net state income tax liability
up to a maximum of $2 million a year, per investor. The tax credit is ap-
plied in percentages, over a ve-year period.
Production income tax credit. In order to take advantage of the refund-
able production tax credit, a lm producer has to get the Hawaii Film
Ofce to send a letter to the Hawaii Department of Taxation certifying
that the lm production actually occurred. An income tax return and
the Motion Picture and Film Production Income Tax Credit Request
(on state form N-316) must then be led with the Hawaii Department
of Taxation.
Qualifying productions may receive, as a production income tax credit,
4 percent of the total production expenditures incurred during the lms
production in Hawaii, including purchases and payroll, as well as a credit
amounting to 7.25 percent of hotel room taxes incurred during production
in Hawaii. In order to receive 100 percent of these credits,
a Hawaiian name or word must be in the title;
the lm needs to depict Hawaiian scenery, culture or products;
at least $2 million must be spent during production in Hawaii; and
a distribution agreement covering a minimum of 66 percent of the U.S.
market must be in place (evidence of domestic/foreign distribution may
be substituted).
The Hawaiian lm production income tax credit must be claimed on a
state income tax return led within one year after the close of the taxable
year during which principal photography began in Hawaii.
Illinois Film Production Services Tax Credit Act
Illinoiss Film Production Services Tax Credit provides a 25 percent tax
credit on Illinois income tax for wages paid by a production company to
each employee that is an Illinois resident. Production companies must
also be willing to promote diversity by hiring a certain percentage of
minorities or by participating in a job-training, education or recruit-
ment program.
Tax credit eligibility. The Illinois Film Production Services Tax Credit is
limited to the rst $25,000 of wages paid to each employee of the produc-
tion. To be eligible for the tax credit, a production of 30 minutes or less
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27
must pay at least $50,000 in wages, while productions of 30 minutes or
more must pay at least $100,000 in wages. The salaries for the two high-
est paid employees of the production are excluded. The tax credit has to
directly contribute to the productions lming in Illinois.
Application requirements. Written applications are required and must
be submitted prior to lming activity on an application form provided
by the Illinois Film Ofce. The applicant will be asked to provide the
following information:
production title;
full script;
type of production: lm, television series, movie-of-the-week (MOW),
commercial, music video, documentary;
length of production;
number of planned shooting days in Illinois;
total budget of production;
estimated total salary and wages;
estimated number of Illinois residents to be hired to work on the pro-
duction;
percentage of minority workers in Illinois that the applicant plans to
employ to perform work on the production;
documentation on the applicants intention to participate in training,
education and recruitment programs; and
documentation showing that the Illinois lm production services tax
credit is essential to the decision to lm in Illinois.
Tax credit exclusions. The following types of programs cannot take
advantage of the Illinois lm production services tax credit:
news, current events or public programming, or a program that includes
weather or market reports;
talk shows, games, questionnaires or contests;
sports events or activities; and
awards shows, galas or telethons.
Out-of-state applicants. If an applicant is not an Illinois taxpayer (i.e.,
has no Illinois income tax liability), the applicant may use one of the fol-
lowing structures in order to be eligible for the Illinois lm production
services tax credit:
establish a partnership or an LLC (limited liability company) in Illinois;
establish a subsidiary company registered to do business in Illinois; or
contract with an Illinois taxpayer to coproduce the production.
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Subsidies
28
For more information, contact the Illinois Film Ofce.
Louisiana Motion Picture Incentive Act
Louisianas Motion Picture Incentive Program was created by state
legislation passed in July of 2002. It provides three separate sets of pro-
duction initiatives: (1) a sales-and-use tax exclusion, (2) an employment
tax credit and (3) an investment tax credit. The Louisiana Motion Picture
Incentive Program was created in order to achieve three basic goals:
to encourage lm and video production in Louisiana;
to advocate the hiring of Louisiana technical crew and talent; and
to support and encourage the use of Louisiana equipment and services
related to lm and video production.
A non-Louisiana producer or production company seeking to take
advantage of the Louisiana tax incentives may have to coproduce with a
Louisiana-based production company or establish a Louisiana LLC with
Louisiana-based investors to whom the tax credits can be transferred.
sales-and-use tax exclusion
The Louisiana Motion Picture Incentive Act grants an exclusion from the
state sales-and-use tax (4 percent). A lm production company will be
granted the exclusion if it reports anticipated expenditures of $250,000
or more from a checking account in a nancial institution in Louisiana
in connection with lming or production of one or more nationally dis-
tributed motion pictures, videos, television series or commercials in the
state of Louisiana within any consecutive 12-month period.
Eligibility. Eligible applicants are motion picture production companies
that report anticipated expenditures in the state that in the aggregate
equal or exceed $250,000 in connection with the lming or production of
one or more motion pictures in the state within a consecutive 12-month
period. An eligible applicants expenditures must be made from a check-
ing account at any nancial institution in Louisiana.
Application procedure. The Louisiana Ofce of Film and Television
Development provides a standard form that applicants need to use in
applying for the sales-and-use tax exclusion. The application asks for
name of the production company;
phone number of the production company;
name of the producer;
name and phone number of a company contact person;
dates of rst preproduction activity and production dates in Louisiana;
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29
production ofce address and phone number in Louisiana;
total budget of the project;
total anticipated expenditures in Louisiana; and
synopsis of the project.
Submission and review procedure. Applicants must submit their
completed application to the director of the Louisiana Ofce of Film
and Television Development. Submitted applications will be reviewed
and evaluated by the director. Upon determination that an application
meets the eligibility for this program, the director will then forward the
application for approval to the Secretary of the Louisiana Department
of Economic Development.
Recapture provision. A motion picture production company that fails
to expend the required $250,000 within a consecutive 12-month period
will be liable for the sales-and-use taxes that would have been paid had
the approval not been granted. In such cases, the sales-and-use taxes will
be considered due as of the date that taxable expenditures were made.
Reporting requirements. The production company applicant will be
required to complete an expenditure questionnaire on a form provided
by the Louisiana Film and Video Commission (Commission).
employment tax credi t
Louisianas law provides that a motion picture production company is
entitled to a tax credit for the employment of Louisiana residents in con-
nection with the production of a nationally distributed motion picture,
video, television series or commercial made in Louisiana. The credit is
equal to 10 percent of the total aggregate payroll for Louisiana residents
employed in connection with such a production when total production
costs in Louisiana equal or exceed $300,000 but are less than $1 million
during the taxable year, which increases to 20 percent when the total pro-
duction costs in Louisiana equal or exceed $1 million during the taxable
year. The term total aggregate payroll does not include the salary of any
employee whose salary is equal to or greater than $1 million.
The credit may be applied to any income tax or corporation franchise
tax liability applicable to the motion picture production company. If the
company is not subject to income or franchise tax (e.g., a limited partner-
ship or limited liability company), the credit ows through its partners
or members in the following manner:
corporate partners or members are to claim their share of the credit on
their corporation income or corporation franchise tax returns;
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Subsidies
30
individual partners or members are to claim their share on their indi-
vidual income tax returns; and
partners or members that are estates or trusts are to claim their share
of the credit on their duciary income tax returns.
Any unused credit may be carried forward no more than 10 years from
the date the credit was earned.
Eligibility. Motion picture production companies are eligible for the 10
percent Louisiana state tax credit if production costs spent in Louisiana
on the qualifying lm or other production equal or exceed $300,000, but
are less than $1 million during the taxable year. Motion picture produc-
tion companies are eligible for the 20 percent Louisiana state tax credit
if production costs spent in Louisiana on the qualifying lm or other
production equal or exceed $1 million dollars during the taxable year.
Amount of credit. The credit is based on the total aggregate payroll of
the employment of Louisiana residents.
Application procedure. The Commission provides a standard form that
applicants need to use when applying for the tax credit. The application
is similar to that used for the sales-and-use tax exclusion.
Submission and review procedure. Applicants must submit their com-
pleted application to the Director of the Louisiana Film and Video Com-
mission. Submitted applications will be reviewed and evaluated by the
director. Upon determination that an application meets the eligibility for
this program, the director will send a certication letter to the production
company and the Louisiana Department of Revenue.
Reporting requirements. The production company is required to com-
plete and submit an expenditure questionnaire on a form provided by the
Commission, along with a nal cast and crew list for the project.
i nvestment tax credi t
The State of Louisiana also offers a tax credit against state income tax for
taxpayers domiciled and headquartered in Louisiana. The stated objective
of the Louisiana tax credit is to attract private investment for the pro-
duction of nationally distributed feature-length lms, videos, television
programs or commercials made in Louisiana, in whole or in part, for
theatrical or television viewing or as a television pilot. Further, the state
hopes by means of the tax credit to encourage development in Louisiana
of a strong capital base for motion pictures, in order to achieve a more
independent and economically sustainable lm and video industry.
Amount of tax credit. Investors earn the tax credit at the time of their
investment. If the total base investment is greater than $300,000 and
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31
less than or equal to $8 million dollars, each taxpayer will be allowed a
tax credit of 10 percent of the actual investment made by that taxpayer.
If the total base investment is greater than $8 million dollars, each tax-
payer will be allowed a tax credit of 15 percent of the investment made
by that taxpayer.
Application for state certication. Again, the Commission provides a
standard form for applicants to use in applying for state certication.
Submission and review procedure. Applicants must submit their com-
pleted application to the director of the Ofce of Film and Television De-
velopment. Submitted applications will be reviewed and evaluated by the
director of that ofce. Upon determination that an application meets the
criteria for this program, the director will send a certication letter to the
investors and the Louisiana Secretary of the Department of Revenue.
Unused credit. In the event the entire credit cannot be used in the year
earned, any remaining credit may be carried forward and applied against
state income tax liabilities for the subsequent 10 years.
Audits. A motion picture company applying for the investment tax
credit will be required to reimburse the Louisiana Department of Revenue
for any audits required in relation to granting it.
Reporting requirements. The production company is required to submit
a report evidencing the total base investment made in Louisiana, along
with a completed expenditure questionnaire (on a form provided by the
Commission) and a nal cast and crew list for the project.
Recapture of credits. If an investor received credit for funds not actually
invested and expended in a state-certied production within 24 months
of the date the credits were earned, then the investors state income tax
for that taxable period will be increased by the amount necessary for the
recapture of those previously granted credits.
Procedure for recovery. The Louisiana Secretary of Revenue may recover
investor credits previously granted to an applicant, but later disallowed,
through any collection remedy authorized by state law.
New York Tax Credit
The State of New York offers a production tax credit program. Among
the benets is a 10 percent credit for below-the-line costs, provided that
at least 75 percent of these costs are spent at a New York State soundstage.
If below-the-line expenditures amount to less than $3 million, location
shoots also are eligible for credit.
The production scheme is capped at $25 million each year and credit
is distributed on a rst-come, rst-served basis. New York City offers
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32
an additional 5 percent credit on production costs, as well as help with
marketing, location scouting and sourcing.
New Mexico Tax Incentives
New Mexico offers a gross receipts tax deduction on certain produc-
tion costs at the point of sale. In order to benet from the deduction,
production companies lming in New Mexico have to apply for an
exemption certicate.
In addition, New Mexico offers a lm production tax credit. It is a
fully refundable tax credit of 15 percent for eligible production costs
that may be deducted from the income tax of a New Mexicobased pro-
duction company or producer. Thus, producers not from New Mexico
may want to coproduce a suitable lm with a New Mexico production
company.
To qualify for either incentive, production companies must register
with the New Mexico Film Ofce. Qualifying companies may choose
one incentive per documented expenditure. Feature-length lms must
include an onscreen credit for the state of New Mexico. New Mexico also
does not charge location fees for state-owned buildings.
North Carolina Film Industry Development Accounts
The State of North Carolina offers what it calls a Film Industry
Development Account. The account is funded by taxpayers and pays
up to $200,000 to any qualied production company making a lm in
North Carolina.
The Film Industry Development Account subsidies require that a
company spend at least $1 million in North Carolina to receive grants
and prohibits a subsidys use for political and issue advertising or for
obscene lms. Unlike similar statutes in other states, the North Caro-
lina statute creating the program does not, however, require that the
lm company be from North Carolina, create jobs for North Carolin-
ians, contract with North Carolina businesses, purchase North Carolina
products or pay North Carolina income taxes.
North Carolina also offers fee-free use of state property and a 1 percent
cap on the state sales-and-use tax. In addition, state sales taxes for hotel
room occupancy in excess of 90 consecutive days may be refunded.
Oklahoma Tax Programs
The State of Oklahoma has created a rebate program to entice more
long-term narrative lm and television production to the state. It is
referred to as the Oklahoma Film and Music Enhancement Rebate
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33
Program. The program rebates 15 percent of documented production
expenditures made in Oklahoma. Costs incurred with state workers and
businesses and directly attributable to the production, reproduction and
postproduction of a long-form narrative lm or television program will
be rebated to producers.
Producers choosing to use the Oklahoma rebate program may also take
advantage of the Oklahoma Sales Tax Rebate. It offers eligible motion
picture and television production companies a state and local tax rebate
on all goods and services used or consumed on virtually any project shot
in Oklahoma. The states current sales tax is 4.5 percent. Local taxes,
which vary from city to city, range from 1 to 4 percent.
The Texas Sales Tax Exemption
The State of Texas offers production companies an exemption from
sales tax on goods and services purchased, rented or leased for the pro-
ductions direct and exclusive use. This exemption applies to goods and
services used in the production or postproduction of the lm or video
master. The Texas state sales tax rate is 6.25 percent, while local sales tax
rates range from 0.25 to 2.0 percent.
Productions eligible to qualify for this exemption include features,
television projects, commercials, corporate lms, infomercials or other
projects for which the producer or production company will be compen-
sated and that are intended for commercial distribution.
South Carolina
Film productions spending $1 million or more in the state of South
Carolina may qualify for a 5 percent rebate on the withholding tax for
labor and a rebate of up to 7 percent on goods and services purchased
from state vendors.
Puerto Rico
The self-governing U.S. Commonwealth of Puerto Rico also offers
tax breaks for local lm productions. The Puerto Rican government has
passed new legislation that allows local investors to write off a portion of
their investment while the lm is still in production and permits some
80 to 90 percent of the lms revenues to remain tax exempt after the
picture begins recouping its costs.
Additional Information
In addition to the Sources and Further Reading, the Association of
Film Commissioners International (AFCI) website (http://www.afci.org)
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Subsidies
34
provides links to the details of the tax incentives and other nancial
incentives offered by each of the member jurisdictions. In addition, the
Motion Picture Association of America (MPAA) publishes a state-by-state
list of tax incentive programs for the lm industry (see http://www.mpaa.
org). Another good source of information is the Christopher Lytton ar-
ticle Soft Money: The Weapon of Choice for Runaway Productions.
Advantages
Another source of nance. Government subsidies or tax incentives at any
level represent another opportunity to whittle down the size of a lms
budget. Tax incentives may reduce the net expenditure by 10 percent to
15 percent.
Motivation for investors. Tax incentives may help to motivate investors
to invest in a high-risk investment such as lm.
Disadvantages
Thrust into debate. Accepting the benets of tax incentives may thrust
a producer into the vortex of a never-ending public debate regarding the
propriety of government subsidy of the lm industry.
Philosophical conict. Taking advantage of tax incentives or other
government subsidies may be inconsistent with the producers personal
philosophy regarding the proper role of government.
Investor abuse. Historically and almost inevitably, there always seem to
be some investors who interpret the tax laws so liberally as to engage in
tax-shelter abuse, and a public outcry will follow and governments will
reduce or eliminate the tax advantages.
Ruinous competition. Many believe the studios here in the United States
are pitting the different lm commissions and legislative bodies from
various jurisdictions against each other, as a way to get bigger and bigger
subsidies, with the only sure result being larger prots for the studios and
increased salaries for studio executives.
The Great Debate over Government Tax Incentives for Film
The appropriateness of and need for government tax incentives to en-
courage lm production in any given locale has been and continues to
be debated all across the country. Many of the arguments for and against
such measures appear below:
Arguments for State Subsidies
Lost jobs. More than $13 billion in lost wages, production expenses, ba-
sic hotel and support industry budgets go across the border and overseas
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35
every year on lms that could be produced in the United States, costing
American jobs, American revenue.
Helps the local economy. When a lm shoots entirely in one area, as much
as 40 percent of the budget may be injected into the local economy.
Boon to tourism. Additionally, tourism (an important industry in many
states) can be signicantly impacted. There appears to be no stronger
advertising medium available than the international release of a feature
lm that depicts potential vacation destinations in a favorable light (more
conrmation that motion pictures inuence behavior).
Helps working people. Runaway production is a problem for the work-
ing people and small businessmen who depend on motion picture and
television production for their livelihood.
Millions lost. Runaway production can also be a problem for the
economy of a given state, which could lose hundreds of millions of dol-
lars directly, and more hundreds of millions indirectly, if the Canadians
or others are allowed to hijack the U.S. lm industry.
Tax loss. Runaway production is a problem for California, which will
lose a signicant portion of tax revenues generated by motion picture
and television production activities.
Unfair competition. The U.S. lm industrys plight results from unfair,
excessively generous tax breaks being offered by Canadian governments
for production north of the border (as well as unfavorable currency
exchange rates).
Cheaper labor. With government assistance, lm production compa-
nies are better able to afford shooting a lm in locations away from Los
Angeles, particularly in foreign locations, where they may also be able to
take advantage of cheaper labor.
Arguments against State Subsidies
Unconstitutional. State subsidies of the lm business violate some state
constitutional requirementsthose providing that tax revenues be col-
lected and spent only for a public purpose, not for public aid to private
businesses.
Self-induced problems. When outsiders, such as the Wall Street Journal,
examine the lm industrys problems, runaway production isnt even
mentioned. On the other hand, advocates of the tax breaks never men-
tion the lm industrys self-induced problems.
Cyclical business. The lm industry is a cyclical business. It also has
let its costs get out of hand. Just because the lm industry may be going
through a mild downturn does not mean that taxpayers ought to be asked
to give lm moguls multimillion-dollar subsidies.
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Subsidies
36
Misdirected. Most of these tax breaks do not necessarily do anything
about runaway production. The tax benets being offered could easily
be obtained by producers who never had any intention of moving their
lm out of a particular state.
Supports pornography and violence. In most instances, the tax breaks
could also be claimed for pornographic lms or those glorifying the kind
of mindless (copycat) violence seen in high schools around the country.
Taxpayer subsidies. In effect, taxpayers are being asked to subsidize the
lm industrys irresponsible conduct, while adding millions of dollars
more to the bank accounts of some of Hollywoods richest residents.
Social services squeeze. Tax subsidies for the lm industry are difcult
to justify when state-provided social services are being cut because of a
scal squeeze.
Independent lms should get the support. If government-sponsored
subsidies are to be made available, their application should be limited to
low-budget, independently produced lms.
Hollywood does not deserve subsidies. The Hollywood major studio/
distributors have allowed their production and promotion costs to soar
out of control, in large measure due to the ludicrously lucrative deals
made with studio executives (e.g., a $90 million severance package for a
studio executive only working at the studio for a little over a year), agents,
managers, entertainment attorneys, advertising media, actors, directors,
producers and screenwriters. Recent studies show that the average cost
of making a motion picture released by the major studio/distributors
reportedly doubled from $26 million to $52 million in less than a decade.
Instead of subsidizing scal irresponsibility, it would make more sense
to require the majors to tighten their belts. In effect, some legislators are
simply asking whether Hollywood has enough money without a state
legislature throwing taxpayer dollars its way.
A bad idea. At a time of nancial crisis in many states, the idea of
handing over taxpayer funds to Hollywood lmmakers is seen as a waste
of taxpayer dollars. It is an idea that should have ended up on the cut-
ting-room oor. Making movies is not a necessary public activity, and
the government has no business using taxpayer funds to enrich private
lm companies. If state government has to tax and spend, it should spend
our tax dollars on projects that truly have a public purpose, like building
roads, schools or hospitals for the citizens of the state.
Ill-conceived schemes. These state subsidy schemes force state taxpay-
ers to give their money to Hollywood lm companies to pay directors,
actors and actresses primarily coming from California or New York in
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37
the hope that some economic benet will trickle back down to the states
taxpayers generally. It is an inappropriate use of the governments power
to tax and an unconstitutional expenditure for a private purpose. Ensur-
ing that some Hollywood starlet has a nicer trailer isnt a public use of
our taxpayers hard-earned money.
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Cones Ch2.indd 38 12/20/07 1:46:57 PM
39
PART TWO
Investor Financing
Investor nancing of all or part of a lm production or its distribution
is distinctly different than the other common forms of lm nance we
will consider, such as gifts, grants or loans. With investments, the people
or entities providing the money have an expectation of not only getting
their money back but of making a prot, even if, as with independent
lms, the investment is a risky one. On the other hand, investors must
accept that if the business venture does not go well, some or all of their
investment could be lost, because as a general rule, the producer does
not have to pay the money back unless the lm is an economic success
at a level that allows the investors to recoup their investment and/or
make a prot.
Investors may be actively involved in the management of the project
they are invested in, or they may be passive (i.e., not involved in man-
agement). Certainly it is generally more desirable for the producers of a
creative venture like a feature lm to have the investors be passive, but
sometimes, if the right active investors are brought together, it may make
sense to nance a lm project with funds provided by a small group of
them. The distinction between active and passive investors is likely to
be the most critical factor determining whether a lm-nancing scheme
does or does not involve the sale or offer of securities. The sale or offer of
a security triggers compliance obligations relating to the federal and state
securities laws. Thus, lmmakers considering investor nancing may rst
want to give some thought to the kind of investors who are available to
them and who they would prefer to work with. In short, active investors
are those who are regularly involved in helping the producer make im-
portant decisions with respect to the management of the project. Passive
investors are those who do not materially participate in the management
of the business.
Investor Financing
40
Investor Financing Strategies
Within the context of lm nance, investor nancing offers a consider-
able amount of exibility to lmmakers. Generally speaking, there is
no legal limit to the amount of money that can be raised through in-
vestor nancing, although specic securities laws relating to securities
registration or exemption from registration may impose ceilings on the
amount of money that can be raised pursuant to that particular type of
securities offering.
Spreading the Risk
Investor nancing can work with small groups of active investors
(e.g., 13 investors) or with much larger groups of passive investors. One
important point to remember about allowing a large number of inves-
tors to invest in a lm project is that the risk of losing the invested funds
is spread among more individuals, and therefore it is less likely that any
single individual investors will suffer signicant nancial harm in the
event that the lm does not recoup their invested funds. In a highly risky
venture such as the production of an independent lm, that may be one of
the more important risk-reducing mechanisms a producer has to offer.
Alternative Uses for Investor Funds
Investor nancing can be utilized in a number of different ways. Note
that there are three stages in the life of a feature or documentary lm
that can be nanced separately:
development (including acquisition, script development, packaging and
possibly even some preproduction activities, such as location scouting
and budgeting);
production (including preproduction, principal photography and post-
productionalong with marketing to distributors and delivery items);
and
distribution.
Thus, investor nancing can be used to provide some or all of the
funds necessary to accomplish the following:
Single-lm development offering. To pay the costs associated with ac-
quiring rights, developing a single lm script and packaging a project;
and when the project is fully developed and packaged, seeking production
nancing from other sources, or selling the project outright.
Multiple-lm development offering. To pay the costs associated with ac-
quiring rights, developing several scripts and packaging multiple projects;
Investor Financing
41
and when the projects are fully developed and packaged, seeking produc-
tion nancing from other sources, or selling the projects outright.
Single-lm production offering. To pay the costs involved in producing
a single lm, including preproduction, principal photography and post-
production, along with expenses associated with marketing the completed
lm to distributors and delivering all required items to a distributor.
Multiple-lm production offering. To pay the costs involved in produc-
ing a slate of lms.
Coproduction offering. To pay for a portion of the production costs,
with the express intention of seeking out a coproduction partner (i.e.,
joint venturer) to cover the balance of the lms production costs.
Finishing fund. To create a fund dedicated to the purpose of providing
nancial assistance to other lmmakers in nishing their lms. Such
funds may be used to aid in completing the production of a lm, to pay for
postproduction, to nance marketing the lm to distributors and to pay
the cost of distributor delivery items (also called completion funds).
Distribution deal. To pay some or all of the costs of distributing one or
more lms, whether through a self-distribution or a rent-a-distributor
arrangement.
Thus, for example, investor nancing may be used by a producer to
resolve the classic catch-22 of independent lmmaking; namely, the
producer cannot raise production money without recognizable name
actors attached to the project but cant get such actors attached without
money. Keeping in mind that the three stages in the life of a lm can be
and often are nanced separately, it becomes apparent that by raising
money through an investor offering as a development deal and using
those early funds to, among other things, attach attractive elements to
the project (create a package), a producer may be able to approach other
sources of nancing, whether studio or industry sources, lenders or other
investor groups, with a completed and fully developed script along with
a partly or fully packaged lm project.
On the other hand, this catch-22 may only exist in the minds of some
lmmakers. After all, in the view of Paul T. Boghosian as set forth in his
Imagine News article (see The Beach: American Film Market 2002), the
world market for independent lm appears now to be in the television and
video markets, more specically in DVD, and not in a theatrical release.
Further, as Chris Anderson opines in his Wired Magazine article online
(The Long Tail) lmmakers should forget about squeezing millions
from a few megahits at the top of the charts. The future of entertainment
is in the millions of niche markets at the shallow end of the bitstream.
And that shallow end of the bitstream includes the Internet, which in
Investor Financing
42
the view of many will inevitably become a medium for the distribution
of feature-length movies.
Choice of Investment Vehicles and Entities
Another decision that must be made by a lmmaker seeking nancing,
investor nancing or otherwise, is to choose the entity through which
to conduct the business of the production company and the investment
or nancing vehicle for the current project or projects. The investment
vehicle may or may not be the same as the production company. This
choice is commonly referred to as the choice of entity question, al-
though sometimes the choice does not involve an entity (e.g., see The
Sole Proprietorship below). Thus, the discussion is really about what
form of doing business is considered best for the lmmaker at various
stages in his or her career. At other times, the choice is not so much about
which form or entity is most appropriate for the business, but which is
most suitable for raising investor funds for one or more lm projects.
As noted above, there are two levels of choice relating to investment
vehicles or entities: (1) which would be best for the ongoing operations
(production and development) of the company; and (2) which would be
best to serve as an investment vehicle for one or more lm projects.
These choices of entities and investment vehicles generally are made
from the following types:
sole proprietorship
general partnership
joint venture
corporation (regular C corporation or S corp)
member-managed LLC
manager-managed LLC
limited partnership
Note that business plan is not listed as an entity or an investment ve-
hicle, for the simple fact that it is neither (see discussion below relating
to the proper use of a business plan).
Then there is even a third level of choice with respect to the entities and
investment vehicles that can be used to serve the needs of the indepen-
dent lm producer: whether to choose an active investor (nonsecurities)
vehicle or a passive investor (securities) vehicle. Each of these choices is
discussed further in the following pages.
It may prove helpful to independent lm producers to provide an
outline or brief overview of the likely choices to be made in seeking some
form of investor nancing:
Investor Financing
43
Operating/production company. How should the production and devel-
opment or operating company be organized for the moment? Remember
that some forms of operating or production companies offer an oppor-
tunity for a rst level of (start-up) nancing.
Investment vehicle or entity. What form of doing business should be
selected to raise money to develop or produce the current lm or lms?
Does the independent producer really want to combine control and
ownership of the operating and production entity with nancing of the
movie or movies, or should those be kept separate for now?
Securities or nonsecurities. Should an active investor investment vehicle
or entity (one not involving the sale of securities) or a passive investor in-
vestment vehicle or entity (one involving the sale of securities) be chosen
to serve as the vehicle for raising money from investors?
Type of offering. Assuming that the producer has chosen to raise money
through some sort of securities (passive investor) vehicle, the next ques-
tion relates to whether it should be a public (registered) offering or a
private (exempt) offering?
Private offering choices. Then, assuming (as is the case with investor
nancing of most independent lm projects) the producer chooses to
raise money from a large group of passive investors using one of the
private (exempt) offering choices, a decision has to be made as to which
provides the best combination of features for the current project.
Public/private hybrid possibilities. Also because of the Internet, a pro-
ducer may want to consider one of the so-called public/private hybrid
exemptions that permit some limited advertising and do not restrict
solicitation by requiring preexisting relationships (see chapter 13).
There are no quick and easy answers to the above questions, certainly
not for all producers of feature or documentary lms. Often they are
also very close questions and require some study. In each case, there are
advantages and disadvantages for each proposed course of action. This
book attempts to provide an objective presentation of those advantages
and disadvantages so that producers can anticipate what the consequences
of their choices might be.
Caution
If any of the industry professionals working in the eld of lm nance
seem to be aggressively pushing one approach or another, suggesting
that they know the best way to nance lms, be cautious, because, in
truth, the business models they promote may only be the ones that are
most familiar to them and not necessarily the business model best suited
to the current needs of independent producers. One of the independent
Investor Financing
44
producers responsibilities is to be familiar enough with the various avail-
able investment vehicles and entities (or other lm nance options) to be
able to make that decision on his or her own. That is not to suggest that
the independent producer should not consult with as many lm nance
attorneys, consultants and advisers as possible, but that ultimately these
decisions should be based on the special needs of the lm production
and the producer.
The Sole Proprietorship
Often the lmmaker will start out as a self-funded sole proprietorship.
The sole proprietorship is neither an entity nor an investment vehicle.
But, in the context of lm nance, the sole proprietorship is the simplest
and usually the rst form of doing business for the producers produc-
tion company. Such a sole proprietorship would be an unincorporated
production company owned and managed by one person, for the purpose
of making a prot. Out-of-pocket start-up expenses are often typically
paid for by the sole owner, although it is possible for a sole proprietor-
ship to make arrangements using the investor-nancing agreement to
bring additional capital into a sole proprietorship from an investor who
is not an owner (for a sample of an investor-nancing agreement, see
Film Industry Contracts).
Generally, it will be necessary for the owner of a lm production
company organized as a sole proprietorship to le a Fictitious Business
Name Statement (in California) or to effect what in other states is called
an assumed name ling, if the name under which the business is being
conducted is different from the name of the individual owner. In some
jurisdictions this form of doing business is referred to as a dba, that is,
doing business as (name of company).
As noted above, the lm production company organized as a sole
proprietorship will generally be self-funded by the individual owner;
however, the sole proprietor may also seek gifts, grants, loans, use an
investor-nancing agreement, serve as the general partner of a limited
partnership or serve as the manager of a manager-managed LLC in order
to raise subsequent development and production funds.
Advantages
Creative control. The owner of a production company operating as a
sole proprietorship has the authority to ultimately make all of the creative
and other decisions regarding the operations of the company. In other
words, there is only one boss and conicts are thus minimized.
Self-reliance. The sole proprietor is not subject to the incompetence,
Investor Financing
45
mismanagement or fraud of others who may have to be relied on in other
forms of doing business.
Cannot be red. The sole proprietor of a lm production company
cannot be red or otherwise removed from his or her ofce.
Few legal formalities. There are few, if any, legal formalities that need
be followed in creating the sole proprietorship except to make the afore-
mentioned ctitious name ling, if one is required, with the county
clerk in the county in which the rm is doing business (also called an
assumed name ling in some states) and possibly with the secretary of
state in other states.
No formal maintenance requirements. There are also no formal main-
tenance requirements as in a corporation, such as the holding of annual
shareholder meetings, the calling of regular meetings of a board of di-
rectors, the maintenance of minutes of such meetings or the approval of
board resolutions for signicant company actions.
Inheritance. A lm production company organized as a sole proprietor-
ship can be left to the individual owners heirs with or without a will.
Selling the business. The owner of a lm production company orga-
nized as a sole proprietorship can sell the business or its assets (e.g., lms
produced or equipment) without the approval of or negotiations with
partners or other owners.
Taxation. The income of the sole proprietorship is taxed as the per-
sonal income of the individual owner at individual rates as opposed to
corporate rates. Thus, depending on the current state of the tax laws and
the individuals level of income, the sole proprietorship may be taxed at
a lower rate.
Disadvantages
Start-up costs. The owner of a lm production company organized as
a sole proprietorship may have to bear the burden of start-up costs.
Only decision maker. In some instances, being the only decision maker
can be a burden.
Raising funds. It is generally more difcult to raise funds from inves-
tors using this form of doing business.
Personal liability. The owner of the lm production company orga-
nized as a sole proprietorship is personally liable for the obligations of
the business and its debts.
Tax deductions. The unincorporated sole proprietor cannot deduct
losses from passive income, write off medical expenses or deduct the
cost of pension plans, while under current tax provisions a corporation
can do so.
Investor Financing
46
Difcult to sell. A lm production company organized as a sole pro-
prietorship may be more difcult to sell than a production company
organized as a corporation since the most important asset of the sole
proprietorship is often its owner.
Doing business with others. Many businesses prefer to do business with
corporations as opposed to sole proprietorships.
Key employees. It is more difcult to entice key employees to work for
a sole proprietorship and to create prot-sharing arrangements.
The balance of this part two discussion relating to investor nancing
is divided into the two broad categories relating to active investor vehicles
and passive investor vehicles. The passive investor vehicles (discussed in
chapters 7, 8 and 9) all involve securities law compliance, and that mate-
rial is further divided into an additional three sections relating to private
(exempt) offerings (chapters 10, 11 and 12), private/public (hybrid) exemp-
tions (chapter 13) and public (registered) offerings (chapters 1418).
Active Investor Vehicles
There are at least four readily identiable so-called active investor lm-
nancing vehicles:
the investor-nancing agreement;
the general partnership, or its more specialized form, the joint venture;
the initial incorporation; and
the member-managed limited liability company (LLC).
At least initially, active investor vehicles appear to be attractive because
the money might be raised from one or two wealthy individuals.
Occasionally, in fact, the Hollywood-based trade press will produce
articles about lm nance, but unfortunately such articles tend to focus
on what are perceived to be current trends in lm nance as opposed to
providing a more balanced perspective that would be useful to a great
majority of lmmakers. As an example, in February of 2003, Variety
reporter Beth Pinsker wrote an article titled Who Wants to Hook a Mil-
lionaire Film Patron? implying that wealthy individuals are seemingly
the sole source of capital (this latter statement was, in fact, the subtitle for
the article). Pinsker went on to write that most of the nancing schemes
concocted by independent producers over the years have stopped working
in this difcult economy. She then went on to add that an old source
of investmentprivate equityis again bringing signicant capital into
the marketplace.
There are several problems with the article that tend to make it mis-
leading. First, equity nancing, or what is referred to in this book as
investor nancing, has always been available and has always played a part
in lm nance. The level of capital contributed by private investors may
vary from year to year, but to suggest that it once played a role and then
went away for awhile but once again is signicant overlooks the many
intervening years in which investor nancing played an important role
in either development or production nancing.
If, on the other hand, the article is concerned only with major studio
nancing or the nancing of lms intended to ultimately be released by
the major studio/distributors, that bias would make the statement about
equity nancing a bit more accurate, but such bias ought to be disclosed.
Investor nancing has long been a source of capital for independently
produced lm projects.
Furthermore, the article seems to suggest that the only area of inves-
tor nancing that has made this remarkable comeback is nancing by
47
Investor Financing
48
wealthy individuals (the individual investors more accurately catego-
rized in this book as active investors). There is little to no discussion
about the investment vehicles being used, or the much broader eld of
passive investor nancing, or the advantages or disadvantages of choos-
ing between active investors or passive investors or of the many options
within each of those differing types of nance, and no hint about the
need for securities law compliance should the investors want to be passive.
The discussion merely cites several examples of this apparent trend,
which is lot like reasoning from a representative sampling of one (i.e.,
the sampling is not representative at all).
The point being made here is that the information about lm nance
in trade press articles generally is not very reliable, because such articles
are merely exposing the tip of an iceberg and are therefore inherently
misleading. To the extent that this particular article convinced anyone to
seek out one or two wealthy (active) investors to nance some lmmaking
ambitions, the article in all likelihood did a disservice to its readers.
All persons investigating the world of lm nance need to step back
and take a broader view, recognizing that there are and have always been
many ways to nance a feature lm, that each form of lm nance has
its advantages and disadvantages and that each lmmakers situation is
different, not only from other lmmakers, but on each lm being con-
sidered. The choices made will depend more on what a given lmmaker
brings to the table for a particular project than on what any industry
reporter perceives to be the latest trend in lm nance.
3 The Investor-Financing Agreement
The investor-nancing agreement is one of several active investor--
nancing (nonsecurities) transactions that may be used to raise a limited
amount of funds from one, two or a few active investors. The other
three discussed in this book are the general partnership/joint venture,
the initial incorporation and the member-managed LLC. The investor-
nancing agreement is merely a contractual arrangement between the
lms producer (or production company) and a single active investor. The
single active investor makes whatever contributions to the project that are
agreed upon and set forth in the contract in exchange for screen credit
and a percentage participation at some specied level of the lms revenue
stream; for example, 50 percent of the producers share of net prots or
25 percent of the lms net proceeds (percentages may vary).
Use with Business Plan
Just as with the initial incorporation, the joint venture and the mem-
ber-managed LLC, the investor-nancing agreement may be used in
conjunction with a business plan to offer a single active investor an
opportunity to review the business plan for a given lm project or lm
production company and then to immediately invest by signing the
accompanying investor-nancing agreement and submitting his or her
check to the producer.
Active Investors Only
The investor-nancing agreement should specically set out how the
investor is going to be involved in the management of the project. In
other words, in order to be considered active, the investor must materi-
ally participate in the activity; that is, the investor must be involved in
the lms operations on a sufciently regular, continuous and substantial
basis. Not only must the investor-nancing agreement describe the level
of investor involvement, but the investors actual conduct must reect
49
Investor Financing
50
that active involvement, and it is important that the producer develop
documentary evidence tending to show such involvement on the part of
the investor. It is important that the investor be active in fact, so that if
any securities regulator chooses to question the transaction after the fact
(alleging that it might have involved the sale of a security to a passive
investor), the producer will be able to demonstrate the active nature of
the relationship.
The investor-nancing agreement typically runs to six or seven pages
in length. (A sample of an investor-nancing agreement appears in Film
Industry Contracts.)
Agreements like the investor-nancing agreement may be called by
another name. For example, if the agreement is actually being used to
raise development money, it may be referred to as a Development Money
Investor Agreement, or something similar. It is important to recognize,
however, that even if the money being raised is to be used only for acqui-
sition and development purposes, the critical distinction for securities
law compliance purposes is whether the investor is passive or active. As a
general rule, passive investors invest in securities; active investors invest
in nonsecurities.
Incidentally, from a legal perspective, this active/passive distinction, as
described here, is an oversimplication of the law relating to the question
of when a security is being offered or sold. But it is a much more easily
applied concept for making nonlawyers aware of the possibility that they
may be engaged in selling a security, and thus it is much more useful than
the more cumbersome and more legalistic denitions of a security.
Advantages
Simplest form of investor nancing. The investor-nancing agreement
may be the simplest form of investor nancing and therefore the least
expensive.
Works with business plan. The investor-nancing agreement can be
provided to prospective investors along with the business plan so that if
the prospective active investors are impressed with the business plan and
want to invest, they may do so by signing the agreement.
Disadvantages
Single investor. It is extremely rare to nd a single investor who has
the wherewithal or willingness to fund the entire production budget for
a motion picture, even a low-budget lm.
No limited liability. The investor-nancing agreement is merely a con-
tract. It is not an entity. Therefore, it offers no limited liability protection
for either the investor or the producer. Thus, if any third party sues the
production company, the personal assets of both the producer and the
active investors may be placed in jeopardy.
Multiple investors. To the extent that the producer may want to add a
few active investors, he or she must realize that the more investors there
are, the less likely that all of them will be truly active investors. Thus, the
chances are increased that the producer has actually raised money from
one or more passive investors, which probably means that the securities
laws are involved and compliance with such laws would be required.
Active investor. In order to comply with the federal and state securi-
ties laws, the producer must make certain that the investor is actively
involved in the making of management decisions on a regular basis (i.e.,
the investor is materially involved in management).
Producer difculties. Use of an investor-nancing agreement, or any of
the active-investor nancing options, for that matter, may not ultimately
be to the advantage of the independent lm producer since it places a
heavy burden of nancial risk on just one, two or a few individual inves-
tors, and if any one of them becomes the proverbial disgruntled inves-
tor, that could create some difculties for the producer.
The Investor-Financing Agreement
51
52
4 General Partnerships and Joint Ventures
General Partnerships
Another of the active investor vehicles that may be initially considered
by a lmmaker for starting a lm production business is the general
partnership. Whenever two or more persons associate for the purpose
of carrying on a business for prot, regardless of whether they intend to
create a partnership or whether they call their association a partnership,
a joint venture or any other name, the association may be considered a
general partnership. A general partnership may be formed with or with-
out a written agreement, although a written agreement is preferable.
The laws relating to general partnerships are primarily based on state
law. The discussion that follows is based on general principles that apply to
general partnerships, but such principles may be modied by the specic
provisions of a given states statutory or case-made law. There are several
factors that typically indicate that a partnership has been formed:
expression of an intent to be partners;
contributing or agreeing to contribute money or property to the
business;
participation or right to participate in control of the business;
receipt or right to receive a share of the prots; or
sharing or agreeing to share losses or liabilities.
Partnership management. General partners have a great deal of latitude
for providing in the partnership agreement how the partnership will be
managed. Unless the partnership agreement states otherwise, each part-
ner has an equal right to participate in the management of the business.
In some cases, however, partners will designate a partner or partners who
will have management authority.
Fiduciary duties. A partner owes duties of loyalty, care and candor to
the partnership, the other partners and their heirs, legatees or personal
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General Partnerships and Joint Ventures
53
representatives of a deceased partner, to the extent of their respective
partnership interests. These duties are duciary in nature (i.e., acting
primarily for the benet of others). The duty of loyalty requires general
partners to place the interests of the partnership ahead of their own in-
terests. It requires them to account to the partnership for any partnership
asset they receive or use and prohibits them from competing with the
partnership or dealing with the partnership in an adverse manner. The
duty of care requires a partner to act as an ordinarily prudent person
would act under the same or similar circumstances. The duty of candor
imposes a duty of disclosure of all material facts in dealings with the
other partners.
Partnership liability. As a general rule, all partners of a general part-
nership are jointly and severally liable for all debts and obligations of
the partnership unless otherwise agreed by a claimant or otherwise
provided by law. Typically, under common law, a general partnership as
an entity is liable for loss or injury to a person, as well as for any ne or
other penalty incurred as a result of the wrongful acts or omissions of
any of its partners acting either in the ordinary course of the business of
the partnership or with the authority of the partnership
Provisions in a partnership agreement that serve to allocate liability
among the partners are generally ineffective against third-party creditors.
Under the applicable states law, however, any partner who is forced to
pay more than his or her allocable share of a particular liability may have
a right of contribution from the partnership or from the other partners
who did not pay their allocable share.
A person admitted as a new partner into an existing general partner-
ship does not have personal liability for an obligation of the partnership
that relates to an action taken or omission occurring prior to his admis-
sion or an obligation that arose before or after his admission under a
contract or commitment entered into before his admission.
A general partner who withdraws from the partnership in violation
of the partnership agreement is liable to the partnership and the other
partners for damages caused by the wrongful withdrawal. A withdrawing
general partner may also be liable for actions committed by the partner-
ship while he was a partner, even though the action was not adjudicated
to be wrongful until after the partner withdrew from the partnership.
General partnerships as nancing vehicles. Some of the features of a
general partnership, such as the lack of free transferability of interests,
the unlimited liability of its partners and its decentralized management
are all features that tend to make the general partnership ineffective as
a vehicle for raising signicant amounts of capital. On the other hand,
Cones Ch4.indd 53 12/20/07 1:47:19 PM
Investor Financing
54
persons associating together for the purpose of conducting a business
may have inadvertently formed a general partnership before they take
steps to organize their business in any other fashion, and for these initial
organizational purposes, a general partnership may be a quick and easy
way to bring in a limited amount of start-up capital. A general partnership
may also serve as the general partner of a lmmaking limited partner-
ship (LP) or as the manager of a manager-managed LLC, thus using the
general partnership as the lm production (operating) company and the
LP or LLC as the investment vehicle.
General partnership interests as securities. As a general rule, interests
in a general partnership are not considered securities. However, a gen-
eral partnership interest may be treated as a security when the venture,
though a general partnership in name, functions as a limited partnership
(i.e., certain partners do not actively participate in management and
rely primarily on the efforts of others to produce partnership prots).
Thus, a lm producer who tries to avoid compliance with the federal
and state securities laws by calling his or her investment vehicle a general
partnership and seeking to raise money from a large group of investors,
some of whom are passive, may well be guilty of selling an unregistered
security without also complying with any of the available exemptions
from the registration requirement, thus potentially triggering both civil
and criminal liability.
Self-employment tax. Partners of a general partnership generally will be
subject to federal self-employment tax on their share of the net earnings
of the trade or business income of the partnership and any guaranteed
payments for personal services.
Joint Venture Financing
The following summary discussion of the joint-venture-nancing vehicle
seeks to distinguish the joint venture from similar forms of lm nance
and to highlight some of the more important issues that arise when us-
ing this vehicle. A joint venture as applied to a lm project may also be
referred to as a domestic coproduction deal.
Joint venture versus general partnership. A joint venture is a special-
ized form of general partnership, created for a limited purpose (e.g.,
the production of a feature lm). In other words, the business scope of
the joint venture is limited. A general partnership, on the other hand, is
used when the active investors intend to establish a continuing business
relationship devoted to a broadly dened purpose or purposes.
Joint venture versus investor-nancing agreement. Generally, an inves-
tor-nancing agreement may be used when a single active investor is
Cones Ch4.indd 54 12/20/07 1:47:20 PM
55
providing all of the funds to nance the production costs of a motion
picture (which may also be the case with a joint venture). However, the
investor-nancing agreement merely involves a contractual arrangement
between the investor and the production company. No separate entity,
as with the joint venture, is created.
Joint venture versus limited partnership. Generally, the joint venture
will be used when the investors are fewer in number and nancially
knowledgeable, but, even more important, they must all be active in-
vestors, that is, actively involved in the project. In contrast, the limited
partnership investors must be passive investors. Thus, some aspects of
the advantage to the producer of maintaining creative control, which the
limited partnership offers, may be lost with the joint venture. Also, the
limited partnership offers its investors limited liability, whereas the joint
venture does not. The joint venture would be most appropriate when
one entity provides the nancing, the other entity brings the literary
property and talent to the deal, and both are to be actively involved in
the management of the project.
Joint venture versus manager-managed LLC. The joint venture compares
to the manager-managed LLC much as it does to a limited partnership.
The limited partnership and manager-managed LLC are very similar in
most respects, the main difference being in the limited liability for the
manager or general partner. Whereas an individual or ctitious-name
company serving as the general partner of a limited partnership does
not enjoy limited liability protection, an individual or ctitious name
company serving as the manager of a manager-managed LLC does. Fil-
ing costs and tax requirements may also differ between the LLC and LP
(see discussions of both entities below).
No limited liability. Under applicable law, general partnerships and
joint ventures are treated the same. Both are general partnerships in that
joint venturers have the same liability that general partners have under
the law of partnerships; that is, joint and several.
Joint venturer contributions. In the context of nancing a feature lm
or lms, the joint venture usually consists of two or more companies
that contribute various elements to the project, some of which may be
nonmonetary, such as unequal responsibilities, the script or underly-
ing property, commitments from a director or actors, below-the-line
facilities and the like. In other words, one joint venturer may contribute
some or all of the money, and the other joint venturer may contribute
the packaged literary property. The contributions of limited partners
in a limited partnership (or of members in a manager-managed LLC),
on the other hand, are generally monetary, even though some of the
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Investor Financing
56
state laws regulating such contributions permit limited partners or
LLC members to contribute money, property and past services (but not
future services).
Creative control issue. In negotiating and drafting a joint venture agree-
ment, one of the most important issues is creative control. The joint ven-
turer contributing the creative elements will typically want to maintain
as much creative control as possible. The joint venturer contributing all
or most of the nancing for the project may want to have some important
input relating to creative matters; thus, specic provisions need to be set
out on this issue, such as approval rights.
Duration of the joint venture. The term of the motion picture joint
venture will generally be expressed in the alternative, for example, for a
short specied term if production nancing is not obtained, or for the
longest term of any of the agreements relating to the literary property or
for the duration of any and all copyrights owned by the joint venture.
Title to the property. Usually, the literary property is transferred into the
joint venture, and a provision is included that species that all rights to
the literary property are held in the name of the joint venture. If, on the
other hand, the joint venture does not hold title to the literary property,
but merely acquires some more limited rights to it, the joint venturer
contributing most or all of the money may want to create a security inter-
est in the literary property to help assure performance by the other joint
venturer of its obligations under the joint venture agreement.
Allocation of prots and losses. Like the general and limited partner-
ships, the prots and losses of the joint venture pass through to the joint
venturers; thus, the joint venture itself is not a taxable entity. The joint
venturers are free to allocate prots, losses, tax credits and deductions
in whatever manner suits them. Such decisions may be changed and
modied at any time before the due date of the joint ventures federal
informational return for that taxable year.
Books, records and bank account. Provision must be made for the
creation and maintenance of books, records and a bank account for the
joint venture, for naming the person responsible for such activities and
for securing access to such by the other joint venturer.
Resolving disputes. Since it is vital to keep a motion picture project
moving forward without undue delay, it is extremely important to include
a provision in the joint venture agreement relating to how disputes that
arise between the joint venturers can be quickly resolved. For example,
they can agree either that one of the joint venturers will have the nal
say on certain specied issues or that a third party or third parties will
resolve such differences within a specied period of time.
Cones Ch4.indd 56 12/20/07 1:47:20 PM
57
Tax consequences. Like limited partnerships and LLCs, a joint venture
must normally le an informational tax return. Certain tax elections, for
example, methods of depreciation, affecting the computation of a joint
venturers taxable income must be made by the joint venture itself. A joint
venture must adopt its own taxable year, but it may not adopt a taxable
year different from that of any principal partner without the consent
of the IRS. Tax issues may also arise when each of the joint venturers
makes different contributions of money and property; for example, who
will be credited with the depreciation on contributed property, and who
receives any capital gain or loss allocations. These are issues for the joint
ventures accountant.
Other issues and provisions. Additional provisions of the joint venture
agreement may relate to management responsibilities of the parties,
screen credit, distribution of available cash, joint venturer involvement
in other similar projects at the same time, indemnication and warranty
requirements, procedures in the event of the death or disability of a
joint venturer, dissolution and termination of the joint venture, notices,
arbitration and so forth.
A sample joint venture agreement as used for a lm venture appears
in Film Industry Contracts.
Advantages
Not securities. Interests in a general partnership or in a joint venture
are generally not considered securities; thus, it is not necessary to provide
investors with a detailed securities disclosure document or otherwise
comply with the burdensome federal and state securities laws.
Less documentation. A general partnership does not require a written
agreement, but it is preferable to set out the points of agreement between
the general partners. A joint venture is a contractual arrangement, so it
should be created with a joint venture agreement, but this contract is
shorter and less complicated than the documentation associated with the
offer and sale of interests in limited partnerships and manager-managed
LLCs or shares in a corporation (i.e., securities disclosure documents).
No formation ling. There is no required ling of a general partnership
or joint venture agreement with a secretary of state as is required for the
limited partnership, LLC and corporate forms of doing business.
Corporate joint venturers. If both general and joint venture partners
are corporations, the risks relating to the lack of limited liability for such
partnerships can be reduced, since the owners of the respective corpo-
rate partners already enjoy limited liability protection provided by the
corporate entities.
Cones Ch4.indd 57 12/20/07 1:47:20 PM
Investor Financing
58
Disadvantages
Limited term. The general partnership may exist for the life of the
partners, but a joint venture is usually set up for a limited term and is
thus not suitable for an ongoing long-term business.
Active partners. Each of the general and joint venture partners needs
to be actively involved in the project.
Creative control. Since general and joint venture partners will be active-
ly involved in the project, there may be disputes over creative issues.
Limited liability. Neither the general partnership nor the joint venture
offers its investors limited liability.
Tax consequences. General partnerships and joint ventures are treated
for federal income tax purposes the same in that neither pays such taxes,
and instead their income or loss is allocated to the general partners or
joint venturers.
Cones Ch4.indd 58 12/20/07 1:47:20 PM
59
5 The Initial Incorporation
A third active investor vehicle possibility involves the creation of a new
corporation. This transaction also provides an early opportunity to raise
a limited amount of funds. As an example, if a producer brings together
four or ve close friends, family or business associates for the purpose
of starting a new corporation and contributes the rights to a script as
consideration for shares while the other founding shareholders contrib-
ute cash, property or past services as consideration for their shares, the
new corporation will have some corporate funds with which to pursue
its goals, including paying the costs associated with a subsequent round
of nancing needed to help reach those goals.
An unincorporated production company that has been seeking funding
for any number of purposes (e.g., development or production of a single
lm or a slate of pictures) and that has engaged in a properly conducted
general solicitation through the use of a business plan but has failed to
identify that single active investor capable of funding the entire project
through the investor-nancing agreement (see chapter 3) may instead opt
for the formation of a corporate production company. Assuming that the
initial active-investor general solicitation by means of the business plan
resulted in interest from several prospective investors, none of whom
are willing to fund the entire project, but who are willing to join with
the producer as founding shareholders of a newly organized corporation
(and whom the producer considers suitable as active investors), then the
producer may be in a position to execute the initial incorporation scenario
without actually conducting a securities offering.
Although, technically speaking, corporate shares are securities, and
corporate shareholders are passive investors, meaning that federal and
state securities laws apply to the sale of corporate stock, a presumption
arises during the formation of a corporation that all of the founding
shareholders are adequately informed regarding the corporation and have
adequate means to protect their interests in the creation and operation
Cones Ch5.indd 59 12/20/07 1:47:04 PM
Investor Financing
60
of such an entity. After all, they have an opportunity to get together in
their rst annual meeting and select the corporations initial board of
directors, and some of them will likely be elected to the board, thus giv-
ing them considerable control over the activities of the corporation. This
in turn means that the shareholder-directors will no longer be strictly
passive investors and will not need the protection ordinarily provided
by the securities laws that apply to the sale of corporate stock to outside
shareholder prospects after a corporation has already been formed.
That sort of secondary offering would surely require compliance with
all of the federal and state securities laws covering any securities offer-
ing, including the provision of a complete disclosure document to each
prospective investor.
Forming a new corporation with a group of investors who are willing
to be involved in the management of the corporation as shareholders,
directors or ofcers allows the producer to avoid the time and expense
involved in conducting a full-edged securities offering (whether public
or private). Again, such an offering would be required if the producer
rst incorporated and then sought to raise money from new shareholder
investors.
This two-stage investor solicitation strategy works best if the producer
initially goes out into the marketplace to conduct a general solicitation by
means of a generic business plan with the bona de intent to nd a single
active investor or an active joint venture partner and only after failing to
nd one then shifts his or her attention to forming a corporation with sev-
eral investors identied during the original general solicitation. In other
words, the business plan must not precommit the producer to the initial
incorporation strategy or the sale of any other security. If such language
appears in the business plan, the general solicitation may be considered
to have been conducted for the purpose of nding corporate sharehold-
ers, who are ordinarily passive investors. And a general solicitation
conducted for such prospective investors can only be done legitimately
after registering the securities with the Securities and Exchange Com-
mission (SEC) at the federal level and with the state securities regulatory
authorities in each state in which such sales or offers are contemplated;
or, alternatively, by qualifying for available federal and state exemptions
from such registration requirements (i.e., private placements).
Bad Advice
Some accountants advise producers that all that is necessary to do to in-
corporate is to le articles of organization with the secretary of state; what
they fail to mention is that unless and until the rst annual shareholder
Cones Ch5.indd 60 12/20/07 1:47:04 PM
The Initial Incorporation
61
meeting is held and supported by minutes, the initial board of directors
meeting is held and supported by minutes, ofcers are elected, corporate
bylaws are approved, corporate shares are physically issued and noted of
record, the corporate formation process is not complete and its limited
liability protection may not be available.
Angel Investor Financing
This initial incorporation stage creates an opportunity to seek out so-
called angels to provide angel nancing. The term angel nancing is
typically associated with early-stage nancing provided by individual
wealthy investors, as opposed to that provided by the groups of indi-
viduals or companies organized as venture capital rms (see Venture
Capital Financing in chapter 9). Furthermore, it is not necessary to
form a corporation to bring in angel capital. The term may also apply to
any of the active investor nancing options discussed here. As a practi-
cal matter, however, the term is most often associated with early-stage
corporate nance.
Although no one can authoritatively say that it is incorrect to refer to
an angel investor as a venture capitalist or to say that an angel investor is
going to provide venture capital for a company, it would be more accurate
to say that an angel investor provides start-up or early-stage nancing,
while venture capital rms usually provide funds for later stages in a
companys growth.
The fact of the matter is that some wealthy individuals prefer to act as
their own nanciers rather than invest indirectly through an intermedi-
ary, such as a venture capital rm. The exact number of such individuals
at any given time is not known, and the size and nancial capabilities of
these so-called angel nanciers varies considerably. However, some com-
mentators estimate that the amount of money invested in a given year by
angel investors exceeds that invested by venture capital rms.
The more important questions for lmmakers seeking nancing are,
what are the odds of nding an angel investor interested in risking money
in a lm venture; and to the extent there are such people, why would they
be motivated to invest in one particular project when the lm industry
marketplace is crowded with lms seeking production-money nanc-
ing, and many of those projects have much more experienced producers
attached? Without presuming what the answers are to such questions,
part of the strategy of the lm producer should be to pursue that sort of
nancing that is most likely to succeed for a given project.
Secondly, the independent producer must carefully examine whether
he or she is willing to work closely with such a wealthy individual and
Cones Ch5.indd 61 12/20/07 1:47:05 PM
Investor Financing
62
whether they both share a common vision for the lm project. There
may be nothing worse for a lmmaker than to have an active investor
who has contributed most, if not all, of the money needed to produce
a lm get into a disagreement with the original independent producer
over important issues like choice of talent or director and changes in the
script (see the 1998 indie lm 20 Dates for an example of an active investor
placing burdensome demands on an independent producer).
Angel Capital Electronic Network (ACE-Net)
At one time in the mid to late 1990s, the federal governments Small Busi-
ness Administration (SBA), in partnership with a number of nonprot
organizations around the country, the SEC and the North American
Securities Administrators Association (NASAA), sought to facilitate
small companies access to such potential investors by establishing
ACE-Net (Angel Capital Electronic Network), an Internet-based, secure
listing service for companies seeking nancing between $250,000 and
$5 million in equity capital from angel investors. The potential investors
were prescreened to ensure their status as qualied investors for private
placements. The SBA actually sought to serve as an incubator for the
program with the intention of allowing private entities to eventually as-
sume stewardship of the program. The SBA-sponsored ACE-Net system
was abandoned in 2004, and various private entities have created websites
in an effort to continue the system.
Advantages
One-stop shopping. All of the money needed for a particular low-budget
lm project may be put up by a single active angel investor.
Wealthy investor screening services. Even though the ACE-Net program
is no longer in operation, there are some for-prot entities offering similar
services (i.e., access to a prequalied group of wealthy investors online).
Unfortunately, there also appear to be scam artists online who claim to
offer access to prescreened wealthy investors, without performing what
they promise.
Avoids securities offering. If properly handled, this so-called initial
incorporation technique can save the time, effort and money involved in
preparing a complicated securities disclosure document and conducting
a securities offering.
General corporate nance. As shareholders of the corporation, the initial
investors are in a position to benet from all of the corporations activities
to the extent that such activities are protable and the board of directors
chooses to declare dividends for the shareholders. The producer may also
Cones Ch5.indd 62 12/20/07 1:47:05 PM
The Initial Incorporation
63
use this form of nance to fund a production companys initial startup
phase; that is, to raise a small amount of funds from a limited number
of founding shareholders to cover lm project acquisition, development,
general corporate or subsequent securities offering expenses, while rely-
ing on other forms of nance for the lms production costs.
Disadvantages
Angel interest. The vast majority of angel investors are not usually
interested in providing the rst-level nancing for start-up companies.
High-risk investments. There is no evidence that the angel investors
previously on ACE-Net or now signed on to any of the other online pre-
screening services are interested in the very high-risk lm production
companies.
Some uncertainty. The active investor (nonsecurities) strategy would
probably not work with a large number of investors, and how many in-
vestors are too many cannot be predicted with certainty.
Limited funds. The initial incorporation strategy is also only appropriate
for raising a small amount of money for general corporate purposes from
a limited number of founding shareholders, but again there are no ofcial
guides to how much is too much or how many investors are too many.
Less control. In using this technique, the producer may have to give up
some control of the company. Shareholders have the right to vote on board
members. The board of directors must approve all of the corporations
major decisions. Some of these same people may serve as ofcers of the
corporation. The original producer may be red.
Cones Ch5.indd 63 12/20/07 1:47:05 PM
64
6 The Member-Managed LLC
A fourth active investor vehicle that may be considered by a lm producer
is the member-managed limited liability company. The LLC is a relatively
new form of business entity available in most states. Its formation is based
on state law and typically involves ling articles of organization with the
secretary of state in the state selected as the base of operations and the
drafting and signing of an LLC operating agreement. A producer choosing
to form an LLC should be sure to check that states LLC statute for specic
provisions that must be included in the operating agreement. Also, note
that despite what many sources of information relating to lm nance
say, this entity is not properly referred to as a limited liability corpora-
tion. It is a limited liability company. Including the word corporation in
the label may tend to confuse the LLC with the corporate form of doing
business, but the two are quite distinct.
The LLC combines aspects of the corporation, the limited partner-
ship and the general partnership. The member-managed LLC has mem-
ber-managers who function much like the general partners of a general
partnership. The member-managers of an LLC, however, enjoy limited
liability protection.
It is important to note that there are actually two different kinds of LLCs.
The company may be operated either in the fairly democratic tradition
of a general partnership, with all of the member-owners involved in the
management of the company (i.e., management by committee), in which
case it is referred to as a member-managed LLC. Alternatively, the LLC may
be operated in the more centralized manner of a corporation, with one or
more managers, in which case it is referred as a manager-managed LLC.
That distinction is usually made in completing the state form that is
initially led with the secretary of state (i.e., the articles of organization),
but it is also made in the drafting of the provisions of the LLC operating
agreement, since the two types of LLCs are operated differently. With the
member-managed LLC, a limited number of investors are actively involved
Cones Ch6.indd 64 12/20/07 1:47:57 PM
The Member-Managed LLC
65
in the management of the company. The LLC is managed by committee
and majority vote. With the manager-managed LLC, the company is man-
aged by one or more designated managers, and the members are passive
(i.e., they are not actively involved in the management of the company).
The former typically does not involve the sale or offer of securities (i.e.,
the LLC units or interests are not considered securities). But, with the
latter, the LLC units or interests are considered securities, triggering the
obligation to comply with the federal and state securities laws when of-
fering and selling them (i.e., preparing a disclosure document, written
disclosure of all material facts, notice lings, etc.).
Either form of LLC may engage in any lawful business or purpose,
including the production and distribution of a feature lm. For federal
income tax purposes, the LLC is treated much like an S corporation or a
limited partnership; that is, the company is not taxed at the entity level
(it is considered a ow-through entity for federal income tax purposes).
However, unlike the limited partnership, which must have at least one
general partner who does not have limited liability, all of the LLCs man-
agers and members can enjoy limited liability.
Unlike an S corporation, the LLC can have subsidiaries and can al-
locate benets differently among its various owners (the S corporation
can only have one class of stock).
It is important to discuss the advantages and disadvantages of an
LLC with an experienced securities attorney before forming one. For
example, it may not be necessary to create a member-managed LLC as
the operating company (i.e., a production and development company) if
a manager-managed LLC is subsequently to be used to raise money from
a large group of passive investors. Furthermore, it may not be necessary
to even create the manager-managed LLC until the minimum amount of
the stated offering proceeds are actually raised and in the bank.
Bad Advice
Some accountants advise producers that to create an LLC, the ling
with the secretary of state is all that is required. However, drafting and
approving of the LLC operating agreement is also required; otherwise,
the LLC would have no rules for operating (see further discussion under
Bad Advice in chapter 7).
Advantages
Best of both worlds. The LLC combines the tax benets of a partnership
with the limited liability benets provided by a corporation. Each of the
member-managers enjoy limited liability protection.
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66
Flexibility. LLCs are generally more exible with regard to their opera-
tions than are corporations, and they are easier to maintain.
Informal and democratic operations. The member-managed LLC can be
operated in a fairly democratic and informal manner like a general partner-
ship without the burdens of the more formal corporate maintenance.
Nonsecurities entity. The formation of a member-managed LLC does
not generally involve the sale of a security. The member-managed LLC
is considered an active investor entity.
Suitable for operating company. The member-managed LLC may ef-
fectively serve as the operating company for a lm development and
production company, which in turn could serve as the manager for a
manager-managed LLC used as the investment vehicle for nancing the
production of a lm.
First-level nancing. The member-managed LLC may be used to bring
in a limited amount of start-up nancing for the company from its limited
number of active investors.
Disadvantages
Not suitable for many owner-investors. The member-managed LLC is
not very useful for business entities involving a large number of own-
ers because of restrictions that may require the companys dissolution
upon the death, dissolution or bankruptcy of a member, and because
the larger the number, the less likely that all of the investors will remain
active. One or more passive investors could recharacterize the interests
into securities.
Not suitable for second-round nancing. The member-managed LLC is
generally not suitable as the investment vehicle for raising a signicant
amount of nancing from large numbers of investors.
Creative control issues. Just as with any of the active-investor entities
or vehicles, creative control issues may arise within a member-managed
LLC, and such conicts can be devastating for a creative venture, such
as a feature lm.
Franchise tax. In most states, the LLC is subject to an annual franchise
tax, just like a corporation.
Gross receipts tax. Some states also impose a gross receipts tax on the
LLCs revenues. The law regulating the formation and operation of an
LLC in the selected state should be consulted.
Cones Ch6.indd 66 12/20/07 1:47:58 PM
Passive Investor Vehicles
Once the producer decides to raise money from a large group of passive
investors (as opposed to one, two or a few active investors), he or she needs
to recognize that the sale of a security is being proposed (regardless of
the choice of investment vehicle). In other words, even if a producer calls
the form of doing business a general partnership, which normally does
not involve the sale of security interests, when enough general partner-
ship interests are sold that it is either not possible for all of the purported
general partners to be actively involved in the companys management
or one or more of these purported general partners are actually passive,
then those interests are legally considered securities, no matter what the
promoter thought or claimed they were, and that triggers an obligation
to comply with the federal and state securities laws.
As a general rule, compliance with the securities laws imposes an
obligation to comply with both the federal securities laws and rules, as
well as an obligation to comply with state laws and rules in every state in
which sales or offers of the securities are planned. Often the state securi-
ties laws, as they are commonly known, are referred to as Blue Sky laws.
There are some exceptions to the requirement to comply with the laws
and rules at a dual jurisdictional level. As discussed in more detail below,
the National Securities Market Improvement Act (NSMIA) provides a
regulatory scheme for federal law to preempt certain aspects of state law
in certain circumstances (see National Securities Market Improvement
Act in chapter 12).
Choice of Securities Offering
Having made the choice of entity for operating as a production company
and selected the investment vehicle through which investor nancing
may be sought, the producer who chooses to raise money from a group
of passive investors is quite likely selling a security. In that case, the pro-
ducer next has to decide whether to conduct a private (exempt) offering,
or one of the newer public/private hybrid exempt offerings or a public
(registered) offering of such securities. The more specic choices include
the following:
1. Exempt (Private) Offerings
Sec. 4(2) of 1933 Securities Act
Sec. 4(6) of 1933 Securities ActAccredited Investor Exemption
Sec. 3(a)(11) of 1933 Securities ActIntrastate Offering
67
Cones Ch6.indd 67 12/20/07 1:47:58 PM
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68
Regulation D Offerings
Rule 504
Rule 505
Rule 506
National Securities Market Improvement Act (NSMIA)
2. Public/Private Hybrid Exemptions
California Sec. 25102(n)
SEC Rule 1001
Model Accredited Investor Exemption (MAIE)
3. Public (Registered) Offerings
Small Corporate Offering Registration (SCOR)
Regulation A Offerings
Regulation S-B Public Offerings
S-1 Public (Registered) Offerings
Over-the-counter, NASDAQ and stock exchange companies
Each securities offering choice is associated with its own set of rules.
There is some overlap in the rules, but each choice brings certain advan-
tages and certain disadvantages. There is a great deal of risk in simply
copying or modifying a securities disclosure document prepared by
someone else (and assuming that is all that will be required) without
knowing the rules with which the disclosure document was intended to
comply. Without the preparer actually reading and understanding the
applicable rules, it is highly likely that the offering will fail to comply. In
addition, certain types of securities offerings require that an attorneys
securities opinion be included as an exhibit, that a tax discussion (either
prepared by an attorney or accountant) be included in the body of the
securities disclosure document and that a tax opinion (either prepared
by an attorney or an accountant) be included as another exhibit to the
securities disclosure document.
Furthermore, the securities antifraud rule requires that all material
facts relating to the proposed transaction be disclosed, that no material
facts be omitted and that the facts set forth in the disclosure document
be stated in a manner that is not misleading. Arguably, the judgments
required to make the many decisions required to fulll the antifraud
requirements alone require the expertise of an experienced securities
attorney. Considering these requirements, it is incredibly naive for inde-
pendent lm producers to assume that a securities disclosure document is
so similar to a business plan that it can be prepared without the assistance
of an experienced securities attorney and will actually comply with all
of the rules for the specic type of offering selected. Contrary to the bad
Cones Ch6.indd 68 12/20/07 1:47:58 PM
advice being passed out in the lm industry by some writers and seminar
presenters, in the area of lm nance, particularly investor nancing
through securities offerings, there actually are rules, and particularly in
the securities arena, noncompliance has consequences.
Most independent lm producers seeking investor nancing from a
group of passive investors tend to choose the private placement, since it
takes less time to prepare and is less costly and less complex than public
(registered) offerings. For that reason, the exempt (private) offerings are
discussed here rst.
Exempt (Private) Offerings
Once a lm producer has decided to raise money from passive investors,
whether through the sale of shares in an existing corporation, units in
a limited partnership or units in a manager-managed LLC, all such in-
terests become securities and therefore compliance with the federal and
state securities laws is required if the producer wants to conduct business
in a legitimate manner. As noted above, the producer seeking to raise
money from a group of passive investors (i.e., sell securities) must decide
whether to conduct
a public (registered) offering;
a public/private hybrid offering; or
a private (exempt) offering.
Pursuant to the securities laws, when someone chooses to sell or offer
securities, they must rst register those securities with the SEC at the fed-
eral level and with the state securities regulatory authorities in each state
in which sales or offers are to be made. That registration is referred to as
a registered, or public, offering. As discussed below, public (registered)
offerings are more time-consuming, expensive and complex than private
placements, so if a producer decides not to conduct a public offering, the
only other alternatives are a private (exempt) offering or one of the more
recently developed public/private hybrid offerings. The word exempt,
as used here, does not mean exempt from all rules, but rather that the
offering is exempt from the securities registration requirement. Exempt
offerings simply have to comply with a different set of rules, those associ-
ated with the specic exemption chosen, and it is essential that an issuer
of securities know which set of rules apply to a proposed offering.
Bad Advice
Some entertainment attorneys and other lm nance pseudo-experts
regularly advise lmmakers that selling securities only to accredited
69
Cones Ch6.indd 69 12/20/07 1:47:58 PM
Investor Financing
70
investors in some of the private placements (exempt offerings) discussed
below eliminates the need to provide a securities disclosure document to
the prospective investors. However, the entire federal regulatory scheme
relating to the sale and offer of securities is based on the premise of an
informed investor (i.e., one who has been advised in writing about ev-
erything that is important about the transaction offered).
That is exactly what the antifraud provisions of the Securities Ex-
change Act of 1934 requirethat all material aspects of the transaction
be disclosed in writing, that nothing important be omitted and that
everything be stated in a manner that is not misleading (see Sec. 10[b]
of the Securities Exchange Act of 1934 and SEC Rule 10b-5). It would be
absurd to assume that all accredited investors are knowledgeable about
investing in the lm industry. Thus, the irresponsible position that no
securities disclosure document is required for making sales to accredited
investors accomplishes only one thingit places the lm producer in a
relatively weak position if disgruntled investors should come forward to
ask for their money back, because they can argue that the producer did
not fully advise them of certain risks associated with an investment in
an independent lm.
The producer who failed to provide a properly drafted securities dis-
closure document has no convenient way to prove that such risks were
fully disclosed, and the burden for proving otherwise in court will rest
with the producer who sold the security. Producers concerned about their
future careers who are seeking to sell securities would be well advised to
comply with the more conventional interpretation of the securities laws
and not put themselves at risk for both the civil and criminal liability that
may apply. Those purveyors of bad advice are obviously not concerned
about protecting the interests of producers who follow their advice. (For
a more thorough discussion of issuer disclosure obligations in securities
offerings, see Issuers Raising Capital Directly from Investors: What
Disclosure Does Rule 10b-5 Require? by Harry S. Gerla).
Cones Ch6.indd 70 12/20/07 1:47:59 PM
71
7 The Manager-Managed LLC
The manager-managed LLC is one of the more popular passive inves-
tor vehicles for project nancing of feature and documentary lms. Its
formation is similar to the creation of a member-managed LLC, in that
articles of organization need to be prepared and led with the ofce of
the secretary of state in the state in which it is being created. Generally,
the form or articles used will provide a space for designating that the LLC
is to be manager-managed as opposed to member-managed. In addition
however, an LLC operating agreement must be drafted, approved by the
members and signed so that the LLC will have a set of rules by which to
operate. And the operating rules for a manager-managed LLC are sig-
nicantly different, longer and more complex than the corresponding
operating rules (agreement) for a member-managed LLC. The operating
agreement usually does not have to be led with the secretary of state,
but is kept in the LLCs les. Formation of the manager-managed LLC is
neither the end of the task nor the most signicant portion of the work
involved in using such a vehicle to raise capital (see Choice of Securities
Offering below).
Limited Liability
Of particular importance to low-budget lmmakers, the manager-man-
aged LLC offers limited liability protection to one or more individuals or
a ctitious name company (dba) serving as the LLCs manager, without
having to take the time, trouble and expense of creating and maintain-
ing another entity such as a corporation or a member-managed LLC to
serve as the manager.
When to Form the LLC
In many instances, entertainment attorneys and accountants advise
lmmakers to rst go out and form an LLC, for example, without ever
Cones Ch7.indd 71 12/20/07 1:50:01 PM
Investor Financing
72
discussing whether it should be member-managed or manager-managed
and that there are securities law implications for the latter.
In addition, there are differing opinions about when to form a man-
ager-managed LLC that will be used as the investment vehicle to raise
money from a large group of passive investors. Some practitioners insist
that forming the LLC must be the rst step in the process. They suggest
that investors will not invest in a company that has yet to be formed.
However, hundreds if not thousands of successful manager-managed LLC
securities offerings have been conducted in the United States, selling what
are termed pre-formation units in an LLC to be formed upon funding.
Thus the argument that investors wont invest in a company to be formed
is not based on an adequate sampling of real world experience.
The same is true of many corporate and limited partnership offerings
over the years. The advantage of this deferred approach is that no out-of-
pocket expense is incurred by the manager or producer for the creation of
the entity until the investor funds are in the bank and therefore available
for prompt reimbursement, as soon as the LLC is formed and a second
production bank account has been opened in the name of the newly
formed LLC.
The liabilities most commonly associated with the production of
lmsnegligence on the set and defamationdo not occur until after
principal photography has begun or, in the latter instance, after the lm
is released. Thus, so long as the manager-managed LLC is formed before
principal photography begins, the manager will still enjoy the limited
liability protection needed.
Bad Advice
Many independent lm producers are either misled by somebody or
simply misunderstand what they are told about LLCs. These independent
producers repeatedly indicate that they have been advised that all they
need to do to raise money from passive investors using an LLC is to create
one, and that it merely involves the preparation and ling of the articles
of organization with the secretary of states ofce in the state in which
the LLC is to be formed. This is bad advice on several levels:
1. To create an LLC, not only should the articles of organization be
properly prepared and led with the secretary of state, but also an LLC
operating agreement must be drafted, approved and signed. Otherwise
there are no rules set out for operating the LLC, and it cannot function
effectively.
2. When the articles of organization are led and the operating agree-
ment is drafted, the producer must be certain to properly designate in the
Cones Ch7.indd 72 12/20/07 1:50:01 PM
The Manager-Managed LLC
73
articles which form of LLC is being created, a member-managed or man-
ager-managed LLC, and to carry over this distinction into the operating
agreement, because the provisions of the operating agreement for each
form of LLC are signicantly different. Before a producer can make that
designation, he or she must understand the difference between the two
LLC forms and to what purpose the one that is chosen will be devoted.
3. Assuming the LLC is being created to serve as the investment vehicle
for a large group of passive investors (the manager-managed LLCthe
form of LLC being discussed in this chapter), the ling of the articles
and the drafting of the LLC operating agreement amount to a small part
of the tasks involved. Since the units or interests in a manager-managed
LLC are securities, compliance with the federal and state securities laws is
required. That involves an informed choice with respect to the appropri-
ate form of registration or exemption, the proper drafting of a securities
disclosure document and an understanding of and compliance with other
applicable securities laws and rules.
Advantages
Number of investors. There is no limit on the number of investors im-
posed by the LLC statutes, but such a limitation may be imposed by the
securities laws. Regulation D, for example, permits 35 unaccredited inves-
tors and an unlimited number of accredited investors (see chapter 12).
No creative control issues. Since the manager-managed LLC is controlled
and operated (pursuant to statutory law and the operating agreement)
by the manager or managers, and the investor-members are passive,
there are no conicts between management and investor-members over
creative matters.
Less oversight. So long as the manager of a manager-managed LLC acts
in the manner described in the securities disclosure document, it is not
necessary to go back to any board of directors or the investor-members
for approval to conduct the business. Signicant departures from the
original plan of business may need the approval of the investor-members,
and the LLCs operating agreement makes provision for doing so.
Disadvantage
Securities compliance required. Compliance with the applicable federal
and state securities laws are required because manager-managed LLC
interests are being offered and sold to passive investors (i.e., such interests
are securities).
Cones Ch7.indd 73 12/20/07 1:50:01 PM
74
8 Limited Partnerships
Another investment vehicle (a form of passive investor nancing) that has
been around much longer than the manager-managed LLC is the limited
partnership (LP). The two entities are very similar so far as their tax
treatment is concerned and in the way that they are formed and operated.
However, an individual serving as the general partner of a limited part-
nership does not enjoy the limited liability protection that an individual
manager of an LLC enjoys. That explains why most LPs have corporate
general partners, or sometimes, member-managed LLCs.
General Requirements
Formation and lings. All limited partnerships must have at least one
general partner and one or more limited partners. The partners (both
general and limited) must enter into a limited partnership agreement
that should be in writing. However, no government review or approval is
required for the limited partnership agreement associated with a privately
placed limited partnership offering. A certicate of limited partnership
signed by all of the general partners has to be led with the secretary of
state of the state in which the limited partnership is being formed. As
with the LLC, the ling of the certicate of limited partnership and thus
the formation of the entity can wait until the offering is funded. Such
an offering consists of an offering of units in a limited partnership to
be formed upon funding. These units are still securities, and therefore
compliance with the federal and state securities laws is required.
Misinformation. Despite some of the misinformation oating around
in lm industry circles (some from prominent lm industry organiza-
tions), a limited partnership, or LP, is not the same entity as a limited
liability partnership, or LLP. The LLP is a specic and statutorily autho-
rized entity used by attorneys, accountants and architects and is not a
suitable entity for lm nance; but the LP is.
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Limited Partnerships
75
Naming the limited partnership. The name of a limited partnership
cannot be the same or similar to other limited partnerships already
organized in that same state. A particular name can be reserved with or
cleared by the secretary of state in some states, and the name is protected
in the state by the ling of the limited partnership certicate. Further
steps, however, may need to be taken to protect the name of the limited
partnership outside the state of its formation. The names of limited part-
nerships generally are required to include the words limited partnership
or the abbreviations L.P. or Ltd. as part of their ofcial name.
Cost of formation. The drafting of the limited partnership agreement
itself is usually, but not always, included in the cost of an attorneys prepa-
ration of the associated securities disclosure document. Filing fees and
other costs may range from $50 to $150. These are paid to the secretary
of state and private ling services (if used to expedite the ling) upon the
formation of the limited partnership. Keep in mind that there is much
more involved in a feature lm limited partnership offering than merely
creating the limited partnership entity, and it is not necessary to form
the limited partnership entity before starting the offering. Also note that
just because some lawyers present themselves as entertainment attorneys
does not mean they have bona de expertise in the more specialized arena
relating to compliance with the federal and state securities laws.
Capital. Partners capital contributions and loans to the partnership
from partners and outsiders are typically the main sources of capital for
the limited partnership. Quite often, most, if not all, of the capital con-
tributions in the form of cash come from the limited partner investors.
Management and control. Management and control of the limited
partnership is in the hands of the general partner or general partners.
General partners may be individuals, ctitious name companies, general
partnerships, member-managed LLCs, or corporations. Limited partners
may lose their limited liability if they participate in the control or man-
agement of the limited partnership (except for specic acts listed in the
applicable state statutes).
Liability of owners. General partners have unlimited liability to third-
party outsiders. Limited partners risk only the loss of their capital contri-
bution unless they take part in management. Limited partners ordinarily
are not required to guarantee partnership indebtedness.
Operations. Important transactions effected by the general partners do
not require advance approval if such activities are in compliance with the
partnership agreement and applicable state statutes. In contrast, signi-
cant corporate actions require the support of board resolutions.
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76
Books and records. The limited partnership is required to maintain
certain books and records at its principal ofce, but the requirements
are less burdensome than those for the corporation.
Sharing of prots. Limited partnerships provide considerably more ex-
ibility (as opposed to a corporation) in the structuring of prot-sharing
arrangements between the general partner group and the limited partner
investors pursuant to the partnership agreement. This same exibility is
also an attribute of the manager-managed LLC.
Continuity of business. The limited partnership exists for a limited and
stated term. Thus, it may be more suitable for project nancing (i.e., one
or just a few lms) as opposed to the long-term nancing generally as-
sociated with corporate nance. Dissolution of the limited partnership
may result from the loss of a general partner but not from the loss of
limited partners. Such issues are dealt with pursuant to the terms of the
partnership agreement and the applicable state statute.
Transfer of interests. Restrictions on the transfer of limited partner-
ship interests may be imposed by state statute, the limited partnership
agreement or the securities and tax laws. The general partners right
to receive distributions is typically assignable, but a transferee cannot
be substituted as a general partner except by consent of the remaining
partners (including the limited partners). Limited partners interests are
also assignable, but an assignee cannot be substituted as a limited partner
without the other partners consent, unless the partnership agreement
provides otherwise. Substitution occurs when the limited partnership
certicate is appropriately amended.
Fringe benets. Some, but not all, of the fringe benets that corporations
can offer employees are now available to limited partnerships as well.
Taxation. Limited partnerships do not pay federal or state income tax
at the entity level (unless qualied as a publicly trading partnership under
federal tax laws), but limited partnerships must le information returns.
Thus, a federal tax liability may be created for individual investors even
though prot distributions have not actually been recorded. Both general
and limited partners are taxed by the IRS on their share of the prots,
whether distributed or not. The traditional double taxation of the cor-
porate form is avoided through use of the limited partnership entity. Use
of the limited partnership form may result in lower taxes generally, even
without considering double taxation. If the partnership is the producing
entity and it does not make enough money to return to the limited part-
ners their total investment, the loss for income tax purposes is considered
an ordinary loss, which may be offset (i.e., deducted) against ordinary
income. Most investors need a loss that can be offset against income more
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77
than they need a capital loss, even though such passive activity losses can
only be offset against passive activity gains. Limited partnerships doing
business in a state may be subject to a franchise tax, but it is generally not
prepaid as with corporations and LLCs. The applicable states law must
be checked with reference to this question.
Owner identity. Limited partners names often need not be disclosed
to the public (depending on the state of formation); however, the name
of the general partners are led with the secretary of state as part of the
LPs articles of organization.
Securities considerations. Interests in limited partnerships are secu-
rities and must be registered with federal and state authorities unless
qualied for exemptions from registration (see discussion beginning
with chapter 10).
Offering costs. Attorney fees for the lawyers work involved in the prepa-
ration of a private placement feature lm limited partnership offering
disclosure document (offering memorandum) and related consultations
regarding the proper way to conduct the offering vary widely in terms of
(1) whether an hourly or a at fee is charged, (2) how much is required up
front, (3) whether there are fee deferrals, (4) whether the deferred portion
is contingent on the success of the offering and (5) what specic tasks are
undertaken by the attorney (e.g., creation of the entity, preparation of
the securities disclosure document, federal and state notice lings, tax
discussion, tax opinion, securities opinion, nancial projections, etc.).
The typical at fees may range from $10,000 to $50,000, depending on
the experience and ability of the attorney. The attorney fees associated
with a public offering are generally signicantly higher.
Also, the costs associated with the printing and binding of the disclo-
sure documents and artwork, if any, must be considered. (The printing
and binding costs for publicly offered disclosure documents are con-
siderably more expensive because of the smaller unit size typical of the
public offeringthus, more investors and more disclosure documents
are needed). Accounting fees may be incurred for preparation of nancial
statements and nancial projections. If used, broker/dealers due dili-
gence expenses and commissions are limited by the rules of the National
Association of Securities Dealers (NASD) to 10.5 percent of the offering
proceeds in public offerings, but such commissions and fees are more
exible in the context of a private placement, although ceilings on offer-
ing expenses, including broker/dealers commissions may be imposed by
state law. Issuer marketing costs, which may be substantial, also might
include phone, delivery service, fax, postage, envelopes, travel and the
like. State notice ling fees may range from $50 to $800.
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78
Other states. If the limited partnership is actually doing business in
a state other than the state of its formation, the laws of that other state
regarding limited liability and foreign limited partnerships must be
considered.
Advantages
More exibility. The limited partnership offers more exibility in
structuring the deal between management and the investors as compared
with corporations.
Lower maintenance. The limited partnership is generally less cumber-
some to maintain than a corporation. Fewer meetings and no minutes
are required.
Single-picture nancing. The limited partnership may be more suitable
for single-picture nancing than a corporation because it is a limited-
term entity; however, it can also serve as a nancing vehicle for a slate
of pictures.
Creative control. The limited partners are not permitted to participate
in the management or control of the business; thus, creative control issues
do not arise as with active investor vehicles.
Flow-through tax vehicle. The limited partnership still has one sig-
nicant tax benet over the regular C corporation; that is, the limited
partnership entity itself is not taxed at the entity level. Revenues to the
partnership ow through to the partners and are only taxed at the in-
dividual level.
Disadvantages
Negative perception. The many thousands of investors who put money
into the large, public, lm limited partnerships of the 1980s and early
1990s experienced disappointing nancial results and are not likely to be
interested in any sort of similar offering unless it is clearly distinguished
from the earlier offerings in a persuasive manner.
Securities law compliance. Compliance with the dual system of securi-
ties law regulation (both federal and state) can be somewhat burdensome
for small production companies, unless an experienced securities attorney
is available to help.
Fewer signicant tax advantages. There are not as many signicant tax
advantages that favor the use of the limited partnership as an investment
vehicle in the United States as there were before the 1986 Tax Reform Act,
although the 2004 American Jobs Creation Act offers some help in this
regard (see chapter 2).
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79
Securities attorney. Because of the complexity of the federal and state
securities laws, it may be necessary to retain the services and pay the fees
of an experienced securities attorney, specically a securities attorney
with feature-lm offering experience.
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9 Corporate Finance
Another traditional passive investor vehicle is the existing corporation (as
opposed to the newly formed initial incorporation scenario described
in chapter 5). A corporation is a statutory entity created and regulated by
state laws that has its own legal identity separate from any of the people
who own, control, manage or operate it. It is a legal person capable
of entering into contracts, incurring debts and paying taxes. Thus, the
corporation is a separate taxable entity.
C Corporations
Forming the Corporation
A regular C corporation is created by taking the following steps:
drafting and ling articles of incorporation with the secretary of state of
the state in which the corporation is being created;
obtaining the secretary of states approval of the articles;
obtaining a certicate of incorporation from the secretary of state;
conducting an initial meeting of shareholders of the corporation, nam-
ing a board of directors and creating minutes to reect the action taken;
conducting an initial meeting of the board of directors and naming of-
cers, setting up a bank account, approving the corporate seal, approving
corporate bylaws and issuing shares (all of which should be reected in
the boards minutes);
physically issuing share certicates to shareholders; and
noting the issuance of such shares in the corporate stock transfer log.
In the event that the board of directors determines that it wants the
corporation to be treated as an S corporation for tax purposes, in addi-
tion to the above steps to formation, special language should be included
in the initial board of directors minutes authorizing the corporations
characterization as an S corporation and directing the ofcers to le the
necessary forms with the IRS (see S Corporation below).
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In some states, a corporation may be required to le something akin to
a notice of sale regarding the issuance of the corporations initial shares
with the state regulatory agency governing the formation of corporations,
and a form disclosing the names of the ofcers of the newly formed cor-
poration and its corporate address may be required to be led at a later
date (e.g., within 90 days).
The corporations name cannot be the same or similar to other cor-
porations in that state; thus, it must be reserved with or cleared by the
secretary of state. The name is protected by ling the corporations articles
but may need to be protected outside the state with trademark registration
or doing business lings in each state.
A nominal ling fee (something in the neighborhood of $100) is gener-
ally required when ling the articles of incorporation. Also, a minimum
franchise tax prepaid deposit may be required. Corporate kits should also
be purchased. The kits typically include sample bylaws, sample minutes,
a corporate seal, share certicates and a stock transfer log, and they cost
from $50 to $150. Attorney fees for a simple incorporation may be as little
as $1,000 but vary widely depending on the state and whether the attorney
is practicing in an urban environment or in a more rural area.
Generally, but not always, the corporation is formed rst (with one or
more founding shareholders), and then if additional funding is needed,
and the decision is made by the corporations board of directors to raise
such nancing by selling additional corporate shares (as opposed to
so-called project nancing options using limited partnerships or man-
ager-managed LLC investment vehicles for so-called off-balance sheet
nancing), an offering of shares (i.e., securities) is conducted to those
beyond the initial founding shareholders in public or private offerings
(see chapters 1017).
However, the initial incorporation process offers an opportunity to
bring a limited amount of start-up capital into the entity. A lmmaker,
for example may contribute rights to a screenplay as consideration for
his or her shares in the newly formed corporation, whereas the other
founding shareholders may contribute other property, past services or
cash as consideration for their shares. This start-up cash may be used to
pay the costs associated with the acquisition of rights, script development,
packaging, some preproduction expense and possibly even a subsequent
securities offering.
Capital. The sale of corporate shares (equity ownership interests) may
be made in various forms, including common, preferred and convertible
stocks. Also, corporate debt instruments can be issued in various forms,
including bonds, debentures, notes and other evidences of indebtedness.
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Management and control. Corporate management and control is highly
centralized in ofcers and directors. Many control devices are available
to separate management from ownership, such as nonvoting stock, vot-
ing trusts, shareholder agreements and supermajority vote requirements
for certain matters.
Owner identity. Shareholder identities are not disclosed on public
records in most states, but the names of the corporations ofcers and
directors are filed and are thus available through inspection of the
public records.
Offering Corporate Shares
After the corporation is initially formed, in the event that the corpo-
rations board of directors decides to offer additional shares to a broader
group of investors (beyond the founding shareholders), such an offering
would typically involve the sale of securities.
Offering costs. Just as with a limited partnership offering, attorneys
fees for private offerings of corporate stock vary widely in terms of
(a) whether an hourly or a at fee is charged, (b) how much is required
up front, (c) whether some of the fee may be deferred and (d) whether
the deferred portion is contingent on the success of the offering. Attorney
fees may range from $10,000 to $50,000, depending on the attorney or
law rm and what services are included. An attorney or law rm will
generally charge much more for a public offering of corporate stock.
The costs for printing, artwork and binding for the disclosure docu-
ment (prospectus for most public offerings and offering memorandum
for private placements) also must be considered.
The printing costs for the public offering prospectus is typically
much greater than for a private offering because of the smaller unit size
of the public offering and the need for a signicantly larger number of
disclosure documents. Private placements are generally not printed but
copied from a computer-produced camera ready original. Account-
ing fees may be incurred in the preparation of nancial statements and
nancial projections that may be included in the disclosure document
or as exhibits. Also, if broker/dealers are used to raise funds, they may
require up-front due diligence fees and the reimbursement of due dili-
gence expenses. Broker/dealer commissions and expenses are limited in
public offerings by the rules of the NASD (10.5 percent ceiling for public
offerings, but more exible for private offerings). Issuer marketing costs
also may be substantial. State and federal ling fees for public offerings
can also be signicant.
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Advantages
Long-term ventures. The corporate structure is most suitable for a long-
term ongoing business as opposed to project nancing of a single feature
lm or limited number of movies. Corporations generally are created to
have perpetual existence but may be dissolved.
Doing business with others. Many other businesses, for example, banks,
prefer to do business with corporations in most circumstances.
Liability of owners. Risks are primarily borne by the corporation. Share-
holders risk only their investment, not their personal estates, unless there
are defects in the organization or the corporation has been improperly
maintained (e.g., failure to hold board meetings and prepare minutes).
Ofcers and directors may incur liability for certain acts or omissions.
Lenders may require personal guarantees of principal shareholders of
closely held corporations.
Transfer of ownership. Corporate shares may be more readily trans-
ferable than interests in partnerships or LLCs if there is a market for
them. However, restrictions on sales to outsiders may be imposed by the
corporations articles, bylaws or shareholder agreements or by federal
and state securities laws.
Tax considerations. Business income can be sheltered in the corporation
and reported and taxed at the business (corporate) level.
Tax-favored benets. The corporation is eligible for tax deductible
employee fringe benets paid to its employees. Many tax-favored fringe
benets are available for corporate employees, such as prot-sharing,
pension, health insurance and sick-pay plans.
S corporation alternative. Use of an S corporation may reduce the
federal tax burden on the corporation.
Disadvantages
Securities considerations. Debt and equity interests in corporations are
securities and must be registered with federal and state authorities unless
qualied for exemptions from registration (private placements).
Taxation. Regular C corporations are taxed by the Internal Revenue
Service on predividend prots, and shareholders are taxed on dividends, if
any, which may result in the double taxation of the same revenue stream,
once at the corporate level and again at the shareholder level. If the cor-
poration is the producing entity of a feature lm and it loses money, the
loss is in the nature of a capital loss. Most investors need a loss that can
offset income more than they need a capital loss (see chapters 68 for
discussion of ow-through vehicles).
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Franchise tax. An annual state franchise tax is imposed on corporations
in most states and is typically prepaid upon formation.
Operations. Many corporate ofcer actions require resolutions ap-
proved by the corporations board of directors in addition to being in
compliance with any applicable statutes, the corporations articles of
incorporation and its bylaws.
Foreign corporations. A corporation may have to register as a foreign
corporation in any other state in which it conducts its business and pay
taxes in that second state on the portion of its revenues derived from
doing business there (see The Out-of-State Corporation below).
Books and records. The corporation is required to follow specific
formalities in the creation and maintenance of its initial organizational
minutes, shareholder meeting minutes and minutes of board of direc-
tors meetings. The corporation must elect directors, adopt bylaws, issue
shares, record transfers, conduct annual shareholder meetings, keep
minutes of the boards actions, prepare and publish annual nancial
statements, provide reports to shareholders and (if publicly held) submit
periodic SEC lings.
Sharing of prots. Corporate prots are paid to shareholders by means
of corporate dividends in exact proportion to the ownership interests
of the shareholders and at the discretion of the corporations board of
directors. Corporations do not have the same exibility as LPs and LLCs
in the structure of revenue-sharing ratios between management and
investors.
Suspension of powers. A corporations powers may be suspended for fail-
ure to comply with certain of the corporate formalities described above.
S Corporations
Once the decision has been made to wholly or partly nance a lm or
lms using investor nancing generally, as opposed to the various stu-
dio, industry, lender or foreign nancing alternatives, and the corporate
vehicle is chosen, the producer must still decide whether to opt for an S
corporation or a regular C corporation. A corporation that satises the
requirements of subchapter S (often referred to as an S corp) is taxed
differently than a regular C corporation (IRC Section 1362).
Basic Characteristics of an S Corporation
No federal entity level taxation. With the exception of certain capital
gains, an S corporation bears no federal income tax consequences at the
corporate level. However, some states may impose a small tax on the
income of an S corporation.
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85
Shareholder taxation. The shareholders of an S corporation are taxed
on all income of the corporation, with a few exceptions, regardless of
whether or not the income is actually distributed to the shareholders; that
is, a cash distribution to investors is not a taxable event, but the receipt
of income for accounting purposes is (IRC section 1366).
Requirements of an S Corporation
The failure to meet any of the requirements listed below will cause the
disqualication of the entity as an S corporation effective on the date of
the failure.
Timely election. To be taxed as an S corporation, a timely election must
be made by the corporation under IRC section 1362. That election must
be made for the current year on or before the fteenth day of the third
month of the taxable year (or prior to the rst day of the year to come)
in order to be effective for that year.
Calendar year. An S corporation must use a calendar year for its scal
year, unless it establishes a business purpose for a scal year.
Unanimous consent. All shareholders of the corporation and persons
who have an interest in the stock must consent to the S corporation elec-
tion. Such consent should be reected in the minutes.
Domestic, unafliated operation. The S corporation must be a domes-
tic U.S. corporation and cannot be a member of an afliated group of
corporations, nor a nancial institution or an insurance company. An
S corporation can only own up to 25 percent of the stock in another
corporation.
Limited number of shareholders. The maximum number of shareholders
has to be fewer than seventy-ve (a husband and wife are treated as one
shareholder, as is the case with stock owned by a trust or other qualify-
ing estate).
Only individual shareholders. A shareholder must be an individual (U.S.
citizen or resident), an estate or a qualied subchapter S trust. Thus, no
corporations or partnerships may be shareholders of an S corporation.
No foreign shareholders. A nonresident alien (those who reside in
foreign countries) may not be a shareholder in an S corporation. Be es-
pecially careful with loans from nonresident aliens, particularly if those
loans have equity features.
Only one class of stock. Only one class of stock may be issued and out-
standing, although there may be differences as to the voting rights among
stockholders (e.g., it is currently permissible for S corporations to have
voting and nonvoting common stock). Corporate debt may be allowed
if it is not a disguised second class of stock. Proposed IRS regulations
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86
concerning the one class of stock requirement must be carefully con-
sidered when issuing stock other than ordinary common stock.
Tax Features of Operating as an S Corporation
Pass-through vehicle. Income, losses, deductions and credits are passed
through to shareholders on a per-share, per-day basis. This is similar to
the tax treatment of a limited partnership or LLC. (Pass-through vehicle
is just another way of saying a ow-through vehicle.)
Shareholder basis. The shareholder basis is increased by income,
contributions and loans to the corporation but decreased by losses and
distributions.
Losses carried forward. Losses in excess of stock and debt basis are
suspended and carried forward.
Tax-free distributions. If the corporation has no earnings or prots,
distributions not in excess of basis are tax-free. Distributions in excess
of basis are capital gains.
Taxation of dividends. Earnings and prots are taxable as dividends
when distributed.
Corporate level taxation. There is a tax applied at the corporate level
on certain long-term capital gains or built-in gains. There is also a cor-
porate-level tax on excess passive income of a former C corporation that
has earnings and prots.
Terminating the S Corporation
The S corporation election will be terminated immediately if noneli-
gible shareholders or too many shareholders acquire stock. The election
will also be terminated immediately if the corporation ceases to be a small
business S corporation. Following termination, no new election can be
made for ve years. Relief may be available for inadvertent termination.
The election will be terminated on the rst day of the fourth year if the
corporation has earnings and prots and excessive passive income for
three consecutive years.
Advantages
Flow-through vehicle. The S corporation (generally speaking) is consid-
ered a ow-through vehicle for federal income tax purposes (just like a
limited partnership or a manager-managed LLC); that is, the entity itself
is not subject to the payment of most federal income taxes.
Ordinary losses. Corporate operating losses are deductible as ordinary
losses by the shareholders, pro rata, up to their basis in the stock.
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Avoidance of double taxation. The double taxation normally associated
with a regular corporation can be avoided by using the S corporation.
Expected prots. The S corporation is a good idea if the corporation
is expected to earn prots right away and there is no need to reinvest
earnings in the corporation.
Family income. The S corporation election allows corporate income to
be spread among various family members to minimize the total income
tax for the family as a whole.
Disadvantages
Shareholder limit. The number of shareholders is limited to seventy-
ve.
Termination. The S corporation special status may be terminated if
noneligible shareholders or too many shareholders acquire stock.
Nonresident aliens. Nonresident aliens may not be shareholders in S
corporations.
Single class of stock. S corporations can only offer one class of stock.
Individual shareholders. Generally speaking, shareholders must be
individuals.
Professional advice. The decision to choose this form of conducting
business should almost certainly involve the professional advice of an
accountant or tax attorney.
Effect of legislation. One effect of the Revenue Reconciliation Act of
1993 is that S corporations that retain earnings to fund growth may be
putting their shareholders in higher tax brackets than they would be if
they terminated their S corporation election.
Summary
If earnings are not to be reinvested. An S corporation election is gen-
erally desirable when the business is expected to make a prot soon
after incorporation and there will be little need to reinvest earnings
in the business for expansion. In that case, the corporation will likely
distribute most of its net income to shareholders, and so by making
an S election, the double taxation of a regular C corporation would be
avoided.
If earnings are to be reinvested. On the other hand, if prots are going
to be reinvested in the business for a few years, then an S corporation
election is probably not desirable, because there would be no double
taxation anyway since earnings are being reinvested rather than dis-
tributed to shareholders.
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Venture Capital Financing
Venture capital nancing is typically associated with corporate nance,
although it does not have to be. As used in this discussion, the term ven-
ture capital refers to organized funds that serve as a source of nancing for
early-stage companies. This denition reects the use of the term in the
real-world marketplace. It is technically possible for wealthy individuals
to function as venture capitalists; however, the term angel investor is the
one more commonly associated with such individuals (see Angel Inves-
tor Financing in chapter 5). Venture capital companies are generally
organized as privately held limited partnership or limited liability com-
panies, and they receive most of their funds from institutional investors
like pension plans, trust funds and insurance companies.
Venture capital companies (or rms) provide a substantial amount
of equity investment capital for small and developing companies, gener-
ally. Unfortunately for lmmakers, there is little evidence to suggest that
venture capital sources are very interested in nancing independently
produced feature lms. Typically, the venture capital funds act as a fund-
ing resource for companies that need considerable working capital but are
not in a nancial position to appeal to a broad public market of investors
(i.e., not ready for signicant securities sales to the public). On the other
hand, venture capital rms are generally not interested in nancing pure
start-ups in any eld.
Venture capital companies may invest a substantial amount of capital
and, in return, receive equity securities, often preferred stock, board of
director positions and an ongoing role in management decisions. This
description presumes that the company being invested in is organized
as a corporation and that the venture capital rm is taking an active role
in management, not necessarily a good thing for a creative venture like
feature lm production.
Types of Businesses
Each venture capital company tends to develop its own investment
philosophy and portfolio of investments in client companies. Even
though the investment interests of venture capital rms may change
over time, they are typically more interested in computer hardware and
software, telecommunications, electronics, biotechnology, healthcare,
pharmaceuticals, environmental products and services, retailing, con-
sumer products and services and sometimes environmentally and socially
responsible projects. Even though there has been some interest in the
related CD-ROM, multimedia, interactive television and Internet elds,
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89
there has been little venture capital interest in the feature lm segment
of the communications and entertainment industry.
Investing Stage
Although there are no universally agreed-upon denitions for the
various stages in the life of a business, generally speaking in the business
world, preformation or initial company nancing, is referred to as seed
capital nancing, and that is different from the early-stage nancing
that generally comes in after the company is established. Seed capital
nancing and early-stage nancing may be referred to in the context
of lm nance as development money, development nancing, or
development funds and even as start-up funds.
Thus, a lmmaker must decide how to raise these early monies. He
or she might consider gifts or grants (see chapter 1) or some of the active
investor options discussed in this book (investor-nancing agreement,
coproduction or joint venture, initial incorporation or member-man-
aged LLC). A lmmaker may also choose to cross that line between
nonsecurities transactions and selling a security and to seek this devel-
opment funding from a group of passive investors. As discussed under
Alternative Uses for Investor Funds (see the introduction to part 2),
this development-stage nancing for one or more feature lms may
be used to cover the costs of acquiring the underlying literary rights,
developing the screenplay or attaching elements to the script (packag-
ing) to create a presentation that may then be taken to the industry for
production nancing. Another decision that is inextricably intertwined
with these considerations is whether to approach prospective investors
with a business plan or a securities disclosure document (see appendix
B, Limited-Use Business Plans).
Continuing the consideration of the traditional terminology associ-
ated with business generally, the terms second or third round, mid-stage
or mezzanine nancing refer to stages of funding for companies after the
seed capital nancing or early-stage nancing, but before their eventual,
more complete nancial development through one or more public securi-
ties offerings. Again, this traditional terminology is generally associated
with the creation and nancing of corporations.
Thus, another decision a lmmaker has to make is whether to form a
corporation and seek this sort of traditional nancing to pursue the goals
of nancing and producing feature lms, or whether to (at least initially)
nance one or more lms on a project basis (the choice of entity or
choice of investment vehicle question). The limited partnership or lim-
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90
ited liability company may be better suited for this latter form of project
nancing, regardless of whether it is intended to nance the production
costs of a single motion picture or a limited number (slate) of lms.
Some venture capital companies in recent years have begun specializ-
ing in start-up and early development situations. These rms, commonly
referred to as incubators, often impose a substantial degree of control
over business development and marketing. Once again, however, most,
if not all, of the so-called incubators specialize in the technology sector,
not feature lms.
Studies of investing patterns by venture capital rms show that ap-
proximately 60 percent of such investments go to second- and later-stage
companies. In fact, these same studies demonstrate that the average
venture-backed company has been in existence for more than three years
and has more than thirty employees when the venture capital nancing
comes in. Once again, these do not sound like lm production company
start-up situations.
Venture capital rms are also looking for real depth of experience
among the companys management, so the venture capital route does
not make much sense for the rst- or second-time lmmaker. In addi-
tion, venture capital rms are generally looking for average returns at the
time of their exit from the company of 20 to 50 percent per year. They
will also want the company receiving their investment to be willing and
able to sell the company or complete a successful public offering of the
companys stocks in three to seven years.
In any case, a directory of venture capital rms is available through
the National Venture Capital Association at http://www.nvca.org or 703-
524-2549. Also see Pratts Guide to Venture Capital Sources. Another list
of venture capital companies is available from the National Association
of Small Business Investment Companies, 202-833-8230.
Advantages
One-stop shopping. A lm production company may be able to get all
the money needed from one venture capital source.
Signicant money. Venture capital rms offer large amounts for equity
nancing.
Specialized expertise provided. Sometimes, venture capital rms can
provide expertise in marketing, human resources and business devel-
opment.
Helpful advice. Venture capital rms may be able to provide some
helpful business advice in addition to capital.
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Disadvantages
Not for start-ups. The vast majority of venture capital investments are
made in second- or third-stage nancing for companies; therefore, ven-
ture capital nancing is simply not available for most lm start-ups.
A real long shot. The chances of getting an independent lm funded
this way are not good. The turn-down rate for venture capital applications
may be higher than 99 percent, and that rate is based on other industries
considered less risky than independent lm.
Corporate securities. Most venture capital companies prefer to invest in
corporate securities, partly because they hope to gain substantial prots
when the company goes public or is sold.
Equity position. Most venture capital companies demand a substantial
equity position in exchange for their investment, most typically through
common or preferred stock or a combination of equity and debt.
Management. Venture capital companies will typically demand a
signicant presence on the corporations board of directors and other
controls on corporate or business management. Even if the venture capital
company does not end up with a majority of equity ownership, it will
generally require approval for all major business decisions. For a creative
venture like lm, this simply may not work.
Not really long-term. Venture capital companies do not want to have
their money tied up in a venture for more than several years.
High growth. Venture capital companies look for high growth pros-
pects. The most attractive start-up operations are considered to be those
with nationwide markets and forecasted sales of $50 million to $100
million after ve years.
Different goals. The economic philosophy of a venture capital rm may
not necessarily be consistent with the lmmakers plans for the companys
development and in fact may be in conict with the companys long-term
growth goals.
Not for high-risk ventures. Venture capital companies prefer not to take
substantial risks with their investments. They have to be persuaded that
there is even more than a reasonable chance of making a good return on
their investment; thus, seeking venture capital as a form of lm nance
places a more than unreasonable burden on the lmmaker.
Time and documentation. The process of seeking venture capital is
generally time-consuming for both the venture capital company and
those seeking venture capital investments. The venture capital company
will demand a great deal of documentation from those seeking funding;
thus, a great deal of time and effort has to be expended by those seeking
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92
venture capital funds. In addition, venture capitalists expend a considerable
amount of time and effort examining and analyzing that documentation
Highly competitive. Filmmakers seeking venture capital funding will be
competing with thousands of other businesses seeking the same funding,
and many of those are more suited for this type of nancing. Some ven-
ture capital rms report receiving as many as two thousand applications
a year, while choosing to invest in only one business per 166 applicants.
Exit strategies. Venture capital rms are as concerned about getting out
as getting in and are not often favorably inclined to invest except in com-
panies that offer the likelihood of (1) being bought out fairly soon by larger
companies, (2) being attractive to subsequent venture capital nancing
that will take over their initial positions or (3) being good prospects for
signicant public offering opportunities in the foreseeable future.
Fast growth companies. Venture capital rms are under pressure to
identify and exploit fast growth opportunities before more conventional
nancing alternatives become available.
Tough terms. Venture capital rms have a reputation for negotiating
tough nancing terms and setting high demands on their target companies.
Not for indie lms. Venture capital nancing is not generally available
and not even a good choice of nancing for independently produced
feature or documentary lms.
Expensive money. The cost of nancing through venture capital rms
is high. Ownership demands for an equity interest in the company of 30
to 50 percent are not uncommon even for established businesses, and a
start-up or higher risk venture could easily require transfer of a greater
ownership interest to the venture capital rm.
Loss of control. The demand of a high level of ownership may result in
loss of control of the company.
High returns expected. Venture capital rms might invest for periods
of three to seven years, but they will expect at least a 20 to 50 percent
annual return on their investment. That sort of return on investment is
difcult, if not impossible, for start-up independent feature lm produc-
tion companies to offer.
Existing businesses. Venture capital rms favor existing businesses
that have a minimum operating history of several years. The nancing
of start-ups is limited to situations where the high risk is tempered by
special circumstances, such as a company with extremely experienced
management and a very marketable product or service.
Preexisting capital investment. The target companies for venture capi-
tal rms will often already have revenues in excess of $2 million and a
preexisting capital investment of at least $1 million.
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93
The Out-of-State Corporation
The following points relate specically to the question of whether to
incorporate as an out-of-state corporation and do business in another
state (the actual base of operations). Feature lm producers are advised
to consult with an attorney or accountant (or both) before making this
decision and to look beyond the initial start-up costs and not rely on the
formation expense as the sole deciding factor.
Qualication
Out-of-state corporations (also referred to as foreign corporations) that
want to transact business in a state may have to rst apply for registration
with that states secretary of state. The application for registration typi-
cally has to be accompanied by a Certicate of Good Standing executed by
an authorized public ofcial of the state or place in which the corporation
was organized. A qualication fee may also be required to accompany
the application. Qualifying as an out-of-state corporation to do business
in another state may therefore be just as expensive and troublesome as
incorporating in the second state, especially if that is where the business
is actually being conducted.
Annual Report
A foreign corporation that is qualied to do business in a state may be
required to le an annual report with that states secretary of state, in addi-
tion to the reporting requirements of the state where the corporation was
organized. A corporation can forfeit its powers or rights by failing to le its
annual statement. Thus, it may have to le annual reports in two states.
Franchise Tax
An annual franchise tax based on the amount of net prots earned in a
state where a corporation is doing business may have to be remitted in that
state. Simply being incorporated in another state may not avoid such a tax.
Application of Corporations Code Provisions
A foreign corporation that does more than half of its business in a state
other than its state of incorporation and has half of its shareholders in
that second state may be subject to many of the same provisions of that
states laws that apply to domestic corporations.
Forfeiture
If a foreign corporation fails to properly qualify itself, the exercise of its
corporate powers, rights and privileges in that state in which it is doing
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business may be forfeited. If forfeited, all contracts made by a nonquali-
ed foreign corporation are voidable at the option of the other party.
The secretary of state may also forfeit the right of a foreign corporation
to transact intrastate business.
Other Penalties
A foreign corporations failure to qualify or be in good standing to
transact interstate business may make it impossible to maintain any cause
of action in the courts of that state. A ne for pursuing such a suit may be
imposed. A foreign corporation that transacts intrastate business without
holding a valid Certicate of Registration may also be subject to a penalty
for each day unauthorized business is transacted. Such a corporation may
also be held guilty of a misdemeanor, punishable by a ne.
Advantages
Avoidance of state taxation. This is the single most popular reason put
forth by lm producers trying to decide whether to incorporate their
production companies in a particular state. The better practice is to bring
in some early investors who can provide the start-up funds needed for
such expenses.
Local production company. An independent producer who actually
operates out of another state and seeks to raise a substantial amount of
its funds from investors in that state for a local lm production may nd
it advantageous to organize as a local corporation.
Disadvantages
Tax liabilities not entirely avoided. As discussed above, incorporating
out of state does not always avoid the imposition of taxes on income
generated by actually doing business in another state.
Second level of bureaucracy. A production company that is organized as
an out-of-state corporation but that is actually doing business in another
state has merely superimposed a second level of rules, paperwork and
expense on the corporations operations.
The bottom line is that forming a corporation in a state other than
the one in which the business is actually to be conducted, primarily to
save some small up-front fees, is a short-sighted strategy. The supposed
benets are outweighed by the costs and burdens of qualifying to do
business in another state as a foreign corporation.
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Securities Compliance
A lmmaker selling corporate shares, units in a limited partnership or
interests in a manager-managed LLC (i.e., any of the three passive investor
vehicles just discussed) would be selling securities. Thus, the lmmaker
would be obligated to comply with the federal and state securities laws
in order to engage in legitimate lm nance transactions. The balance
of this part two discussion relating to investor nancing is organized
around the three levels of available securities law compliance:
private (exempt) offerings (chapters 10, 11, and 12)
public/private (hybrid) exemptions (chapter 13)
public (registered) offerings (chapters 1418)
Although there are some similarities among each level of compliance
(e.g., relating to disclosure) there are also signicant differences (e.g.,
how the securities can be marketed).
95
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96
Securities Compliance: Private (Exempt) Offerings
10 Statutory Exemptions of the 1933
Securities Act, Section 4
Section 4(2): Nonpublic Offering
One of the rst nonpublic (private) exemptions a lmmaker may want to
consider is Section 4(2) of the Securities Act of 1933. Federal legislation
requires that all securities offered through the mail or other channels
of interstate commerce be registered with the SEC. That requirement
is found in Section 5. Once a lm producer decides to sell any form of
security in order to raise money for a lm project, registration is the rst
obligation. Congress, however, provided certain exemptions from this
registration requirement where there appeared little need for protecting
the investing public. These exemptions are often referred to as unregis-
tered offerings or exempt offerings (and sometimes private offerings, private
placements or nonpublic offerings). They provide an alternative to the
registration requirement (see Public (Registered) Offerings starting
at chapter 14).
Section 4(2) is the most basic of those private exemptions. It merely
provides that transactions by an issuer not involving any public offering
are exempt from the securities registration requirement. Unfortunately,
it provides no further guidance with respect to the details of compliance,
and anyone trying to rely on it for an exemption from the registration
requirement has to look to years of conicting and confusing case law
(along with a few intermittent SEC rules) to determine how many people
can be approached with a private offering, how many investors can be
accepted, whether a disclosure document is required, what has to be
disclosed in the offering memorandum and so forth.
The actual intent and design of this statutory provision is to protect
investors by encouraging full disclosure of information thought neces-
sary for prospective investors to make informed investment decisions.
Some practitioners make the mistake of assuming that since no specic
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97
disclosure is required (or that only access to such information is man-
dated), no offering memorandum need be given to prospective offerees.
There are two problems with that interpretation:
the antifraud rule still applies across the board to all securities offerings,
and the antifraud rule requires that all material aspects of the trans-
action be disclosed, that nothing important be omitted and that the
information disclosed must be stated in a way that is not misleading to
prospective investors; and
providing no written disclosure document gives no protection to the
issuer in a dispute over what was stated orally to the prospective inves-
tors when they were considering the investment.
Thus, it would appear that some form of disclosure document is not
only required to protect the best interests of potential investors, but that
it is the safer choice for the lm producer or other issuer. Unfortunately,
none of this is actually stated in the statutory language, and not much
else is provided for.
Courts have held that the application of Section 4(2) should be based
primarily on whether the particular class of persons affected needs the
protection afforded by the law. This question, in turn, may be based on
the level of knowledge the offerees have concerning the issuing entity
and on the need of the offerees for the protection that would have been
afforded by a registration statement. In other words, access to the kind
of information that a registration statement would disclose is considered
an important factor. An offering to those who are shown to be able to
fend for themselves would likely be considered a transaction not involv-
ing any public offering. Pursuant to this provision, it is also important
to know what steps the issuer has taken to prevent a redistribution of the
securities from occurring.
Thus, the courts and the SEC have interpreted the Section 4(2) ex-
emption to be available for offerings to persons who have access to the
same kind of information that a registration of the same securities would
provide and who are able to fend for themselves. That being the case, a
securities disclosure document (the private offering memorandum) for
such an offering should look something like the prospectus for a registered
offering for approximately the same or a similar amount of securities.
In addition, the statutory language transactions . . . not involving any
public offering has been interpreted in many judicial and administrative
decisions to indicate that both the purchasers and nonpurchasing offerees
must satisfy the requirements of the exemption in a private offering based
on Section 4(2). Compliance is made even more complicated by the 1933
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98
Acts very broad denition of the term offer, which creates offerees out
of almost any modest solicitation effort.
In all of its administrative rulings, opinions and responses relating
to the prohibition against a general solicitation for nonpublic offerings,
the SEC has taken the consistent position that the issuer and the offeree
must have a preexisting business relationship (i.e., the SEC has never
rendered a favorable opinion regarding the question of whether a general
solicitation has occurred without the existence of a preexisting relation-
ship). A preexisting relationship is dened as any relationship consisting
of personal or business contacts of a nature and duration such as would
enable a reasonably prudent purchaser to be aware of the character, busi-
ness acumen and general business and nancial circumstances of the
person with whom the relationship exists. The preexisting relationship
requirement has been applied even in mailings to individuals considered
sophisticated in investment matters and to wealthy persons. On the other
hand, this preexisting relationship need not be of a formal or contractual
nature. It is enough if the relationship is sufcient to allow the issuer or
someone acting on the issuers behalf to know about the offerees nancial
circumstances or level of sophistication.
The initial burden of proof for an alleged securities registration re-
quirement violation is on the plaintiff, or purchaser of the security, to
show that the defendant, or issuer, offered or sold the security, that no
registration statement was used and that interstate transportation or
communication or the mail was used to sell the security. The burden then
shifts to the defendant, or issuer, to demonstrate that all of the condi-
tions and limitations imposed on the available and specic exemption
relied on were complied with. When those conditions and limitations
are so uncertain as they are with a Section 4(2) offering, that places a
heavy burden on that defendant (i.e., for purposes of this discussion,
the lms producer).
The chance of an investor becoming disgruntled in a high-risk invest-
ment like independent lm is multiplied if the risk is not spread widely
and the risks have not been adequately disclosed.
Advantages
Faster than a public offering. A private offering can be handled more
quickly than a public offering and with less expense.
No ceiling on amount. There is no ceiling on the amount of money that
can be raised through the Section 4(2) nonpublic offering exemption.
Issuer compliance. Compliance for such an offering initially and
primarily rests with the issuer. Generally, securities regulators will not
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99
become involved in reviewing how the offering was conducted unless an
investor complains.
Disadvantages
State compliance. State blue-sky laws regarding ling requirements,
number of offerees or investors and notice ling fees may still apply. Some
states may even require review of the disclosure document.
Restricted securities. Privately offered securities are unregistered and
thus their transfer is restricted.
Minimal guidance. Little guidance is provided for what information
ought to be disclosed in a private placement offering memorandum
prepared pursuant to Section 4(2).
Offeree limit. Offers pursuant to Section 4(2) need to be limited to 25
offerees (as opposed to the 35 unaccredited and the unlimited number
of accredited investors under the SECs Regulation D, Rules 505 and 506;
see chapter 12).
No advertising. No advertising or general solicitation is permitted.
Primarily for corporate insiders. The offerees should be limited to
company insiders (i.e., directors, executive ofcers or control persons
generally).
Sophisticated investors may be required. Some courts require that each
offeree have a certain level of sophistication (i.e., have sufcient knowl-
edge and experience to understand the risks of the offering).
Limited transfer. The exemption may be lost if qualied purchasers
become mere conduits in the transfer of the securities to unqualied pur-
chasers; thus, according to this interpretation of the statutory language, the
securities must come to rest in the hands of only qualied purchasers.
No compliance certainty. The statutory provision, SEC rules and case
law provide little certainty as to how to comply, thus putting issuers at
risk of inadvertently being guilty of selling unregistered securities.
Section 4(6): Accredited Investor Exemption
Another one of the possible private placement (nonpublic offering) ex-
emptions available to choose from is Section 4(6) of the 1933 Securities
Act. This provision exempts from registration offers and sales of securi-
ties to accredited investors when the total offering price is less than $5
million. The denition of accredited investor is the same as that used in
the SECs Regulation D (see chapter 12).
Just as with the private placement exemptions under Regulation D,
Rules 505 and 506, this Section 4(6) exemption does not permit any form
of advertising or public solicitation. Also, there are no specic document
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delivery requirements, but again, all transactions are subject to the anti-
fraud provisions of the securities laws. In one sense, this just means that
instead of providing any specic guidelines regarding what information
must be included in a disclosure document, the more general provisions
of the antifraud rule apply.
The language of Section 4(6) exempts from registration
transactions involving offers or sales by an issuer solely to one or more
accredited investors, if the aggregate offering price of an issue of securi-
ties offered in reliance on this paragraph does not exceed the amount
allowed under section 3(b), if there is no advertising or public solicitation
in connection with the transaction by the issuer or anyone acting on the
issuers behalf, and if the issuer les such notice with the Commission as
the Commission shall prescribe.
The referenced Section 3(b) provides that
The Commission may from time to time by its rules and regulations, and
subject to such terms and conditions as may be prescribed therein, add any
class of securities to the securities exempted as provided in this section,
if it nds that the enforcement of this title with respect to such securities
is not necessary in the public interest and for the protection of investors
by reason of the small amount involved or the limited character of the
public offering; but no issue of securities shall be exempted under this
subsection where the aggregate amount at which such issue is offered to
the public exceeds $5,000,000.
Disclosure Issues
With respect to the Section 4(2) and Section 4(6) nonpublic offering
exemptions, such offerings will still need to be in compliance with the
provisions of the antifraud rules (specically, the SECs antifraud rules,
including Section 10b-5 of the 1934 Act).
Unfortunately, most low-budget lmmakers seeking to raise small
amounts of money from private investors will not be able to raise all of
the money needed exclusively from wealthy accredited investors. By their
very nature, there are fewer accredited investors in the marketplace than
there are nonaccredited investors, and lmmakers may or may not have
the required preexisting relationships with a sufciently large enough
number of accredited investors to rely solely on that source for the funds
needed. Thus, reliance on Section 4(6) may be out of the question for
these reasons.
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101
There also seems to be a difference of opinion among attorneys as to
which rule ought to be relied on by lmmakers when seeking to raise
money from private investors. Some attorneys rather recklessly advise
lmmakers to take the most risky route and seek to comply with Section
4(2) or Section 4(6), sell only to accredited investors and provide minimal
or no disclosure of information to prospective investors. In such situa-
tions, however, if an investor is disappointed with the results, or for any
other reason decides to challenge the legality of the lmmakers offer-
ing of securities, the lmmaker will likely have a more difcult time in
demonstrating compliance with the law since the standards to be applied
for the Section 4(2) and Section 4(6) offerings are so vague.
The question of what information needs to be disclosed to prospective
investors (i.e., what must an issuer who raises capital through the sale of
securities to investors disclose to those investors in order to comply with
the antifraud provisions of the federal securities laws?) is discussed in
Harry S. Gerlas article Issuers Raising Capital Directly from Investors:
What Disclosure Does Rule 10b-5 Require? While Gerla concludes that
current law on what disclosure Rule 10b-5 requires of issuers who sell
securities directly to investors is unclear, he also points out,
Congress indicated its belief that the market for securities should be
different than the market for other goods, services or commodities.
Congress believed that the market for securities should be populated
by informed purchasers rather than the cadre of potentially ignorant
investors allowed by the doctrine of caveat emptor. These facts support
a nding that an issuer does stand in some form of relationship of trust
and condence with the investors who purchase securities from it. . . .
[and] that [t]he purpose of the federal securities laws has always been
the protection of investors.
Thus, lmmakers and other issuers of securities are left with a choice:
either take the risky road and provide minimal disclosure to investors,
which is clearly contrary to the intention of Congress and the law, or
comply with the specic requirements of Regulation D, Rule 506 (and the
antifraud rules), by disclosing all material aspects of the transaction, not
omitting anything that would be considered material (i.e., important to
investors) and stating what is disclosed in a manner that is not misleading.
This is an issuers basic obligation for disclosure pursuant to the antifraud
rules. That means for lmmakers as issuers of securities to be safe, they
should provide written disclosure documents, prepared in accordance
with the combined standards of Regulation D and the antifraud rules,
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and these documents should be provided to all prospective investors prior
to their purchase of the security.
As a suggestion, when an attorney or other lm nance consultant
encourages a lmmaker to take that more risky route, that lmmaker
should probably ask that attorney or consultant to either provide an
opinion letter on his or her letterhead stating that in the attorneys or
consultants judgment the lmmaker is not offering a security and there-
fore does not have to comply with the securities laws; or alternatively,
the lmmaker could ask the attorney or consultant to provide a securi-
ties opinion stating that when the securities are offered, they are being
offered and sold pursuant to the exemption from registration with the
SEC and will when sold, be legally issued, fully paid and non-assessable.
If the attorney or consultant is not willing to do either, maybe the lm-
maker ought to get a second opinion regarding the issue of what disclo-
sure needs to be provided to prospective investors. After all, a mistake
on this question could lead to both civil and criminal liability for the
sale of an unregistered security, so it is not an issue that should be taken
lightly or approached in a reckless manner. Clearly, the safer approach
is to comply with the more specic disclosure guidelines of Regulation
D and the antifraud rule, not to cut corners. The concept of guerrilla
lmmaking does not apply here.
Advantages
No registration. Since Section 4(6) is an exempt offering, no registra-
tion is required.
No specic disclosure. No specic disclosure requirements are mandated
by the exemption itself.
Disadvantages
Disclosure risks. It is also possible to consider the fact of no specic
disclosure requirements a disadvantage, in that the exemption provides
no guidance for persons seeking to comply with its provisions.
Antifraud compliance. Even without the requirement of specific
disclosure obligations, the issuer must still comply with the disclosure
obligations imposed by the antifraud statute.
Reduced investor pool. Limiting the prospective purchasers to accred-
ited investors signicantly reduces the pool of prospective investors.
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11 Intrastate Offering Exemption
Occasionally, lmmakers want to conduct a so-called intrastate offer-
ing to raise money to produce a feature lm, believing they can raise the
money that is needed in just one state. There are actually two intrastate
exemptions from the securities registration requirement. One is based
on the statutory language of Section 3(a)(11) of the 1933 Securities Act.
The other is Rule 147 promulgated by the SEC. An issuer of securities can
seek to comply with one or both, and the failure to comply with one does
not prevent compliance with the other.
The statutory intrastate exemption requires that the issuer of securi-
ties be organized and doing business in the state in which the securities
are being offered and sold, that the securities be offered and sold only to
persons who reside within that state (i.e., both the issuer and investors
must be from the same state), that offering proceeds be primarily used
within that state and that the securities come to rest within that state
(i.e., no short-term resales to nonresidents of the state).
The intrastate exemption has no offeree or purchaser qualications
other than residence in the subject state. There are no limitations on
the manner of the offering, except that offers have to be limited to state
residents. There is no prescribed disclosure format (but dont forget the
antifraud rule), no ceiling on the amount of securities that can be offered
pursuant to the exemption, no ling or reporting requirements and no
resale limitations except to nonresidents.
Unfortunately, a single offer to a nonresident can void the exemption,
even if all purchasers are residents of the state. For this purpose, it is not
valid to claim that the offer to a nonresident was made by mistake or
in good faith. Also, over the years, courts and the SEC have interpreted
the exemption in ways that make it more complicated and its standards
somewhat indenite, thereby making compliance more difcult.
For example, if a purchaser of an exempt security (i.e., exempt under
the statute) resells the security to a nonresident, that resale although not
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under the control of the issuer, can void the exemption. In effect, state
residency requirements must be met for the issuer, every offeree, every
purchaser and every subsequent transferee of the security. Also, even
though the statute does not refer to the use of offering proceeds, the courts
and the SEC have consistently required that a substantial portion of the
offering proceeds be used within the state. In addition, some courts have
ruled that income-producing activities cannot be out of state. In short,
the cases and administrative decisions are somewhat inconsistent. The
safest practice is to only use the statutory intrastate offering exemption to
raise money for a local company doing business locally (e.g., a restaurant).
Since movies are intended to be exhibited throughout the world and will
hopefully generate revenues from all across the globe, they hardly seem
appropriate for the intrastate exemption.
The same problem exists with the SECs Rule 147 intrastate exemp-
tion, which specically requires that 80 percent of the revenues of the
business be derived from operation of the business within the state of
the offering. Again, lms are usually intended to derive a signicant
portion of their revenues from outside a single state, and thus both the
statutory and Rule 147 intrastate exemptions are inappropriate for most
lm nance situations.
Advantages
Investor qualications. The intrastate exemptions do not impose offeree
or purchaser qualications other than residence in the subject state.
Manner of offering. There are no limitations on the manner of the of-
fering except that offers have to be limited to state residents.
Disclosure. The exemption imposes no prescribed disclosure format.
No ceiling on amount. There is no ceiling on the amount of securities
that can be offered.
Filings. There are no ling or reporting requirements.
Resales. There are no resale limitations except to nonresidents.
Disadvantages
Easily voided. This exemption requires strict compliance and can
easily be voided by an inadvertent failure to comply with one or more
of its provisions.
Limit on source of revenue. Most of the revenues generated by the busi-
ness must also come from that one state.
Not suited for international business like lm. The intrastate exemption
might be suitable for a truly local business venture, such as a restaurant or
nightclub, but not for the selling of a product like a movie that is intended
for international consumption.
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105
12 Regulation D
For many years, the most commonly used private placement exemption
at the federal level has been the SECs Regulation D. It is an exemption
from the securities registration requirement, but it is an SEC rule, not a
statute passed by Congress. Congress did, however, provide the statutory
authorization for such a rule.
As noted earlier, if a feature lm producer raises money from passive
investors, the interests in whatever vehicle or entity is created for that
purpose are most likely going to be securities (corporate stocks, limited
partnership interests, units in a manager-managed LLC); thus, the pro-
ducer must comply with both the federal and state securities laws. One
of the foremost requirements of those laws is that the issuer register those
securities with the SEC at the federal level and with the appropriate state
regulatory authorities in each state in which the securities are going to
be offered or sold (these registered offerings are also referred to as public
offerings). Alternatively, the issuer may wish to comply with available
exemptions from the securities registration requirement, and the exemp-
tions (more specically, the transactional exemptions) are commonly
referred to as private placements, private placement exemptions, exempt
offerings, nonpublic offering exemptions or (at the state level) limited of-
fering exemptions and small offering exemptions.
As already noted, Regulation D is simply one of several exemptions
available at the federal level. Sections 3(a)(11), 4(2) and 4(6) of the 1933
Securities Act are also considered private placement exemptions, although
Regulation D is by far the most commonly relied-upon exemption, and
it offers a so-called safe harbor for issuers who are not sure about how to
comply with the statutory exemptions (and not many are).
General Requirements of Regulation D
In order for a lm production company (or other securities issuer) to
qualify for the transactional exemption for one of its securities offerings
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pursuant to Rule 504 (or Rules 505 and 506), the offers and sales must
satisfy the general terms and conditions of Regulation D relating to
treating a series of offerings as a single offering to avoid application of
the rules (securities integration);
disclosing prescribed information to prospective investors (information
or disclosure requirements);
complying with the general prohibition against advertising and general
solicitation (limitations on the manner of offeringlimitations that as
a practical matter mean sales can only be made to persons with whom
upper-level management of the issuing entity had a preexisting relation-
ship, that is, prior to the start of the offering);
complying with provisions that limit the resale of such securities by the
original investors (limitations on resale); and
ling the required Form D in a timely manner (ling of notice of sales;
although the exemption is no longer voided by a failure to do so).
Rule 504 Offerings
Rule 504 is just one of three different specic sets of rules within Regula-
tion D that permit issuers to sell securities in a nonpublic offering; that
is, in a private placement.
Ceiling on Amount of Money
Rule 504 imposes a limit on the aggregate offering price (or amount
of money that can be raised) in reliance on this specic rule; that is, no
more than $1 million can be raised pursuant to Rule 504 within a twelve-
month period.
Number of Investors
There is no limit on the number of investors who can invest in a
Rule 504 offering. However, since the securities issuer must comply
with both the federal and state securities laws and since most compat-
ible state private placement (or limited offering) exemptions do impose
limits on the number of investors, this provision of Rule 504 is generally
of little value. The ceiling on the number of investors that is imposed
by the state law controls in such situations (i.e., the more burdensome
provision prevails).
No Specic Disclosure Requirements
Rule 504 also provides that The issuer is not required to furnish the
specied information to purchasers when it sells securities under Rule
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Regulation D
107
504. However, as already noted, this provision is often misinterpreted
to mean that a Rule 504 offering does not require the preparation and
presentation of a disclosure document (offering memorandum) to each
prospective investor. Nothing could be further from the truth, since
the Preliminary Notes to Regulation D clearly state that transactions
conducted in accordance with Regulation D are not exempt from the
antifraud . . . provisions of the Federal securities laws, and the anti-
fraud provisions require, as has been noted, that issuers of securities
must disclose in writing to all prospective investors all material aspects
of the transaction and in a manner that is not misleading. A violation
of the antifraud rule could constitute securities fraud; thus, a complete
disclosure document is still required for a Rule 504 offering. The safer
practice, in the view of most experienced securities attorneys, is to rely
on the specic disclosure guidelines provided for the next highest level
of exempt offering (e.g., the Regulation D, Rule 505 exemption).
Issuer Disqualiers
Unlike Rule 505, Rule 504 does not impose the set of so-called issuer
disqualiers (bad boy provisions) on those persons who would seek
to sell securities under Rule 504. The disqualiers basically state that the
exemption is not available to persons who have been guilty of certain
securities law or other violations within the most recent ve years. Again,
however, most of the state exemptions that would need to be complied
with by an issuer relying on Rule 504 do impose similar issuer disquali-
ers; therefore, the producer must carefully review those disqualifying
provisions and be familiar with the backgrounds of persons involved in
the selling of the offering.
Advantages
Disclosure less burdensome. The antifraud rule presumably allows a bit
more leeway with respect to disclosure than the more specic disclosure
guidelines of a Rule 505 offering.
Faster than public offerings. A private placement generally allows the
producer to put together a disclosure document and be on the street
raising money more quickly than a public (registered) offering.
No advance regulatory approval required. The private placement disclo-
sure document does not have to be submitted to the SEC or state regula-
tory authorities for approval prior to its use with prospective investors
as in public (registered) offerings.
Less expensive. Private placements are generally less expensive to con-
duct than public offerings.
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Use with MAIE. Rule 504 can now be used in conjunction with the
NASAAs Model Accredited Investor Exemption (see chapter 13) to raise
up to $1 million from accredited investors only, with some advertising,
including on the Internet (see Selling Securities over the Internet at
appendix D).
Disadvantages
Disclosure mistakes could be costly. A mistake in judgment with respect
to disclosure when merely trying to comply with the very general anti-
fraud rule as opposed to the more specic Rule 505 disclosure guidelines
could constitute securities fraud.
Funding limit. A Rule 504 offering only permits the producer to raise
$1 million.
Preexisting relationship. In contrast to a public (registered) offering,
securities being offered pursuant to any Regulation D (private place-
ment) exemption can only be offered, as a general rule, to persons with
whom upper level management of the issuing entity has a preexisting
relationship (i.e., before the start of the offering)an MAIE offering is
an exception to this rule.
Complex securities laws. The complexity of the securities laws makes
it almost imperative that an experienced securities attorney be engaged,
preferably with specic and successful experience with lm or lm com-
pany offerings, and attorney fees can be relatively expensive for start-up
production companies.
State law compliance required. In addition to complying with the federal
securities laws and regulations, issuers of securities must also comply
with the applicable state securities laws and regulations (blue-sky laws)
in each state in which those securities are to be offered or sold.
Rule 505 Offerings
Rule 505 is the second of the three specic sets of rules within the SECs
Regulation D that permit issuers to sell securities in a nonpublic offer-
ing, that is, in private placements, and that set out the specic conditions
and limitations upon which the issuer can rely. Just as with Rule 504, a
feature lm production company (or other issuer) seeking to qualify for
the transactional exemption for one of its securities offerings pursuant
to Rule 505 must satisfy the general terms and conditions of Regulation
D listed above (see General Requirements of Regulation D).
Ceiling on Amount of Money
Rule 505, however, relaxes the ceiling on the amount of money that
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109
can be raised, to some extent. The Rule 505 limitation on the aggregate
offering price is $5 million; again, that amount must be raised in a
twelve-month period.
Number of Investors
Rule 505 utilizes a different approach than Rule 504 with respect to the
number of investors that may be permitted to invest in such an offering.
No more than 35 nonaccredited investors are allowed pursuant to Rule
505, but an unlimited number of accredited (i.e., wealthy) investors are
permitted. There are eight kinds of accredited investors dened in Regu-
lation D. However, lm producers are most likely to be making offers to
persons in only two categories: (1) natural persons whose individual net
worth or joint net worth with that persons spouse at the time of purchase
exceeds $1 million; or (2) natural persons who had an individual income
in excess of $200,000 in each of the two most recent years or joint income
with that persons spouse in excess of $300,000 in each of those years and
who have a reasonable expectation of reaching the same income level in
the current year.
Specic Disclosure Requirements
Unlike Rule 504, Rule 505 provides specific disclosure guidelines.
Those disclosure guidelines are tied to the specic guidelines of the pub-
lic offerings pursuant to Regulation A or Regulation S-B, depending on
the amount of money being raised (see chapters 15 and 16). Once again,
copying and modifying someone elses offering memorandum provides
no assurances that these disclosure guidelines have been met.
The Rule 505 exemption does not require specic disclosure for sales to
accredited investors, except as required by the antifraud provisions of the
federal securities laws. Any offerings under these rules to nonaccredited
investors require delivery of the specied information to those investors.
Bad Advice
Some practitioners and independent producers mistakenly believe
that no specic disclosure means no disclosure and that no disclosure
document is required to be given to each prospective investor before they
invest. That is not what it means. It simply means that the disclosure re-
quirements have not been set out with specicity. All securities offerings
still must comply with the antifraud rule.
One of the main purposes of Regulation D was to provide more specic
disclosure guidelines so that issuers of securities would be more comfort-
able knowing that they have complied with their disclosure obligations.
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That is why Regulation D is referred to as a safe harbor. Instead of all
of the confusion regarding disclosure obligations associated with the very
general antifraud rule, issuers may rely on the more specic disclosure
guidelines of Regulation D and be more condent of their compliance
with the law.
Issuer Disqualiers
As noted earlier, Rule 505 imposes a set of so-called issuer disquali-
ers on those persons who would seek to sell securities under the rule.
The disqualiers basically state that the exemption is not available to
persons who have been guilty of certain securities law or other violations
within the most recent 5 years. Thus, if a producer allows persons who are
disqualied to sell the production companys securities, the exemption
from registration may be voided, leaving the producer in the awkward
position of having sold an unregistered security, an activity that might
involve both civil and criminal penalties.
Advantages
Disclosure less burdensome. The disclosures required (i.e., the kind of
information that must be put in writing in an offering memorandum
and provided to each prospective investor prior to sale) for a Rule 505
offering are somewhat less burdensome than those required for a Rule
506 offering.
Easier compliance. It is easier to comply with the more specic disclo-
sure guidelines imposed by Rule 505 than the less specic antifraud rule
type disclosure permitted under Rule 504 offerings.
Higher level of funding allowed. As compared with a Rule 504 offering,
the Rule 505 exemption permits the raising of ve times the amount of
money; $5 million as opposed to $1 million.
Faster than public offerings. A private placement such as the Rule 505
offering generally allows the producer to put together a disclosure docu-
ment and be on the street raising money more quickly than a public
(registered) offering. Actually raising the money may take just as much
time, depending on other factors.
Disadvantages
Funding limit. A Rule 505 offering only permits the producer to raise
$5 million, unlike the Rule 506 offering that imposes no ceiling on the
aggregate offering price.
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111
Preexisting relationship. In contrast to a public (registered) offering,
securities being offered pursuant to any Regulation D (private placement)
exemption can only be offered to persons with whom upper-level man-
agement of the issuing entity has a preexisting relationship (i.e., knew
before the start of the offering).
preferably with specic and successful experience in lm or lm company
offerings, and again attorney fees can be relatively expensive for start-up
State law compliance required. In addition to complying with the
federal securities laws and regulations, issuers of securities pursuant to
Rule 505 must also comply with the applicable state securities laws and
regulations (blue sky laws) in each state in which the securities are to be
offered or sold.
Rule 506 Offerings
Rule 506 is the last of the three specic sets of rules within the SECs
Regulation D that permit issuers to sell securities in a nonpublic offer-
ing, that is, in private placements. As with Rules 504 and 505, a feature
lm production company (or other issuer) seeking to qualify for the
transactional exemption for one of its securities offerings pursuant to
Rule 506 must satisfy the general terms and conditions of Regulation D
listed above (see General Requirements of Regulation D).
No Ceiling on Amount of Money
Unlike Rules 505 and 504, Rule 506 does not impose a ceiling on the
amount of money that can be raised under the rule.
Number of Investors
Rule 506 utilizes the same approach as Rule 505 with respect to the num-
ber of investors that may be permitted to invest in the offering. No more
than 35 nonaccredited investors but an unlimited number of accredited
investors are permitted (see earlier discussion of accredited investors).
Specic Disclosure Requirements
Unlike Rule 504 (but as with Rule 505), Rule 506 provides specic
disclosure guidelines that are matched with the disclosure guidelines
for public (registered) offerings of the same or similar level. The Rule
506 disclosure guidelines are the same as those for the small business
or public (registered) offerings conducted pursuant to Regulation S-B
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or Regulation S-1, depending on the amount of money being raised (see
chapters 16 and 17).
Issuer Disqualiers
Rule 506 does not impose the set of so-called issuer disqualiers (i.e.,
bad boy provisions) on those persons who would seek to sell securities
under the rule.
Nature of Purchasers
Rule 506 does impose investor suitability standards on investors
who are not accredited. Thus, Rule 506 requires that each purchaser
who is not an accredited investor, either alone or through a purchaser
representative(s), have knowledge and experience in nancial and busi-
ness matters such that the purchaser is capable of evaluating the merits
and risks of the prospective investment (sophisticated investor). Alter-
natively, the issuer must reasonably believe, immediately prior to making
any sale, that the purchaser comes within that description. Producers
and other securities issuers relying on Rule 506 must therefore inquire
as to their nonaccredited investors nancial knowledge and experience
by means of the subscription application.
Advantages
No funding limit. A Rule 506 offering does not impose any ceiling on
the amount of money that can be raised under the rule.
Faster than public offerings. A private placement such as a Rule 506
offering generally allows the producer to put together a disclosure docu-
ment and be on the street raising money more quickly than a public
(registered) offering. Again, the actual time it takes to raise the money
may be the same, depending on other factors.
Combine with NSMIA. The Rule 506 exemption can be combined with
the National Securities Market Improvement Act (see below) to preempt
state jurisdiction for all purposes except the notice lings.
Disadvantages
Highest level of disclosure. Rule 506 imposes the highest level of disclo-
sure of the three Regulation D exemptions.
Preexisting relationships. In contrast to a public (registered) offering,
securities being offered pursuant to any Regulation D (private placement)
exemption as a general rule can only be offered to persons with whom
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Regulation D
113
upper-level management of the issuing entity had a preexisting relation-
ship (i.e., before the start of the offering).
preferably with specic and successful experience in lm or lm com-
pany offerings, and attorney fees can be relatively expensive for start-up
State law compliance required. In addition to complying with the federal
securities laws and regulations, issuers of securities must also comply
with the applicable state securities laws and regulations (blue sky laws),
except in specic instances were the state laws are preempted by federal
law, as discussed next.
National Securities Market Improvement Act
One of the long-standing burdens relating to securities law compliance
has been that of dual regulation. In other words, the sale of securities
in the United States has been regulated by both the federal government
and by each of the states. The National Securities Market Improvement
Act of 1996 (NSMIA) was passed by Congress and signed into law in
October 1996 to help relieve that burden. Added as Section 18 to the 1933
Securities Act, NSMIA basically provides that U.S. securities offerings
that are national in character are to be regulated only at the federal level
and specically by the SEC, not by the states. Thus, some aspects of state
regulation (blue-sky law) have been removed from certain offerings.
NSMIA preempts state registration requirements with respect to
certain transactions exempt under the Securities Act, including (among
others) private placements pursuant to rules issued under Section 4(2) of
the 1933 Securities Act, 15 U.S.C. 77d (2)(1994), that is, those transactions
exempt under Rule 506 of Regulation D, 17 C.F.R. 230.506 (1996).
In other words, NSMIA provides for the exemption from state regu-
lation of certain offerings of covered securities. Included among the
covered securities are offers to qualied purchasers (now considered syn-
onymous with the accredited-investor concept as dened in Regulation
D) and offerings made pursuant to the Rule 506 safe harbor. However,
the states still retain the right to require notice lings and can bring
enforcement actions with respect to fraud or deceit. Thus, the antifraud
rule still applies to such offerings.
A lmmaker wishing to conduct an interstate, nonpublic offering of
securities may choose to rely on the provisions of Rule 506 and NSMIA,
thus preempting state jurisdiction. Even so, state notice lings will still
need to be effected. The remaining substantial benet appears to be
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that such offerings are removed from state jurisdiction for most other
purposes. NSMIA preserves the authority of the states to require notice
lings and fees with respect to lings and to suspend the offer and sale
of securities within a state as a result of the failure to submit a required
ling or fee (see 15 U.S.C. 77r (c)(2)(1997).
State Compliance
Studies of state coordination with NSMIA have revealed that some 29
states require ling of the Form D in accordance with NSMIA (i.e., no
later than 15 days after the rst sale), but 3 states require presale or preoffer
Form D lings; 3 states require Form D lings other than within the 15-
day period after the rst sale; 2 states require notices other than Form D
or in addition to Form D; 4 states require ling of disclosure documents
as part of the notice ling; 5 states may require issuer registration; and
7 states may require agent registration in Rule 506 offerings. Such state
requirements also continue to change. Thus, state blue-sky compliance
continues to be burdensome in spite of the SECs efforts to coordinate
and simplify it. In other words, the nonuniform state notice ling and fee
requirements continue to be a problem for issuers relying on NSMIA.
Advantages
Preempts state jurisdiction. Complying with NSMIA allows a private
placement offering to avoid state regulation for most purposes.
Less expense. An offering that does not have to comply with state law
could be less expensive, assuming the issuer is paying an attorney to
handle state compliance, particularly on an hourly fee basis.
Disadvantage
Notice lings. State notice lings can still be required by the states in
which securities are offered or sold.
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115
Securities Compliance
13 Public/Private (Hybrid) Exemptions
In the event that a lmmaker (or other small business entrepreneur) is
concerned about there not being a sufciently large pool of prospective
investors with whom the production companys upper-level manage-
ment has preexisting relationships at the time of the offering to be able
to successfully raise the amount of money required, one of the so-called
public/private hybrid exemptions may need to be considered. The fol-
lowing three public/private hybrid exemptions are grouped together as
one form of lm nance for the purposes of this chapter because they
are very closely related and more often than not are used together for a
single offering, or in lieu of one another. In fact, the California Section
25102(n) exemption described below, in all likelihood, has already been
superseded by the Model Accredited Investor Exemption for most inter-
state offering purposes.
Californias Section 25102(n) Exemption
The State of California adopted a new sort of public/private hybrid ex-
emption in September of 1994. It came into law as Section 25102 (n) of
the California Corporations Code. It was designed to allow California
entities (and foreign entities qualied to do business in California) to
advertise, by use of a so-called Tombstone Ad (otherwise referred to as a
General Announcement), that they were conducting a private offering
of securities. Thus, the new California exemption permitted some ele-
ments of a public offering (the ability to advertise) to be combined with
a private offering. The idea was to give issuers an opportunity to conduct
a form of general solicitation within the context of a private offering up
to a limited amount, and this was the rst time such a concept had been
tried by securities regulators.
The California Public/Private Exemption
The Section 25102(n) exemption provides that any offer or sale of
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any security in a transaction, other than an offer or sale of a security in
a roll-up transaction (i.e., a move from one option position to another
having a higher exercise price), that meets all of the following criteria is
exempt from the states securities registration requirement and the states
prohibition against advertising.
Qualied Issuers
The issuer has to be a California corporation or be doing business in
California (see California Corporations Code 2115 for the tests to deter-
mine whether a foreign corporation is doing business in California and
is therefore subject to regulation in the state), or in the alternative, the
issuer may be any other form of business entity, including a partnership
or trust organized under the laws of California, but not a blind pool or
investment company. In other words, this exemption is not available to a
limited partnership or other investment company that does not specify the
properties intended to be acquired (a blind pool issuer), or to an invest-
ment company subject to the federal Investment Company Act of 1940.
Qualied Purchasers
Sales of securities must only be made to qualied purchasers or other
persons the issuer reasonably believes, after reasonable inquiry, to be
qualied purchasers. In effect, the California law provides an exemption
from state registration for offerings made to specied classes of qualied
purchasers that are similar, but not the same as, accredited investors un-
der Regulation D. Not only does the California qualied purchaser deni-
tion differ from the federal accredited investor denition for individuals,
the California law includes additional suitability standards. For a more
complete and detailed listing of the people or entities that may fall within
the category of qualied purchasers see Title 10, Section 260.102.13, of the
California Code of Regulations. Note also that a corporation, partnership
or other organization specically formed for the purpose of acquiring
the securities offered by the issuer in reliance upon this exemption may
be a qualied purchaser if each of the equity owners of the corporation,
partnership or other organization is a qualied purchaser.
Purchaser Representation
Each purchaser must represent that the purchase is being made for his,
her or its own account (or trust account, if the purchaser is a trustee)
and not with a view to, or for sale in connection with, a distribution of
the security.
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117
Disclosure Document
Each natural person purchaser, including a corporation, partnership or
other organization specically formed by natural persons for the purpose
of acquiring the securities offered by the issuer, must receive (at least ve
business days before securities are sold to, or a commitment to purchase
is accepted from, the purchaser) a written offering disclosure statement
that meets the disclosure requirements of the SECs Regulation D and any
other information as may be prescribed by rule of the commissioner.
However, the issuer is not obligated to provide this disclosure state-
ment to a natural person qualied under Title 10, Section 260.102.13, of
the California Code of Regulations. Thus, this provision sets up a two-
tier disclosure system for the 25102(n) exemption, which may be useful
if an issuer is only selling securities to persons who qualify and is foolish
enough to want to sell securities to anybody without the protection of a
properly drafted disclosure document. The better practice is to prepare
and provide a disclosure document to all prospective investors regardless
of whether they t into this overly complicated scheme promulgated by
California legislators and those who inuence them.
General Announcement
The 25102(n) exemption provides that a general announcement of the
proposed securities offering may be published by written document only,
provided that the general announcement of proposed offering sets forth
the following required information:
1. The name of the issuer of the securities.
2. The full title of the security to be issued.
3. The anticipated suitability standards for prospective purchasers.
4. A statement that
a. no money or other consideration is being solicited or will be
accepted,
b. an indication of interest made by a prospective purchaser involves
no obligation or commitment of any kind, and
c. if the issuer is required to deliver a disclosure statement to
prospective purchasers, no sales will be made or commitment to
purchase will be accepted until ve business days after delivery
of a disclosure statement and subscription information to the
prospective purchaser in accordance with the requirements of this
subdivision.
5. Any other information required by rule of the commissioner.
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6. The following legend: For more complete information about (Name
of Issuer) and (Full Title of Security), send for additional information
from (Name and Address) by sending this coupon or calling (Telephone
Number).
The above-referenced general announcement of proposed offering
may also set forth the following information:
a brief description of the business of the issuer;
the geographic location of the issuer and its business; and
the price of the security to be issued, or, if the price is not known, the
method of its determination or the probable price range as specied by
the issuer and the aggregate offering price.
The general announcement can only contain the information set forth
above.
Dissemination to Others
The Section 25102(n) exemption also provides that dissemination of
the only general announcement of the proposed securities offering to
persons who are not qualied purchasers, and nothing more, will not
disqualify the issuer from claiming the exemption.
Telephone Solicitation
No telephone solicitation is permitted until the issuer has determined
that the prospective purchaser to be solicited is a qualied purchaser.
Notice Filings
The issuer must le two notices of transaction for this exemption at
the following times:
concurrent with the publication of the general announcement of
proposed offering or at the time of the initial offer of the securities,
whichever occurs rst, accompanied by a ling fee, and
within 10 business days following the close or abandonment of the
offering, but in no case more than 210 days from the date of ling the
rst notice.
The rst notice of transaction must contain an undertaking, on the
prescribed California form, to deliver a copy of the required disclosure
statement, and any supplement thereto, to the California Department
of Corporations (DOC) within 10 days of the DOCs request for the
information.
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119
This 25102(n) exemption from registration is not available if an issuer
fails to le the rst of the required notices described above, or fails to pay
the required ling fee. The DOC has the authority to assess an admin-
istrative penalty of up to $1,000 against an issuer that fails to deliver the
disclosure statement required by the DOC in a timely manner.
Neither the ling of the disclosure statement nor the failure by the
DOC to comment thereon precludes the agency from taking any action
deemed necessary or appropriate with respect to the offer and sale of
the securities.
Advantages
Limited advertising permitted. The California Section 25102(n) exemp-
tion allows a limited form of advertising for what is essentially still a
private placement.
No ceiling on amount. There is apparently no ceiling on the amount of
money that can be raised (at least per state law).
Disadvantages
California companies only. Only California issuers and entities doing
business in California can use this exemption.
California sales only. All sales must be in California, and it is rare that
lm offerings can be completely nanced with investors in one state.
Federal compliance. At the federal level, the California Section 25102(n)
exemption must be paired with the federal Section 3(a)(11) intrastate ex-
emption (see chapter 11), thus making it even less useful for a lm offering.
Overly complex. The exemption creates an overly lengthy and compli-
cated list of qualied purchasers.
Not well coordinated. Since the NASAA took a different approach (see
NASAAs Model Accredited Investor Exemption below), the California
Section 25102(n) exemption does not work well with other states. And it
does not t well within any current federal exemption, other than Rule
504, which imposes a ceiling of $1 million on the amount of money that
can be raised, or potentially the intrastate offering exemption, Section
3(a)(11), which, as already discussed, has its own problems. Rules 505 and
506 of Regulation D prohibit general solicitations; moreover, Californias
denition of qualied purchasers is broader than Regulation Ds deni-
tion of accredited investors. The intrastate offering exemption is available
only for those offerings by issuers incorporated and doing business in a
single state.
Disclosure problems. The exemption creates a two-tier disclosure system
that encourages issuers to avoid preparing and providing a disclosure
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document to certain designated prospective purchasers if, in their judg-
ment, they think that they can raise the amount of funds needed from
this limited group of investors and that all of their prospective investors
t into the permissible category. Rarely does an issuer know that sort of
information in advance, and the absence of a properly drafted disclosure
document always exposes the issuer to greater potential liability for fraud
and material misrepresentation.
The SECs Rule 1001 Exemption
The SEC reacted positively toward Californias adoption of its Section
25102(n) exemption and subsequently adopted SEC Rule 1001, which,
in effect, encouraged other states to follow Californias lead by adopting
similar laws. This SEC exemption designed to coordinate with Californias
Section 25102(n) was adopted on May 1, 1996 (SEC Release No. 337285).
In summary, the SEC stated that in order to reduce regulatory burdens
associated with certain offers and sales of securities, it would adopt a
new exemption from its registration requirements for limited offerings
of up to $5 million that are exempt from qualication under the 1994
California state securities law, Section 25102(n). The SEC adopted Rule
1001 under Section 3(b) of the Securities Act of 1933. The rule exempts
from the registration requirements of the securities act offers and sales
up to $5 million that are exempt from state qualication under para-
graph (n) of Section 25102 of the California Corporations Code. The SEC
exercised its exemptive authority pursuant to Section 3(b) to provide a
parallel federal exemption for the California exemption by adopting the
new Rule 1001.
Rule 1001 provides that offers and sales of securities, in amounts of up
to $5 million (less the aggregate offering price for all other securities sold
in the same offering of securities, whether pursuant to this or another
exemption), that are exempt from registration under paragraph (n) of
Californias Section 25102 are also exempt from the federal registration
provisions of Section 5 of the Securities Act of 1933 by virtue of Section
3(b) of that act and are exempt from the prohibition against general so-
licitation found in Rule 502(c) of Regulation D, the Securities Act Section
3(a)(11), and the SECs Rule 147.
All issuers that qualify for the state exemption can rely on the Rule
1001 exemption. The SEC took the position that issuers should look to the
state of California for interpretation of who qualies for the exemption,
since any person who lawfully relies on the state exemption also could
rely on its federal counterpart.
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121
Rule 1001 does not require issuers to notify the SEC when they rely
on the California exemption in view of the notication provisions of the
California law.
Antifraud Provisions Still Apply
While the transactions would not be subject to registration under
Section 5, the antifraud provisions of the federal securities laws would
continue to be applicable to all exempt transactions. In other words,
nothing in the Rule 1001 exemption is intended to be or should be con-
strued as in any way relieving issuers or persons acting on behalf of is-
suers from providing the necessary disclosure to prospective investors to
satisfy the antifraud provisions of the federal securities laws. This Rule
1001 only provides an exemption from the registration requirements of
the Securities Act of 1933.
Certain Companies Cannot Use
As noted above, California law precludes reliance on the exemption
in connection with investment company, blind pool or roll-up offerings;
thus, the Rule 1001 exemption also would be unavailable in those cases.
Where a transaction involves other-than-cash consideration, the amount
of the offering would be calculated as provided under California law.
Resale Limitations
Securities issued pursuant to Rule 1001 are deemed to be restricted
securities (as dened in Securities Act Rule 144). Resales of such secu-
rities must be made in compliance with the registration requirements
of the 1933 Securities Act or an exemption therefrom. In other words,
Rule 1001 provides an exemption only for the transactions in which the
securities are offered or sold by the issuer; it is not an exemption for the
securities themselves. Consequently, purchasers must either register
subsequent resales of the securities or comply with all of the conditions
and limitations imposed on the use of such an exemption for sales.
Categorizing the securities offered and sold pursuant to Rule 1001 as
restricted is consistent with the California exemption, since the latter
requires an investment intent on the part of purchasers in the offer-
ing, and such shares could not be resold under California law without
qualication or some other exemption under such law. In addition, the
treatment is consistent with other federal exemptions, the availability of
which depends on the sophistication, wealth or institutional character
of the investor.
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State Compliance Still Required
Nothing in the Rule 1001 exemption obviates the need to comply with
any applicable state law relating to the offer and sales of securities. Thus,
federal and state jurisdictions still apply.
Not an Exclusive Election
Attempted compliance with the Rule 1001 exemption does not act as
an exclusive election, which means, the issuer also can claim the avail-
ability of any other applicable exemption.
No Scheme to Evade
The Rule 1001 exemption is not available to any issuer for any transac-
tion that, while in technical compliance with the provisions of the rule,
is part of a plan or scheme to evade the registration provisions of the
1933 Securities Act. In such cases, registration under the 1933 Securities
Act is required.
The SEC adopted Rule 1001 after California created its Section 25102(n)
exemption, and it also provides that if other states adopt Californias law,
then their sales would be considered exempt up to the 1933 Acts Section
3(b) limit of $5 million. This, of course, differs from the California no-
limit approach. This conict has caused some confusion, since some is-
suers and lm producers think California is limited to $5 million dollars,
but that is not technically accurate. On the other hand, securities sales
are subject to both federal and state jurisdictions, and in cases where
exemption conditions or limitations imposed by various jurisdictions
differ, the securities issuer is obligated to comply with the more burden-
some provision. Thus, since the California Section 25102(n) exemption
is to be used with the federal intrastate exemption, Section 3(a)(11), the
federal $5 million limit would apply.
NASAAs Model Accredited Investor Exemption
In January of 1997, the North American Securities Administrators As-
sociation (NASAA) encouraged all states to adopt rules similar to, but
simpler than, the one adopted in California. Though many states have
now adopted legislation to allow those businesses trying to raise funds
to advertise, most of the states promulgated laws limiting sales to ac-
credited, as opposed to the qualied investors in the California version,
and limited the amount of money that could be raised to $1 million, as
opposed to the limit of $5 million, imposed on the California 25102(n)
exemption by federal law. Thus, for interstate offerings, the California
exemption is not all that useful.
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123
Furthermore, the states other than California that adopted such a
public/private hybrid exemption paired it with Regulation D, Rule 504, at
the federal level, as opposed to the intrastate exemption, Section 3(a)(11),
which was the federal exemption intended to be used in conjunction with
the California exemption.
As a consequence, an issuer can make an offering of securities to ac-
credited investors via a general announcement in a signicant number of,
but not all, states pursuant to the Model Accredited Investor Exemption
(MAIE) and Regulation D, Rule 504. Notice lings are still required in
each state under the MAIE.
Elements of the MAIE
NASAA adopted the MAIE on April 27, 1997. It exempts from registra-
tion and from sales or advertising ling requirements those offers and
sales of securities issued to accredited investors. As noted earlier, the term
accredited investor is dened at Regulation D, Rule 501(a), with a listing
of entities and individuals possessing substantial assets or net worth.
Pursuant to the MAIE, securities may only be sold to persons reason-
ably believed by issuers to be accredited investors who are purchasing for
investment and not for resale. These state exemptions are generally not
available to issuers in the development stage of their business.
To qualify for the exemption, states typically require issuers to le,
within 15 days after the rst sale of the securities in the state, a notice
of transaction, a consent to service of process, a copy of the general an-
nouncement and a fee.
The MAIE was and is intended to serve as a model for state securities
regulators to adopt in their respective states so that small businesses
seeking to raise $1 million or less can engage in a limited form of adver-
tising without having to register their securities in the state. A majority,
but not all, states have since adopted a version of the MAIE. Again, this
state exemption is intended to be paired with a Regulation D, Rule 504,
exemption at the federal level.
More specically, the MAIE provides that any offer or sale of a security
by an issuer in a transaction that meets the requirements of this rule is ex-
empt from those sections of the states securities law requiring registration
and ling of advertising materials. This allows a lm producer to advertise,
use the Internet and make sales without the requirement of a preexisting
relationship. The specic requirements to be complied with include:
Accredited investors only. Sales of securities must be made only to
persons who are, or who the issuer reasonably believes are, accredited
investors, as dened in Regulation D, Rule 501(a).
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No development-stage companies. The exemption is not available to an
issuer that is in the development stage, that either has no specic business
plan or purpose or has indicated that its business plan is to engage in a
merger or acquisition with an unidentied company or companies, or
other entity or person.
Not for resale. The issuer must believe that all purchasers are purchasing
for investment and not with the view to, or for sale in connection with,
a distribution of the security. Any resale of a security sold in reliance on
this exemption within 12 months of its original sale will be presumed
to be with a view to distribution and not for investment, except a re-
sale pursuant to a registration statement effective under the states law
relating to the registration of securities to be sold in that state, or to an
accredited investor pursuant to an exemption available under the states
securities act.
Bad boy provisions. The exemption is not available if certain per-
sons associated with the offering have engaged in specically prescribed
conduct in the past ve years. Thus, the exemption is not available to an
issuer if the issuer, any of the issuers predecessors, any afliated issuer,
any of the issuers directors, ofcers, general partners, benecial own-
ers of 10 percent or more of any class of its equity securities, any of the
issuers promoters presently connected with the issuer in any capacity,
any underwriter of the securities to be offered or any partner, director
or ofcer of such underwriter: (a) within the last ve years has led a
registration statement that is the subject of a currently effective regis-
tration stop order entered by any state securities administrator or the
SEC; (b) within the last ve years has been convicted of any criminal
offense in connection with the offer, purchase, or sale of any security, or
involving fraud or deceit; (c) is currently subject to any state or federal
administrative enforcement order or judgment, entered within the last
ve years, nding fraud or deceit in connection with the purchase or
sale of any security; or (d) is currently subject to any order, judgment, or
decree of any court of competent jurisdiction, entered within the last ve
years, temporarily, preliminarily or permanently restraining or enjoin-
ing such party from engaging in or continuing to engage in any conduct
or practice involving fraud or deceit in connection with the purchase or
sale of any security.
The above-referenced bad boy disqualifying provisions do not apply
if: (a) the party subject to the disqualication is licensed or registered to
conduct securities-related business in the state in which the order, judg-
ment or decree creating the disqualication was entered against such
party; (b) before the rst offer under this exemption, the state securi-
Cones Ch13.indd 124 12/20/07 1:48:16 PM
125
ties administrator or the court or regulatory authority that entered the
order, judgment or decree, waives the disqualication; or (c) the issuer
establishes that it did not know and in the exercise of reasonable care,
based on a factual inquiry, could not have known that a disqualication
existed under this paragraph.
Limited advertising. A general announcement of the proposed of-
fering may be made by any means, but the general announcement can
only include the following information, unless additional information
is specically permitted by the states securities regulator:
the name, address and telephone number of the issuer of the securities;
the name, a brief description and price (if known) of any security to be
issued;
a brief description of the business of the issuer in 25 words or less;
the type, number and aggregate amount of securities being offered;
the name, address and telephone number of the person to contact for
additional information; and
a statement that: (a) sales will only be made to accredited investors; (b)
no money or other consideration is being solicited or will be accepted by
way of this general announcement; and (c) the securities have not been
registered with or approved by any state securities agency or the SEC and
are being offered and sold pursuant to an exemption from registration.
Use of the Internet. The issuer, in connection with an offer, may provide
information in addition to the general announcement described above, if
such information: (1) is delivered through an electronic database that is
restricted to persons who have been prequalied as accredited investors;
or (2) is delivered after the issuer reasonably believes that the prospective
purchaser is an accredited investor.
Telephone solicitation. No telephone solicitation is permitted unless,
prior to placing the call, the issuer reasonably believes that the prospec-
tive purchaser to be solicited is an accredited investor.
Unqualied recipients. Dissemination of the general announcement of
the proposed offering to persons who are not accredited investors will not
disqualify the issuer from claiming the exemption under this rule.
Notice lings. The issuer must le with each state regulatory agency in
the states in which sales occur a notice of transaction, a consent to service
of process, a copy of the general announcement and the prescribed fee
within 15 days after the rst sale in each state.
Even though no specic disclosure requirements are imposed, a lm
producer would still need to provide each prospective investor with a
securities disclosure document that complies with the antifraud rule.
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Such a disclosure document can be delivered electronically (i.e., through
the Internet).
The two major differences between the two schemes (that adopted by
California and that adopted by the other states pursuant to the NASAA
model) is that (1) California requires and denes qualied investor, whereas
the other states require the less complicated accredited investor denition,
as already set forth in Regulation D, and (2) California (combined with
the federal Rule 1001) allows up to $5 million to be raised, whereas the
other states impose a ceiling of $1 million. So if a lm producer believes
he or she can raise all of the money in the one state of California, it may
make sense to use the California Section 25102(n) exemption (but for the
other limitations imposed by the instrastate exemption; see chapter 11).
On the other hand, if a lm producer believes that it may be necessary
to raise money in more than the one state of California and can limit the
amount of money raised from investors to $1 million, it may be worth-
while to investigate which states have adopted the NASAAs MAIE and
use that approach, combined with an Internet announcement.
NASAAs adoption of the MAIE was not actually in response to Cali-
fornias Section 25102(n) but rather to the Small Business Administrations
ACE-Net program (now defunct or at least in private hands; see chapter
5). A majority of the states, the District of Columbia and Puerto Rico
have adopted the MAIE, which works in conjunction with the federal
Rule 504 of Regulation D with its $1 million dollar limit. Even among
those states that have not adopted the MAIE, almost all have some form
of exemption pertaining to accredited investors.
Practical Considerations Re: the Internet. The use of the Internet as a
means of disseminating the general announcement and delivering the
offeree questionnaire and disclosure document has been approved by the
securities regulators for MAIE offerings. They have expressed the opinion
that the downloading of such materials complies with the requirements
of being published by written document only.
The Internet may also provide a platform from which to obtain leads.
However, the follow-up must be done rather precisely in order to qualify
the purchaser. In addition, the producer or producers attorney must be
sure to check with the securities regulator in each state where sales are
proposed to be certain that the conduct of the offering complies with the
applicable state rule. Presumably, as the Internet attracts more investors
looking for opportunities, the California Section 25102(n) exemption
and the MAIE may become the preferred types of offerings for those
who have limited access to qualied investors and who are only seeking
a limited amount of funds (if it can be demonstrated that Internet of-
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127
ferings actually work, which to date has not been the case, certainly not
for lm offerings).
That underlying assumption may never come true, in that investors
rarely look for investment opportunities anywhere, much less on the
Internet, and there is even less reason to believe that very many investors
will set out specically to nd an investment opportunity in a high-
risk investment like independent lm. It is more likely true that most
securities are sold, not bought, meaning that the sale of a security,
including interests in lm LPs or LLCs are more likely to be sold through
means of face-to-face meetings with people known to the producer and
the production companys upper-level management than through some
Internet scheme.
Advantages
Advertising and general solicitation. The MAIE allows a limited amount
of advertising and general solicitation for nonregistered offerings of $1
million or less.
Disadvantages
Of limited use. If an offering extends into other states that have not
adopted the MAIE, the permitted general announcement in California
would be integrated into the other states offerings, and this would
prevent any private placement in those states, since the general announce-
ment would be considered a general solicitation (public offering).
Smaller pool of prospective investors. Arbitrarily limiting the pool of
prospective investors to only accredited investors that reside in the single
state of California signicantly shrinks the pool of prospective investors
for the offering.
Internet sales. The ability to effectively sell lm offerings to investors
over the Internet has yet to be demonstrated.
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128
Securities Compliance: Public (Registered) Offerings
14 Small Corporate Offering Registration
The Small Corporate Offering Registration (SCOR) form of corporate
securities registration (public offering) is designed to reduce the costs
and paperwork involved in public offerings, thus diminishing the burden
on small businesses that seek to raise capital. The NASAA adopted the
SCOR form (U-7) on April 29, 1989, and many state legislatures around
the country have since adopted state legislation patterned after the NA-
SAA model. The Form U-7 was developed pursuant to Congresss Small
Business Investment Incentive Act of 1980 (now contained in Section 19
of the federal Securities Act of 1933).
Form U-7 is the general public-offering registration form for corpo-
rations registering under state securities (blue-sky) laws that provide
exemptions from the registration requirements of the SEC compatible
with the federal agencys Regulation D, Rule 504.
To be eligible to use Form U-7, a company (1) must be a corporation
organized under the laws of the state in which the offering is to be led
and (2) must engage in a business other than petroleum exploration or
production, mining or other extractive industries. Thus, feature lm
production companies qualify. Blind pool offerings and other offerings
for businesses or properties that cannot be specied are ineligible to use
Form U-7. In other words, lm producers cannot raise a fund for use in
producing unspecied lm properties using the form.
The companys securities may be offered and sold only on behalf of the
company, and Form U-7 may not be used by any present securities holders
of the company to resell their securities. The offering price for common
stock must be equal to or greater than $5 per share. Also, the company
must agree not to split its common stock or declare a stock dividend for
two years after the registration becomes effective without the permission
of the state regulators involved. The SCOR process presumes that the
investment vehicle is a corporation; thus, each state in which sales are
anticipated will have to be checked to determine whether other invest-
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Small Corporate Offering Registration
129
ment vehicles, like limited partnerships or manager-managed LLCs, are
acceptable for such offerings.
Companies using Form U-7 may engage selling agents to sell their se-
curities. However, commissions, fees or other remuneration for soliciting
any prospective purchaser may only be paid to persons who are registered
as securities broker/dealers in the state in which sales occur. Thus, nders
who by denition are not registered securities broker/dealers may not be
paid so-called nders fees (see Finder Sales in appendix D).
Advantages
Disclosure document. Form U-7 itself, once lled out, led and declared
effective, constitutes the offering circular or prospectus (disclosure docu-
ment) for the offering and may be reproduced by the company by copy
machine or otherwise for dissemination to prospective investors.
Attorney not necessarily needed. Some producers may be comfortable
with their ability to complete the registration form and conduct the of-
fering without the assistance of counsel so long as compliance with the
applicable state securities laws is observed (but see Attorneys opinion
requirement below).
Disadvantages
No sales until effective. No offers or sales may be made until the regis-
tration has been declared effective by state regulators.
Selling materials must be approved. Any and all supplemental sales
literature or advertisements announcing the offering must be led by
the company and cleared with the state securities regulator of each state
prior to publication or circulation within that state.
Content of public announcements. The information contained in public
announcements regarding the offering is specically limited.
Disclosure requirements. The disclosures required by Form U-7 are very
similar to those required in other securities offerings. The information
is just presented in a less readable Q&A format.
Not a good selling document. Most experienced sellers of securities
indicate that Form U-7 is not as effective a selling document as a well-
drafted private placement offering memorandum.
Ceiling on amount of money raised. The form can only be used if the
total amount of money being raised does not exceed $1 million during
a 12-month period.
Form D required. A completed and signed SEC Form D must also be
led with the SEC, claiming exemption from the federal securities reg-
istration requirement (pursuant to Regulation D, Rule 504).
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Corporate form. The SCOR scheme may require that the corporate
form of doing business be used, when there are other good reasons for
using a limited partnership or LLC.
Attorneys opinion requirement. The opinion of an attorney licensed
to practice in the state of registration must be submitted to the state
regulator. In it, the attorney must state his or her opinion that the se-
curities to be sold in the offering have been duly authorized and, when
issued upon payment of the offering price, will be legally and validly
issued, fully paid, nonassessable and binding on the company, and that
this statement is true and accurate. Such opinions may be hard to come
by unless the attorney is heavily involved in preparing the Form U-7 or
another disclosure document.
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131
15 Regulation A
Another of the small public offering opportunities is provided by the
SECs Regulation A. Although the language of Regulation A describes
the rule as an exemption, it is actually a small public (registered) of-
fering that permits the feature lm producer (or other issuer of securi-
ties) to conduct some limited advertising. In other words, even though
the SECs language refers to Regulation A as an exemption from the
securities registration requirement, that is misleading since the process
of ling a Regulation A offering is more akin to a registration than to a
private placement.
For these reasons, the Regulation A exemption is often termed a mini-
registration process, because it does require the ling of an offering
statement, which includes the securities disclosure document (termed
an offering circular) containing required disclosures, although these
disclosures are not as burdensome as those for an S-1 public (registered)
offering (see chapter 17).
Elements of Regulation A Offerings
Regulation A limits the amount of money that can be raised during
any given one-year period to $5 million, certainly enough for most low-
budget feature lm projects.
Unlike Rules 505 and 506 or registered offerings, the nancial state-
ments in a Regulation A offering statement need not be independently
audited. The offering statement is processed by the SECs Division of
Corporation Finance in a manner similar to that applied to other reg-
istration statements. After completing its review of the disclosure, the
Division qualies the offering statement. Securities may be sold in the
offering only after the offering statement is qualied.
Preling requirement. The regulation specically requires that at least
10 business days (Saturdays, Sundays and holidays excluded) prior to the
date on which the initial offering or sale of the securities is to be made
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under the regulation, the producer must le with the SEC regional ofce 5
copies of the offering statement. That offering statement consists of Part
INotication, Part IIOffering Circular and Part IIIExhibits.
In lieu of the offering circular (the term used by Regulation A instead of
offering memorandum or prospectus for the securities disclosure docu-
ment), Regulation A also now permits the use of a ll-in-the-blank form
similar to the SCOR Form U-7. Once again, however, note that such forms
are generally considered to be less effective selling documents compared
to the other forms of securities disclosure documents (i.e., prospectus,
offering circular, offering memorandum).
Disclosure document. No written offer of the securities can be made
unless an offering circular (or completed form) containing the required
disclosures (the information specied in Part II of the offering state-
ment) is concurrently given or has previously been given to the person
to whom the offer is made. Also, no securities of the issuer (production
company) can be sold under Regulation A unless the offering circular
or the completed ll-in-the-blank form is furnished to the prospective
investor at least forty-eight hours prior to the mailing of the conrma-
tion of sale by the production company (issuer) and the SEC has not
disallowed the offering.
Advertising limits. Written advertisements or other written commu-
nications and radio or television broadcasts can contain no more than
the following information:
the name of the issuer of the security;
the title of the security (e.g., corporate stock, limited partnership inter-
est or LLC units);
the amount being offered (the aggregate offering price or total amount
of money being raised);
the per-unit offering price to the public;
the identity of the general type of business of the issuer (for example,
development or production of feature lms);
a brief statement about the general character of the lm project or proj-
ects; and
from whom an offering circular can be obtained.
Sales materials. Four copies of all of the sales materials prepared in
conjunction with the Regulation A offering must also be submitted to
the SEC.
Revised circular. If the offering is not completed within 9 months from
the date of the offering circular, a revised offering circular must be pre-
pared, led and used in accordance with the Regulation A rules.
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133
Test-the-waters provision. Regulation A procedures allow the feature
lm producer (securities issuer) to engage in a so-called testing of the
waters; that is, to publicly disseminate an executive summary of the pro-
posed offering in order to gather expressions of interest from prospective
investors. Regulation A thus allows producers to gauge investor interest
before incurring the expense of printing and binding hundreds of offering
circulars or other forms of disclosure documents. It is much less expensive
to disseminate a four- or ve-page summary of the offering than the en-
tire offering circular. A similar testing of the waters can be accomplished
through the proper drafting and circulation of a generic business plan,
not specically associated with a possible subsequent securities offering,
but instead tied to active investor vehicles like the investor-nancing
agreement, joint venture, initial incorporation or member-managed LLC
vehicles described earlier (see chapters 36).
State coordination. Unfortunately, many states have not yet adopted
provisions compatible with the SECs Regulation A test-the-waters provi-
sion, and since the securities laws require compliance with both federal
and state laws, that provision may not be useful in those nonadopting
states. Thus, the status of the applicable provisions in each state in which
offers or sales are anticipated must be determined and complied with.
Reports of sales. Within 30 days after the end of each 6-month period
following the date of the original offering circular (or form), the producer
or issuer must le with the SECs regional ofce a completed SEC Form
2-A, and a nal report must be submitted upon completion or termina-
tion of the offering, but no later than 6 months from the last sale.
Advantages
Public offering. Regulation A claims to be an exemption but is actu-
ally a form of small public offering; thus, the producer can conduct a
general solicitation (including the use of cold calls, mass mailings and
the Internet) and engage in some advertising to raise money.
SEC ling. The required SEC ling may be effected through the near-
est regional ofce of the SEC (although this concession can be changed
by the SEC).
Disadvantages
Preling. A proper ling must be effected prior to any sales.
State laws may differ. Regulation A is not fully coordinated with the
various state laws.
Dual regulation. Compliance with both federal and state rules is re-
quired.
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Offering price ceiling. Although $5 million is enough to allow for the
production of most low-budget feature lms, this ceiling on the amount
of money that can be raised pursuant to Regulation A does prevent
higher-budget pictures from relying on it, except for those utilizing other
sources of nancing in conjunction with the funds provided by an inves-
tor-nanced Regulation A offering.
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135
16 Regulation S-B
The SECs Regulation S-B is another form of public (registered) securities
offering for small business issuers, including corporations, limited part-
nerships and manager-managed LLCs. For purposes of the regulation,
the small business issuer is dened as a U.S. or Canadian company with
revenues of less than $25 million; if the company is a majority-owned
subsidiary, the parent corporation must also be a small business issuer.
Regulation S-B Requirements
Regulation S-B does require that the producer (issuer) provide an SEC-
approved disclosure document (prospectus) to each prospective investor
prior to the investment. Currently, such approval is sought through an
electronic ling. The regulation sets out in fairly rigorous detail the kinds
of information that must be included in the disclosure document. For
example, the following information must be provided (but this is not a
complete list of the disclosure requirements):
a description of the business of the issuer (including form and year of
organization);
a statement declaring whether the issuer is a party to any pending legal
proceedings;
certain nancial statements;
the names of the issuers directors, executive ofcers or upper-level
management;
management compensation in all forms;
specic information that must appear on the outside front cover of the
prospectus;
a summary of the prospectus (under some circumstances);
a discussion of any factors that make the offering speculative or risky
(risk factors);
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136
a statement regarding how the net proceeds of the offering will be used
(use of proceeds);
the issuers plan for selling the securities (plan of distribution of the
securities);
certain exhibits, such as existing material contracts and attorneys opin-
ions (under some circumstances); and
other special disclosures relating specically to the nature of the issuing
entity, that is, whether corporation, limited partnership or manager-
managed LLC.
Financial projections. Unlike earlier years, the SEC now encourages
the use of managements projections of future economic performance
in conjunction with public offerings like the Regulation S-B provisions.
However, the SEC does require that such nancial projections have a
reasonable basis and that they be presented in an appropriate format (see
appendix C, Financial Projections).
For additional information regarding the S-B forms, see Corporate
Forms IUnder the Securities Act of 1933, at http://www.aspenpublishers.
com/SECRUYLES/crpfmttI.pdf.
Advantages
Advertising permitted. A public (registered) offering such as that under
Regulation S-B permits advertising to the general public and market-
ing techniques that fall under the label general solicitation (see Selling
Securities over the Internet in appendix D).
Compared to form S-1 offerings. A Regulation S-B offering is somewhat
less burdensome than a Form S-1 securities offering (see chapter 17).
Key employees. A publicly held corporation may have an advantage
over certain other forms of doing business when it comes to attracting
and retaining key employees.
Future options. The management of a publicly held corporation gener-
ally has more options with regard to future nancing of company activi-
ties once past the initial public offering (IPO) stage.
Less review time. In theory at least, the SEC review of an S-B offering
does not take as long as its review of an S-1 offering.
Disadvantages
Securities attorney. The assistance of (and expense associated with
the services of) an experienced securities attorney will undoubtedly be
required to conduct this level of securities offering.
More expensive overall. In addition to the attorney fees, the other ex-
penses associated with a public securities offering are (1) printing and
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137
binding of disclosure documents, (2) accounting fees, (3) broker/dealer
due diligence expenses and commissions and (4) other marketing costs
that are generally higher than SCOR, Regulation A or private placement
securities offerings.
More time-consuming. It will generally take more time to get on the
street with a Regulation S-B offering as opposed to a SCOR or Regulation
A offering, but that partly depends on the experience of the securities
attorney. Certainly an S-B offering will take more time to prepare than
a private placement offering.
Management exibility. Publicly held companies have less exibility
in management.
Loss of control. In the instance of a corporation, corporate insiders
(including the lms producer) may lose control of the company if enough
of the corporations shares are sold to the public.
Film company IPOs. Few, if any, feature lm production companies
have successfully conducted an initial public offering of stock in recent
years, a situation that results more from the inability of the securities is-
suers to provide any assurances that they can resolve existing problems
with the business practices of feature lm distributors than from the
actual form of doing business or the form of the securities offering (see
The Feature Film Distribution Deal and Hollywood Wars: How Insiders
Gained and Maintain Illegitimate Control over the Film Industry).
Cones Ch16.indd 137 12/20/07 1:50:25 PM
138
17 S-1 Public Offerings
The SECs Form S-1 is a form of public (registered) securities offering
that can be used by feature lm producers (and other securities issuers)
when a public offering is preferred, as opposed to a private placement, and
the issuing organization does not wish to use or does not qualify for the
SCOR, Regulation A or Regulation S-B offerings discussed previously.
Elements of an S-1 Offering
There is no ceiling on the amount of money that can be raised through
S-1 offering, but since the S-B form of securities registration permits the
issuing entity to have revenues up to $25 million and imposes no specic
limit on the amount of money that can be raised, it is unlikely that a
feature lm producer seeking to raise funds for a single motion picture
would have to resort to an S-1 offering. On the other hand, if the producer
is seeking to fund the production budgets for a slate of motion pictures or
to nance the activities of a corporate production company, the S-1 may
prove to be the most useful form of securities registration available.
The S-1 requires the highest level of disclosure; thus, the prospectus
used as the disclosure document in conjunction with an S-1 offering
will contain more information or more detailed information, generally
speaking, than the other forms of securities offerings. This in turn means
that the level of expertise required of the securities attorney is a bit higher
than that required for the S-B or other public offerings, and the cost of
that expertise may also be reected in higher attorneys fees.
Like the Regulation S-B offering, the S-1 requires that the producer
(issuer) provide an SEC-approved disclosure document (prospectus) to
each prospective investor prior to the investment. And like Regulation
S-B, the S-1 registration statement and prospectus are submitted to the
SEC electronically through the SECs EDGAR (Electronic Data Gathering,
Analysis and Retrieval) system. The regulation sets out in fairly rigorous
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139
detail the kinds of information that must be included in the disclosure
document. For example, the following information must be provided (but
this is not a complete list of the S-1 disclosure requirements):
a description of the business of the issuer (including form and year of
organization);
a statement declaring whether the issuer is a party to any pending legal
proceedings;
certain nancial statements of existing companies;
names of the issuers directors, executive ofcers or upper-level manage-
ment;
management compensation in all forms;
specic information that must appear on the outside front cover of the
prospectus;
a summary of the prospectus (under some circumstances);
a discussion of any factors that make the offering speculative or risky
(risk factors);
a statement regarding how the net proceeds of the offering will be used
(use of proceeds);
the issuers plan for selling the securities (plan of distribution of the
securities);
certain exhibits, such as existing material contracts and attorneys
opinions (under some circumstances); and
other special disclosures relating specically to the nature of the issuing
entity; that is, whether corporation, limited partnership or manager-
managed LLC.
The primary difference between the S-1 and S-B offerings lies in the
area of nancial reporting. The S-1 will generally require more nancial
information relating to the issuing company and covering a longer period
of time than the form S-B. It is also generally true that the SEC review of
the S-1 takes longer to complete than the other types of offerings.
Financial projections. As with the S-B offerings, the SEC now encour-
ages the use of managements projections of future economic performance
in conjunction with public offerings like the Regulation S-1 provisions.
However, the SEC also requires that such nancial projections have a
reasonable basis and that they be presented in an appropriate format (see
appendix C, Financial Projections).
For additional information regarding the S-1 form see Corporate
Forms IUnder the Securities Act of 1933, http://www.aspenpublishers.
com/SECRUYLES/crpfmttI.pdf.
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Advantages
Advertising permitted. A public (registered) offering such as that under
Regulation S-1 permits advertising to the general public and marketing
techniques that fall under the label general solicitation (see Selling Se-
curities over the Internet in appendix D).
No ceiling. There is no ceiling on the amount of money that can be
raised through an S-1 public (registered) offering.
Key employees. A publicly held corporation may have an advantage in
attracting and retaining key employees.
Future options. In the case of a publicly held corporation, its man-
agement generally has more options with regard to future nancing of
company activities once past the initial public offering (IPO) stage.
Disadvantages
Securities attorney. The assistance of (and expense associated with
the services of) an experienced securities attorney will undoubtedly be
required to conduct this level of securities offering.
Compared to S-B offerings. A Regulation S-1 offering is somewhat more
burdensome than a form S-B securities offering (see chapter 16).
More expensive overall. In addition to the attorney fees, the other
expenses associated with a public securities offering(1) printing and
binding of disclosure documents, (2) accounting fees, (3) broker/dealer
commissions and fees and (4) other marketing costsare generally higher
than SCOR, Regulation A or private placement securities offerings.
More time-consuming. It will generally take more time to get on the
street with a Regulation S-1 offering than a SCOR, Regulation A or S-B
offering, and certainly more time than a private placement.
Management exibility. Publicly held companies have less exibility
in management than private companies.
Loss of control. In the instance of a corporation, corporate insiders
(including a lms producer) may lose control of the company if enough
of the corporations shares are sold to the public. This control issue has
been an ongoing battleground in the lm industry ever since the early
major studio/distributors began going public.
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141
18 Over-the-Counter, NASDAQand
Stock Exchanges
At some point, a well-established, publicly held lm production company
may arrange to trade its securities (i.e., arrange to have its securities
bought and sold) on any one of the several existing markets, such as
over-the-counter, NASDAQ or a stock exchange.
The Over-the-Counter Market
The securities of an over-the-counter (OTC) company are not listed and
traded on an organized exchange. The OTC market was created by deal-
ers who primarily handle trading in securities that are not listed stocks
on an organized exchange. OTC trading differs from exchange trading
in that transactions are carried out through a telephone and computer
network and negotiations with a number of dealers, called market mak-
ers, as compared to the single-specialist, single-location auction market
mechanism used for listed securities trading. In addition, the market
maker acts as principal in the transaction, which involves the dealer as
buyer and seller from his or her own inventory.
Some nancial observers would suggest that trading a companys
securities in the over-the-counter market implies that there is not much
interest in the securities; however, OTC trading can also reasonably be
interpreted to mean that the company has simply chosen not to be listed
on an exchange and thus seeks to exercise more control over the market
for its securities. A number of broker/dealers in the OTC market may
express interest in a particular companys securities, with the result that
they compete more vigorously to get the best possible price for their
customers (or themselves), and this competition in turn benets the
company whose securities are being bought and sold.
From a governmental regulatory standpoint, the OTC market is
primarily regulated by the SEC and to some extent by the securities
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regulatory authority in each state. However, the OTC market is also
regulated in a certain sense by the broker/dealers interest in the security
(governed by the supply of the security and the demand of customers for
it). Erratic price movements may become the subject of SEC inquiry for
facts to justify the activity. Active markets in the OTC sector generally
result from the public (registered) offerings that have been the subject
of SEC lings.
Advantages
Fewer regulations. OTC trading imposes fewer regulations on a public
company than the NASDAQ market or the stock exchanges.
More control. A company may be able to exercise more control over
the market for its securities through the OTC market than through the
stock exchanges.
Disadvantages
Less visibility. The OTC market does not provide a companys stock
or other securities with as much visibility as listings on the NASDAQ
system or the stock exchanges.
Not much interest. Relative to being listed on NASDAQ or one of the
stock exchanges, OTC trading may suggest that there is less interest in
the securities of the company.
NASDAQ
NASDAQ is the acronym for the National Association of Securities
Dealers Automated Quotations, a national automated quotation service
for over-the-counter securities. Operation of the NASDAQ system is
supervised by the National Association of Securities Dealers (NASD)
and informational input is provided by hundreds of over-the-counter
market makers. Market makers are securities broker/dealers who make
a market for a given security; that is, such rms maintain a rm bid and
offer price on a given security by standing ready to buy or sell round lots
at publicly quoted prices. A managing underwriter typically makes a
market for its clients stock.
In order to qualify for inclusion in the NASDAQ system, a security must
satisfy numerous requirements. For example, initially it requires that
the issuer must have two registered and active market makers;
the issuer must have total assets of at least $2 million;
the issuer must have capital and surplus of at least $1 million;
in the case of a convertible debt security, there must be a principal
amount outstanding of at least $10 million;
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143
in the case of common stock, there must be at least 300 holders of the
security and at least 100,000 publicly held shares;
in the case of rights and warrants, there must be at least 100,000 issued;
the security must not be under a current SEC trading suspension;
the issuer has to pay a NASDAQ Issuer Quotation fee;
the issuer has to le with the NASD three copies of all reports and other
documents led or required to be led with the SEC; and
the companys annual reports led with the NASD must contain audited
nancial statements.
Many persons in the securities industry feel the NASDAQ system has
resulted in signicant improvements in the over-the-counter securities
market. NASDAQ has made available electronic price quotations and
trading-volume information for a signicant number of over-the-counter
securities. Many newspapers currently carry the NASDAQ National List
of securities, which has similar nancial criteria to that of the American
Stock Exchange. Some newspapers also publish the Additional List of
NASDAQ securities, which is based on the dollar value of share volume.
The total number of shares traded on the NASDAQ market now exceeds
that of the American Stock Exchange. An actively traded NASDAQ
security supported by several market makers may (1) command more
broker/dealer interest, (2) have a larger trading volume and (3) develop
more market depth than many stocks listed on the exchanges. As a re-
sult, many NASDAQ-traded companies no longer seek exchange listing
when they become eligible for such listing, preferring to remain in the
NASDAQ market.
Advantages
Instant availability. The NASDAQ market makes the securities of
qualifying companies instantly available for trading by broker/dealers
all across the country, which may facilitate rapid capitalization.
Eligibility requirements. The NASDAQ eligibility requirements are
generally less burdensome than the requirements of the major stock
exchanges.
Disadvantages
More mature companies. The NASDAQ market is generally only suit-
able for more mature companies with sophisticated management and
the capability of paying signicant professional fees to accountants and
attorneys qualied to supervise such transactions.
Eligibility requirements. The NASDAQ eligibility requirements are
generally more burdensome than general OTC requirements.
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144
Stock Exchanges
The national securities exchanges provide a convenient marketplace
for their member broker/dealer rms to execute buy and sell orders for
customers. However, a lm production (or other) companys securities
can be traded on a specic exchange only after meeting the exchanges
listing requirements. After those requirements are met, a broker/dealer (a
so-called specialist) is assigned to make an orderly market in the security.
In other words, it is the responsibility of the specialist to match buy and
sell orders for the production companys securities and generally maintain
some degree of liquidity in the companys securities.
The two major stock exchanges (the New York Stock Exchange and
the American Stock Exchange) maintain certain policies that have to be
considered by any company before making the decision to list on either
exchange. Those policies are set forth in the respective New York and
American Stock Exchange guides, which may be obtained from those
exchanges. Such policies relate to conicts of interest, voting rights, the re-
quiring of shareholder votes in certain situations, outside directors, audit
committees, controls relating to the future issuance of a companys stock
and the timely public release of important corporation developments.
Most of the policies are articulated as general guides for the conduct of
their respective listed companies, and the guides are applied on a case-by-
case basis, depending on the individual facts. Even if a lm production
or other company decides not to apply for listing on an exchange, those
well-established exchange policies may serve as useful guides to good
corporate practiceeven for OTC companies.
The exchanges regulate themselves and their specialists with rules
approved by the SEC. Price movement greater than a specied amount
(e.g., over of a point) or other unusual price movements may require
approval of a oor governor or the exchange, as well as general publicity
intended to offer an explanation.
Listing on some of the stock exchanges may provide for automatic
securities registration in certain states. The securities laws of each state
(blue-sky laws) in which the security is intended to be offered or sold
should be reviewed to determine whether exchange listing brings auto-
matic state registration.
If a lm production company can meet the listing requirements of
the New York Stock Exchange, it is generally regarded as highly desir-
able to do so. However, only a few companies can typically meet those
requirements after a single public offering of their securities. If a lm
production company can meet the somewhat lower listing requirements
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145
of the American Stock Exchange, it may choose to do so. Some issuers,
however, prefer to season (mature in the marketplace) their securities
with a brief period of over-the-counter trading before the listing on an
exchange is completed.
Small public issues of corporate lm production company securities
may be listed on regional stock exchanges. The principal regional ex-
changes are located in Boston, Detroit, Chicago (the Midwest Stock Ex-
change), Philadelphia and Los Angeles (the Pacic Stock Exchange, which
actually maintains facilities in both Los Angeles and San Francisco).
The exchanges generally do not have regulations concerning the un-
derwriting of OTC securities by member rms.
Advantages
Prestige. Listing on a stock exchange may create more prestige for a lm
production company in the eyes of investors, customers and suppliers.
Employee considerations. A lm production company whose stock is list-
ed on an exchange may appear to be more attractive to new employees.
Acquisitions. Stock exchange listing of a companys securities may
facilitate the acquisition of the company by another rm.
Collateral value. Securities listed on a stock exchange will generally have
higher and more readily ascertainable collateral values in the event that
the investor wishes to borrow funds using the security as collateral.
Press releases. Stock exchange listing generally increases a companys
ability to get its press releases and quotations more widely disseminated
by the news media.
Value of specialist. The stock exchange listing typically obligates the
specialist to make a fair and orderly market for the security by purchasing
it and selling it for the specialists own account if necessary.
State preferential treatment. Generally speaking, listing on a stock
exchange will qualify a companys securities for preferential treatment
by the state securities regulators.
More stable prices. There is generally less volatility in the price of a
companys securities when those securities are listed on a stock exchange
rather than being traded in the OTC market.
Closer spreads. The spread (difference between the bid and offered
quotations on a security) is typically not as great on listed securities as
on securities traded in the OTC market.
Disadvantages
Listing requirements. Many companies cannot meet the listing require-
ments to become an exchange company.
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OTC trading. Over-the-counter trading of a companys securities may
prove to be more advantageous to a particular company than a listing
on some of the exchanges.
Exchange policies. Certain of the exchange policies may prove too
burdensome for some smaller companies.
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PART THREE
Lender Financing
Another distinctive form of lm nance that an independent lm pro-
ducer may want to consider is a loan (as opposed to a gift, grant or invest-
ment). Loans may be used to nance the development, production and
distribution expenses associated with a feature lm. Loans in the context
of lm nance may take a variety of forms: (1) loans provided by third-
party lenders (i.e., not lm distributors) and not supported by distributor
contracts, (2) the negative pickup and its variation, the so-called articial
pickup, (3) presale nancing, including the foreign presale, (4) variations
on presale nancing (i.e., gap and supergap nancing), (5) the insurance-
backed schemes and (6) securitization. The following chapters treat each
of these forms of lender nancing for lms.
149
19 Lender Financing without
Distributor Contracts
The loans discussed in this chapter are those not involving a preproduc-
tion distribution agreement and guarantee (see chapters 2023). Instead,
this discussion focuses on loans that may be provided by banks or other
lenders, including individuals, that either require collateral in the form
of hard assets or are unsecured loans.
A loan is dened as the delivery of a sum of money to another under
contract to return an equivalent amount at some future time (i.e., a date
certain) with or without an additional sum (interest) agreed upon for
its use. The characterization of a transaction as a loan or some other
type of borrowing has signicance in ascertaining whether usury laws
apply to the amount of interest being charged and whether the securi-
ties laws apply to the transaction. The securities laws generally do not
apply to loans.
Debt or Equity Transaction
Both the lender and the borrowing producer should be careful to insure
that what is intended as a loan to be used for development of a screenplay,
preproduction expenses or production costs can be fairly characterized as
debt and not as an equity investment, if in fact debt is what is intended. If
the transaction is characterized as some form of equity participation,
the lender actually becomes an investor whose investment is at risk; and
there may be no obligation for the producer to repay the loan (which on
the surface sounds good for the producer).
However, characterization as an equity investment may also result in
the producers having sold an unregistered security to a passive investor,
thus triggering securities compliance requirements; and
the creation of an entity (e.g., joint venture or association) that may have
to bear unfavorable tax consequences.
Lender Financing
150
The factors that determine whether a transaction creates debt or equity
include the following:
Recourse. Whether the loan has recourse against (has the right to
demand repayment from) the general assets of the borrowing entity (a
nonrecourse loan secured only by the lm is more likely than a recourse
loan to be considered an equity investment).
Fixed repayment date. Whether a xed repayment date has been es-
tablished (a xed repayment date suggests that the transaction should
be characterized as a loan).
Secured loan. Whether the transaction is secured (security suggests
a loan).
Interest tied to prots. Whether the rate of interest on the loan is tied
to the amount of prots earned by the lm (if the interest rate increases
with the level of prots, that increases the chances that the transaction
would be characterized as an equity investment/security).
Creative control. Whether the lender exercises substantial control over
the production (the more control exercised, the less likely the transaction
would be characterized as a loan).
Subordination. Whether the lender subordinates, that is, takes a
second position to third parties with respect to payments made from the
lms revenues (subordination suggests something other than a loan).
Other lenders. Whether another lender would have lent funds on the
same or similar basis.
Imputed interest. Whether the interest on the loan was set at or below
market rates. If the lender on a lm actually provides the producer with
a below-market interest rate, the Internal Revenue Service (IRS), based
on Code Section 7872, may, in certain circumstances, add interest to the
transaction. This only rarely occurs, and such rules would only be in-
volved if the relationship between the borrower and the lender indicates
that the lower interest rate was intended to transfer wealth from the lender
to the borrower, as is sometimes the case in father/son transactions.
Types of Loans
To obtain a bank loan of any substantial size, it is almost always neces-
sary to offer some collateral; that is, to place within the legal control of
the lender some property that may be sold in the event of a default and
applied to the amount owed. Collateral is an asset pledged to a lender
until a loan is repaid; that is, property, including accounts, contract
rights and chattel paper that have been sold and are subject to a security
interest.
Third party (nonbank) feature lm development loans (1) may be
Lender Financing without Distributor Contracts
151
secured by some form of hard asset and (2) usually have recourse to the
borrower; that is, the lender can seek repayment directly from the bor-
rower personally in the event of default. (Again, banks are not likely to
make loans for signicant amounts of funds unless such loans are collat-
eralized with assets.) If a corporate production company is the borrower,
the lender may also make the principals of the corporation personally
liable for repayment of the loan. In addition, other guarantors may be
required to assure repayment of the loans principal and interest.
Recourse loans. Often loans to lm producers will be made on a re-
course basis; that is, the loan will be made only if an endorser or guarantor
(e.g., the producer) is made personally liable for payment in the event
the borrower (e.g., the production company) defaults. Again, such a loan
is extremely risky for an individual lm producer, not only because the
economic performance of a feature lm can never be predicted with any
certainty, but also because the likelihood of a movie generating sufcient
revenues that some actually get back to the producer is minimal.
Most lending originates with banks, although individuals may provide
loans for start-up or development costs. Bank loans may be a common
type of nancing for most businesses, but it is not necessarily a typical
form of nancing for low-budget, independently produced feature lms.
As noted above, in most instances a lender, whether bank or individual,
making a conventional loan will require that the borrower put up some
sort of collateral to insure repayment of the loan. Collateral for most
business loans may more specically take the form of
a pledge of accounts receivable (i.e., money owed to the business),
although this form of collateral is not likely to be available to most
start-up lm production companies;
inventory (also not commonly available for use as collateral by a lm
production company);
real estate (more likely to be owned by an individual as opposed to a
lm production company); and
other tangible and intangible property.
As noted earlier, banks making loans to a small, privately owned com-
pany will typically require the individual owner or owners to personally
guarantee repayment of the loan and to sign one or more promissory
notes to help insure that repayment. On the other hand, it is altogether
another decision whether a lmmaker seeking such a loan (backed by
either some form of collateral or a promissory note or both) should ac-
tually go through with such a transaction to raise money for a high-risk
venture like producing a feature or documentary lm.
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152
Term loan. The term loan is the simplest form of commercial bank -
nancing. With a term loan, the lm producer borrows a specic amount of
money that is paid back over a specic period of time (usually more than
a year). A term loan is usually repaid in equal installments of principal
and interest. However, some term loans reduce or eliminate principal
payments until the loan is due, at which time the entire outstanding
principal amount is payable. A small term loan made to an individual
lmmaker may serve to provide some start-up funds. However, such a
loan is not likely to be made unless the lmmaker is otherwise employed
with a steady income and good credit or has the backing of collateral.
Lines of credit. A line of credit is a nonbinding commitment by a lender
to lend up to a specic amount of money from time to time. Lines of
credit usually do not exceed one year but may, at the banks option, be
renewed each year.
Revolving credit loan. A revolving credit loan is similar to a line of
credit. The lender commits to loan up to a specic amount from time to
time as required by the borrower. Usually the loan is payable in full within
a year or less. The terms of a revolving line of credit are almost always set
forth in a formal loan agreement. Unlike a line of credit agreement, the
bank is obligated to lend the amount requested by the borrower provided
that, at the time of each request, the borrower is in compliance with all
the terms and conditions of the loan agreement. Amounts borrowed and
prepaid may be reborrowed during the term of the agreement so long
as the total amount of borrowed funds at any one time is not more than
the preset maximum amount. Revolving credit loans often have other
requirements regarding renewing the loan or requiring repayment of the
entire amount of the loan.
Letters of credit. In addition to direct production nancing, some
banks allow for lm acquisition nancing by means of letters of credit.
These banks will issue a letter of credit on behalf of a borrower for the
benet of a licensor or supplier of the lm. A letter of credit is a nancial
instrument or document issued by a bank that guarantees the payment
of a customers bank drafts up to a stated amount for a specied period
of time. The letter of credit substitutes the banks credit for the buyers
and eliminates the sellers risk.
Letters of credit are used extensively in international trade. The letter
of credit may take several different forms:
commercial letter of credit, normally drawn in favor of a third party,
called the beneciary;
conrmed letter of credit, provided by a correspondent bank and guaran-
teed by the issuing bank;
153
revolving letter of credit, issued for a specied amount and automatically
renewed for the same amount for a specied period, permitting any
number of drafts to be drawn so long as they do not exceed its overall
limit;
travelers letter of credit, issued for the convenience of a traveling cus-
tomer of the bank and typically listing correspondent banks at which
drafts will be honored; and
performance letter of credit, issued to guarantee performance under a
contract.
Credit Card Lending
Obtaining money through credit cards is a form of lender nancing. Even
though stories are reported in the trade every so often that some low-
budget lmmaker used credit cards to complete a lm, such use of credit
card nancing is, at best, a desperate move. Even though a credit card may
offer low or no interest for a brief introductory period, borrowing heavily
on a credit card in hopes that a lm will provide a return with which the
credit card debt can be repaid almost inevitably insures that the debt will
still exist when the much higher credit card interest rate kicks in. Thus,
credit card nancing is likely to turn out to be extremely expensive.
There are some advantages to credit card purchases:
more convenient because there is no waiting for check approvals;
easier to track monthly expenses because they all appear on the same
statement;
purchases are protected by the credit card company against nondelivery
and damage; and
rebates are offered by some credit cards in the form of frequent yer
miles, cash toward the purchase of vehicles or money for charity.
In those rare situations in which a lmmaker feels he or she must use
a credit card to nance the production or development costs associated
with a feature lm, the credit card should be used only as a last resort
and only for a small portion of the lms costs. A lmmaker using credit
cards, like any consumer, should always be aware of the interest rate be-
ing charged and try to use the credit card with the lowest interest rate.
The bank or other institution offering the credit card may be willing to
lower the rate upon request.
Since the interest rates on credit card debt are typically much higher
than rates for other debt, it is best to keep credit card balances at a
minimum and to always pay more than the minimum amount due each
month, so as to reduce the balance as rapidly as possible.
Lender Financing
154
The Question of Usury
Independent producers whose lms are being nanced by a studio or
others who charge interest on the production monies provided may
want to consider whether usury laws apply to the transaction. Usury is
an unconscionable or exorbitant rate of interest; that is, an excessive and
illegal requirement of compensation for forbearance on a debt (interest).
State legislatures in each state determine the maximum allowable rates
of interest that may be demanded in any nancial transaction. However,
usury laws generally do not apply to corporate borrowers, so in all likeli-
hood, the usury laws will not apply to lending by a studio since it will
usually require that the production company be incorporated. On the
other hand, it would be interesting and revealing to know whether the
interest rates charged by the major studio/distributors would be con-
sidered usurious if the loans were made to individuals, since if the only
difference between an individual borrower and a corporate borrower is
some paperwork, the corporate vehicle was merely being inserted into
the transaction to circumvent the usury laws.
Bad Advice
Some entertainment attorneys encourage independent producers to
simply use promissory notes to raise production money. They claim that
such loans are preferred because the transaction can often be structured
in a fairly simple and inexpensive manner (i.e., lower attorney fees for that
initial transaction, but higher fees for the rest of the production-related
entertainment work). A short promissory note, they say, can be used,
and the transaction often is not subject to the complex security laws that
govern many investments. Thus, as the scheme goes, there is no need to
prepare a private placement offering memorandum (PPM), which is re-
ally the point: that is, these entertainment attorneys are really saying the
producer does not need to pay a securities attorney to prepare a PPM.
On the other hand, these same entertainment attorneys often fail to
point out that if the promissory note is called a loan but in reality is
more like an investment, the courts will likely view the transaction as
an investment. Giving a supposed creditor a piece of the back-end, or
other equity in the project not only makes the transaction look like an
investment, it may also convert the transaction into a securities transac-
tion for which no attempt has been made by the producer to comply with
the federal and state securities laws.
In many instances, these entertainment attorneys are merely playing
games with the independent producer and inviting them to engage in a
scheme designed to circumvent securities law compliance. After all, how
155
many low-budget independent producers have enough money to pay
back several loans (large enough to produce a movie) based on promis-
sory notes? Not that many. Which means that they clearly intend for the
loans to be paid back out of the revenues generated by the exploitation
of the lm, and any entertainment attorney providing this bogus advice
knows it. A so-called promissory note that depends for its repayment
on revenues being generated by the exploitation of the lm is a prot
participation agreement (a form of investment contract) and if provided
by passive investors it is clearly a security, prompting the need to comply
with the federal and state securities laws. Further, what individuals in
their right mind would loan money to an independent lm producer who
has no readily available assets from which to pay back such loans? Such
a transaction would be a sham.
So independent producers need to be careful when dealing with en-
tertainment attorneys or other attorneys who suggest that promissory
notes are useful and less expensive in situations where the producer
knows he or she cannot repay the loans unless the lm makes money.
If the transaction is a security, go ahead and accept the responsibility
to comply with the federal and state securities laws like any responsible
business person. When an entertainment attorney starts encouraging
a producer to avoid complying with such laws, using shady tactics, it is
probably best to just walk away.
Advantages
Lender does not share in net prots. Producers who borrow money
from a lender are generally not obligated to allow the lender to share in
any of the lms net prots or net proceeds (or the producers share of
such moneys); that is, the lenders consideration for making the loan is
generally limited to the fees and interest charged.
No lender creative control. Lenders do not generally exercise any creative
control over the production of a motion picture.
Noncollateralized loans. Loans not supported by collateral may be
suitable for development money or the nancing of an ultra-low-budget
picture.
Disadvantages
Must be repaid. Loans generally have to be repaid regardless of whether
the lm makes money.
Incorporation requirement. Most lenders will require that the produc-
tion company organize as a corporation so as to avoid any possibility of
usury problems. Incorporating adds additional expense to the transaction
Lender Financing
156
for the producer and creates an entity that must be properly maintained
by the producer over the years.
Collateral may be lost. A feature lm production money loan supported
by hard asset collateral, for example, the family ranch, is a good way to
lose the ranch.
Noncollateralized loans are limited. Loans not supported by collateral
are generally not available except for small amounts of money.
Specic term. Loans are generally repayable at a specied time, regard-
less of whether any of the revenues generated by the motion picture in any
markets and media have been received by the borrower-producer.
Completion guarantor required. Banks generally require that the
producer contract with a completion guarantor to protect the lender
against the risk of budget overruns, thus causing the producer to spend
money on the completion guarantors fees and in all likelihood causing
the production budget to be increased so as to decrease the chances of
exceeding the budget.
Personal liability may be required. Some lenders may make the producer
personally liable for the repayment of the loan in addition to the liability
of the corporate production company.
Tax consequences. Tax problems may occur if the lender provides the
loan at below-market interest rates.
157
20 Negative Pickups and the Articial Version
Negative Pickups
A specic form of lender nancing that has developed in the lm industry
is referred to as a negative pickup. The term refers to the commitment
made by a distributor to a producer to purchase or license feature lm
distribution rights from the producer and the distributors guarantee to
pay an agreed-upon purchase price (pickup price) when the distributor
picks up the lm negative after delivery of the completed picture. The
commitment is usually made prior to the start of production and cer-
tainly prior to the completion of the lm. If the negative pickup deal is
with a distributor that meets the criteria of entertainment lendersfor
example, a major studio/distributor or sometimes a nancially stable in-
dependent distributorthe producer may be able to take the distribution
agreement and guarantee to a bank or lender where it can be discounted;
that is, for a fee paid to the bank, it is converted into an amount of cash
less than the face value of the contract. Such funds may then be used to
pay for some or all of the production costs of the lm. Since the actual
production funding is coming from a third-party entertainment lender,
the major studio/distributors consider a negative pickup to be a form of
off balance sheet nancing.
Sometimes, the term negative pickup or pickup is used to refer to a sale
or license of distribution rights at any time, even after completion of the
lm. However, when a lm is independently nanced and presented to
a distributor for pickup, that distributor transaction is more accurately
referred to as an acquisition or pure acquisition, which is documented
by an acquisition/distribution agreement. It would be less confusing if
the term negative pickup were reserved for use with the lender-nanced
transaction described above and the term acquisition were reserved for
use when the production costs of an independent lm were nanced
independently from the distributor and the distributor merely acquired
the right to distribute the completed lm. Then the term pickup could
be dropped from the lm industry vocabulary altogether.
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Negative pickup deal variables. The important variables in such transac-
tions include whether an advance payment is made to the producer upon
signing of the negative pickup distribution agreement (and if so, how
much), whether an advance is paid to the producer upon delivery of the
completed lm (and if so, how much), whether the distributor provides
a guarantee to the producer and whether the producer obtains a continu-
ing participation in the revenue stream generated by the exploitation of
the motion picture.
Producer considerations. In addition to the nancial stability of the
distributor, a principal consideration for the producer is the pickup price.
Usually the price will be pegged to the estimated negative cost of the pic-
ture. The amount of the producers prot participation, if any, will vary
depending on a number of factors, such as the amount committed to be
paid by the distributor, the rights acquired, the anticipated prospects for
the picture and the perceived risk for the distributor.
Typical provisions. The negative pickup distribution agreement is typi-
cally a lengthy contract. The principal variable provisions include the
rights granted, the territory, the term of distribution, the consideration
(pickup price) and the producers percentage participation in net prots
(see an example of a negative pickup distribution agreement in Film
Industry Contracts).
Producers negotiating strategy. In negotiating the negative pickup
distribution agreement, the producer should try to avoid or minimize
contingencies to the distributors performance. The producer should
eliminate as many grounds as possible that the distributor may be able
to use as a basis for refusing delivery of the lm, for example, because the
nal picture reects insignicant differences from the approved script.
What the distributor wants. In negotiating the negative pickup dis-
tribution agreement, the distributor will typically ask for all rights of
every kind in all territories. The distributor will take the position that
it is entitled to all rights since its domestic theatrical advertising and
promotional expenditures for the lm will enhance the value of all other
rights. The distributor also will want to be able to use its sole discretion
relating to the manner, method and timing of distribution of the motion
picture and in the exploitation of the pictures ancillary rights.
Drafting the agreement. One of the major problems involved in drafting
a negative pickup distribution agreement is describing in words the mo-
tion picture that the producer is obligated to deliver. The script must be
mutually agreed upon and adhered to during production, unless provisions
are included for distributor approval of necessary changes. Otherwise,
deviations from the script during production may render the lm unac-
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159
ceptable to the distributor. The negative pickup/distribution agreement
must include references to, and guarantee the involvement of, certain key
people in the production of the lm, such as the director and principal cast
members. The agreement must also dene acceptable standards of techni-
cal quality for the lm. Disputes relating to this issue may be resolved by
the lm laboratory, although if the distributor picked the lab, there may be
some question as to its loyalties. The distributor will also generally want the
agreement to include a copy of the lms budget (as an exhibit) in order to
provide assurances that the producer will have enough money to produce
the type of motion picture anticipated by the distributor.
Contingency plans. Many things can go wrong in the production of a
motion picture and often do. Thus, the producer should try to include
contingency options in the agreement to provide for some producer
exibility in resolving problems that do occur, such as script changes or
actor replacements.
Retained rights. In some situations, the distributor acquires something
less than all rights, with the producer retaining specied territorial or
media rights that he or she has already presold or intends to exploit
through separate agreements with third parties. The ability to retain
such rights depends rst on the producers willingness to ask for such
concessions and then on the relative bargaining strength of the parties.
Unfortunately, few producers have the kind of leverage required to extract
such concessions from distributors.
Clearance. Producers must ensure that they have or will obtain by
the time of conveyance to the distributor all rights that they intend to
transfer. They must secure the copyright in the underlying property and
must procure any necessary release from persons who may have claims
relating to the subject matter of the motion picture. They must also ensure
they have complied or will be able to comply with all of the distributors
delivery requirements, such as lists of credits and insurance certicates
(see a detailed list of delivery requirements appended to the sample dis-
tribution agreements found in Film Industry Contracts).
Delivery requirements. The producer or the producers attorney must be
very careful in examining the distributors description of delivery require-
ments for the lm, as well as the required production elements, such as
cast, director, script and budget. If the distributor can refuse delivery on
subjective grounds, the negative pickup agreement may not be acceptable
to a bank or other nancier. The producer should therefore try to elimi-
nate from the negative pickup agreement with the distributor subjective
grounds for refusing delivery (such as artistic quality) and try to focus
the agreement on objective grounds (such as technical quality).
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Negative pickup versus distributor guarantee. The main difference be-
tween a negative pickup and a distributor guarantee is that the negative
pickup does not necessarily imply that the distributor guarantees the
repayment of any production loan or investor funds. Instead, the dis-
tributor merely agrees to distribute a producers lm, contingent upon
delivery of the completed picture pursuant to the terms of the delivery
schedule. Sometimes the distributor will agree to pay the producer an
advance against the lms prots, payable on delivery of the completed
motion picture. Any over-budget costs in a negative pickup deal are solely
the responsibility of the producer, who must arrange for a completion
bond that will guarantee delivery of a nished lm to avoid this over-
budget risk. Thus, there is little or no risk for the distributor or the bank
if for any reason the lm is not nished or in any way fails to meet the
requirements set forth in the negative pickup agreement.
Laboratory letter. Upon completion of the lm, assuming that all the
terms of the negative pickup distribution agreement have been met by
the producer, the lm lab (or other mutually agreed-upon third party)
will issue a letter stating, among other things, that the nished lm is of
acceptable commercial quality, that the script adhered to the standards
set out in the agreement and that the preapproved cast members appear
in the nished lm in their proper roles. Upon receipt of the lm and the
laboratory letter, the distribution advance, if any, should be released to the
producer (or to the lending institution to pay back the production loan).
Producer advance is recoupable. Sometimes an advance payment is
made, with the balance paid upon delivery of the picture. It is not un-
usual for a payment made on signing or upon pickup to be considered
an advance that is recoupable by the distributor out of the gross receipts
or out of the producers percentage participation in the net prots of the
lm. In some cases, the distributor will put the agreed-upon sum (ad-
vance) into an escrow account for payment to the producer on delivery
of the motion picture. To the extent that the producer is able to negotiate
a larger advance, the producers percentage participation in the pictures
net prots is likely to be reduced.
Requirements of the distributor. The distributor will typically require
that the completed picture meet certain requirements:
the lm is in substantial compliance with the approved script,
specied cast members appear in their proper roles,
the approved director has directed the lm,
the ceiling on the lms running time has been adhered to and
the lm has a certain MPAA rating.
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161
Producer participation in net prots. Whether the producer will be
able to participate in the pictures net prots to some extent depends
on the size of the advance he or she negotiated, whether any portion of
the advance was payable upon signing the negative pickup distribution
agreement, whether a distributor guarantee was provided, whether
there are any gross participants involved in the picture and how much
discretion in making such payments the distributor is given in the dis-
tribution agreement.
Distribution agreements substantially similar. The terms and provisions
found in a negative pickup distribution agreement are very much like
those found in the production-nancing/distribution (P-F/D) agreement
and the acquisition/distribution agreement. The major differences relate
to who provides production nancing for the lm and when the agree-
ment is signed. Many of the more extreme provisions have been ruled
unconscionable (i.e., so unreasonably detrimental to the interests of a
contracting party as to render the contract unenforceable) by courts. On
the other hand, distributors continue to use such unconscionable provi-
sions simply because they can (see The Feature Film Distribution Deal).
Advantages
Comfort for investors. In the alternative, the producer may use the
distributor commitment to provide assurances to an investor group (e.g.,
limited partnership or manager-managed LLC) that distribution for the
lm is in place and, if a distributor guarantee is included, to reduce the
downside risk for investors. A distributors pickup commitment letter
or agreement documents strong distributor interest in the project and
presumably provides the investors with an improved chance to recoup
at least a portion of their investment (assuming the distributor has the
nancial wherewithal to support its commitment).
Risk of no distribution. By producing a lm without a distributor com-
mitment, the producer assumes the risk that an acquisition/distribution
deal may be difcult or even impossible to negotiate for the completed
lm. Thus, some producers regard a sale after completion of the motion
picture as a less desirable method of proceeding than a prior distribu-
tion commitment. These producers sometimes prefer to make their
distribution arrangements as early as possible, as in the negative pickup
arrangement, rather than later, when distribution may be difcult or even
impossible to nd. By not obtaining a negative pickup arrangement, the
producer runs the risk that the lm will not be as good as anticipated and
that little or no distributor interest will develop after completion.
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May be only alternative. If a studio development deal or a P-F/D ar-
rangement is not available to a given producer for a specic feature lm
and the producer is not inclined to go the investor nancing route, then
the negative pickup arrangement may be the only available choice for
nancing a lm.
The studio perspective. From the point of view of the studio/distribu-
tor, it is not taking much risk in the negative pickup transaction because
if the negative is not delivered, the studio/distributor has no obligation.
This sometimes makes it easier for a producer to obtain a negative pickup
deal with a studio than a production-nancing/distribution agreement
through which the production funds are actually loaned by the studio.
Obligation to pay. If the negative is delivered in accordance with the
delivery requirements imposed by the studio/distributor in the negative
pickup distribution agreement, but the picture is not very good in creative
terms, the studio is still obligated to pay the pickup price, although the
distributors support for the lm may be minimal.
Over-budget risk. In the negative pickup arrangement, the distribu-
tor does not share in the risk that the lm will go over budget, since a
completion guarantee will have been provided by the producer. Any ad-
vance upon signing is usually so nominal (if any is provided at all), that
the distributor runs very little nancial risk if the lm is not delivered
as and when promised.
Competing distributors. Often distributors miss out on obtaining rights
to a good picture because another competing distributor committed to
distribution at an earlier stage. Thus, producers may be able to use this
competition to their advantage in extracting a negative pickup commitment
from a distributor for what appears to be a promising movie package.
Domestic distribution commitment. The negative pickup provides some
assurance that the lm will be distributed domestically. This may be an
important factor in securing foreign or ancillary presales.
Risk reduction. From the point of view of a lender or investors, the
negative pickup removes most of the risk relating to lack of distribution
in nancing a motion picture.
Disadvantages
Production funding. The producer has to obtain production nancing
for the lm from sources other than the studio or distributor.
More restrictive terms. Some producers feel the negative pickup agree-
ment locks them into more restrictive terms than if they were to arrange
production nancing without a distributor commitment, believing that
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163
if the picture turns out to be as good as they envision, they will be in a
position to negotiate more favorable terms in an acquisition/distribu-
tion agreement.
Risk/reward ratio. As a general rule, the more risk the producer assumes
relative to the distributor, the better the deal the producer will be able to
negotiate. Thus, there is an incentive for a producer not to enter into a
negative pickup agreement if nancing can be secured without one.
Less expensive for distributor. Assuming the same level of quality for
a movie, it is generally less expensive for a distributor to make the com-
mitment to purchase a motion picture before the lm is completed as
opposed to after the lm is completed. With a good movie in the can,
a producer may try to create a bidding war between distributors for the
right to distribute the lm.
Speculative deal. From the distributors perspective, the negative pickup
can be highly speculative. No one can accurately predict the quality of a
given lm in its completed form as a motion picture.
Complex transactions. Negative pickups are complex, document-in-
tensive, time- consuming and difcult to get. For a producer without a
substantially packaged property, a negative pickup deal and distributor
guarantee are virtually impossible to obtain, and without both of them,
a bank loan for production nancing is usually out of the question.
A circuitous route. The negative pickup distribution deal and docu-
mentation can be complicated, particularly since the producer will be
trying to take the negative pickup distribution agreement and guarantee,
if any, to a lending source to induce it to lend production funds before
the picture is made. In that scenario, the producer will have to satisfy the
requirements of the distributor in order to secure the negative pickup
distribution agreement (and possibly a guarantee), will have to get that
agreement from a distributor (and on terms) that the lender approves,
will have to obtain a completion bond for the picture from a completion
guarantor that the lender approves and may have to provide additional
collateral for the production loan, such as presales or hard assets.
Favors those with a proven track record. Negative pickups usually go to
feature lm producers who have an established track record and relation-
ships with studios, distributors, completion guarantors and lenders.
Limited availability of suitable lenders. Negative pickup loans are
generally only available through banks or other lenders based in Los
Angeles or New York since they are typically the only lenders who have
the expertise to judge the creditworthiness of the distributor whose paper
is being discounted.
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Articial Pickups
A lm project originally controlled and developed by a studio/distribu-
tor but that has been farmed out pursuant to a negative pickup deal to
an outside production company is referred to as an articial pickup.
Articial pickups are sometimes utilized by the studios partly to avoid
the higher costs of certain below-the-line union crews they might have
to pay if their projects were produced in-house at the studio or on a
production-nancing/distribution agreement basis.
A controversial article of the International Alliance of Theatrical
and Stage Employees (IATSE) union contract allows major studios
to fully nance nonunion movies and television shows so long as the
studios declare they have no creative control and give the union thirty
days notice before production starts. Many union supporters contend
Article 20 has helped to increase nonunion movie production. IATSE
is the parent organization of some one thousand plus local unions in
North America representing every branch of lm production, including
stagehands, makeup artists and wardrobe handlers, as well as employees
in lm distribution and exhibition.
As has been reported in industry trade publications, the studios
sometimes pursue this method of cutting costsdevelop a picture
up to the point of production, then farm it out to an independent
producer and call it a negative pickup. It is difcult to determine how
many lms are produced in this manner, but some estimates have been
as high as one-third of the studio releases, especially on lower-budget
lms. In addition, at times the unions have appeared to go along with
the arrangement.
With an artificial pickup, crew sizes and rates usually are lower,
and indie producers get better union deals than the majors. Also the
nonunion shoots pay no health insurance benets, no pension benets,
no overtime or meal penalties. When the major studios farm out their
articial pickups they claim no artistic control in the picture and make
a distribution deal only. In point of fact, however, they are nancing
nonunion work and cutting off thousands of union members from their
pensions and other benets.
Advantages
Studios save money. The articial pickup allows the studio to make
a motion picture (which it developed) for less money than would be
required if the lm were produced as an in-house production or on a
production-nancing/distribution basis.
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165
Some producers benet. The articial pickup permits some independent
producers, who might not otherwise have the opportunity, to produce a
studio-developed lm.
Disadvantages
Union relationships. The articial pickup arrangement is obviously
controversial and a producer may be hurting his or her relationships with
various unions and guilds by participating in such an arrangement.
Less creative control. Even though a completion guarantor will be
required to substitute its monitoring activities and judgment for the as-
signed studio representative, the producer will still likely feel indebted
to the studio for the opportunity to produce the project and thus will be
more likely to accede to the studios wishes on certain creative issues.
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166
21 Presale Financing
Another variation on lender nancing involves the use of multiple dis-
tribution contracts as collateral for the production loan. Presale nanc-
ing, in the broadest sense, refers to the funding of a lms production
costs through the granting of a license for lm rights by a producer to a
distributor in a particular media or territory prior to completion of the
lm. These distribution contracts are then used as collateral to support
a bank loan.
Presales may actually take the form of funds, guarantees or commit-
ments that may be obtained or used to obtain funds, in addition to other
available production nancing in the form of cash advances or guarantees
paid by domestic or foreign distributors, pay or cable television systems,
DVD producers, television syndicators and bank loans obtained by using
such cash advances or guarantees as collateral. For example, if a producer
had a contract for the presale of a movie to a U.S. or foreign distributor, a
home video company, a pay-TV service or a TV syndicator, the producer
might be able to present those contractual commitments to a bank and
walk away with cash (for a fee). In this broadest sense, the negative pickup
arrangement is a form of presale, although presale transactions are more
commonly associated with foreign territories.
Some Speculative Numbers
A bank spokesperson once estimated that foreign presales are typically
involved in 60 to 65 U.S.-made lms each year. Assuming that somewhere
between 400 and 450 U.S.-made lms are distributed in the domestic
theatrical marketplace in a given year, only 14 to 16 percent of the mo-
tion pictures released in a given year (or about 1 in 6 or 7 movies) utilize
foreign presales.
To the extent that foreign presales are available for a given lm, such
sales may typically account for as much as 60 percent of a lms budget.
That, of course, means that other forms of lm nance will need to be
used to raise the balance of the lms budget.
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Denitions
Presale. A presale is an advance sale or licensing of distribution rights in
various media and territories.
Presale agreement. In the broadest sense, a presale agreement is a con-
tract involving the licensing of a feature lm that is signed in advance
of completion of the lm and often in advance of commencement of
principal photography. Such agreements may be used by producers to
obtain production loans from banks or other lenders (on a discounted
basis). In the view of some lenders, the simplest and most desirable
form of agreement is the single distribution agreement that covers all
rights worldwide. That type of arrangement is usually referred to as a
worldwide negative pickup. In the alternative, such an agreement can
be limited to the United States and Canada (domestic territory). That
would be called a domestic pickup. As noted above, a negative pickup
is a form of presale.
Fractured-rights deal. A fractured-rights deal is a lm nance and dis-
tribution transaction in which the lms producer (or representative of
the producer) presells domestic video and international rights and then
engages a distributor to distribute in the domestic theatrical marketplace
for a fee. Sometimes the producer also retains all domestic television
rights. The presales may cover some or all of the production costs and
some or all of the domestic releasing costs for the picture, leaving the
producers share of theatrical revenues and television rights for poten-
tial net prots. Fractured-rights deals worked (1) before video became
a signicant revenue source for the major studio/distributors (thus,
the studios did not demand to participate in the video revenue stream
at that time); (2) when independent video companies were still paying
substantial fees for video rights, (3) when more banks were prepared to
lend money to support these deals and fund production; and (4) when
the funds supplied by independent video companies and outside banks
were sufcient to cover production costs and a signicant portion of
domestic releasing costs. The fractured-rights deals have generally been
replaced by the so-called split-rights deals.
Split-rights deal. The split-rights deal is a lm nance and distribu-
tion transaction in which the producer presells all domestic rights to a
distributor and retains international rights. The split is between domestic
and international rights. By keeping the international rights on a promis-
ing lm that is prepackaged and nanced, the producer may be able to
sell the international rights on an auction basis to the highest bidder. The
total price obtained may exceed the actual costs incurred in making the
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lm. In addition, the domestic and international rights are not cross-col-
lateralized (i.e., they are uncrossed) with respect to the producer. In the
event that the lm is well received at the box ofce either in the domestic
marketplace or internationally, the producer may earn more overages
than in a crossed situation, such as a worldwide negative pickup or P-F/D
deal. The producer may also be able to limit the studio/distributors term
of rights in split-rights deals, insuring that the lm ultimately becomes
an addition to the producers library of lms, not the distributors.
Note again that lenders do not consider the distribution agreement
alone a presale contract. In their view, in order to be a presale contract,
that is, one that is lendable, the contract must guarantee the payment of a
specic amount of money by a certain date, and a distribution agreement
alone (as opposed to a distribution agreement with a guarantee) only
provides that the distributor will distribute the lm to exhibitors.
A feature lms distribution rights as to separate media may be frac-
tionalized and presold pursuant to separate agreements relating to video
rights, pay television rights, theatrical rights, U.S. network television
rights and possibly even local television syndication rights. In addition,
presales may be negotiated for foreign territories and in fact may begin
with the foreign territories (foreign presales).
Presales Used to Finance Production Costs
The role of the sales agent. The producer typically contracts with an ex-
perienced sales agent to make presale arrangements on behalf of a lm.
Such responsibilities may be divided among domestic and foreign sales
agents (see Know your buyer below). The foreign (or international)
motion picture license agreements are generally entered on a territory-
by-territory basis; thus, the foreign sales agent would be helping the
producer obtain multiple distribution contracts from foreign distributors
in various foreign countries.
What the producer gets. The sales agent at one time might have been
able to obtain a 10 to 20 percent cash deposit from a territorial distributor
at the time of signing the presale agreement (although that is less likely
in todays marketplace) and would seek to obtain a minimum guarantee
payable upon delivery of the motion picture to the buyer. It is more likely
today that the sales agent will get a presale agreement that is backed by
the purchasing entitys letter of credit or other form of nancial guar-
antee; for example, a guaranty provided by a nancially sound third
party to insure payment of contracts by foreign distributors who are not
considered nancially strong by the lender. In this example, the producer
might be required to assign a portion of the pictures net prots to the
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guarantor for providing the guarantee; however, that eliminates one of
the big selling points for using a loan for production funds.
The producer then goes to the lender. The producer then may be able
to take the presale agreement to a bank or other lender and use it in
conjunction with distribution agreements and guarantees, other presale
agreements or other forms of collateral to obtain a production loan,
which alone may cover the cost of producing the lm or may be used in
conjunction with other nancing sources (e.g., investor funds) or other
nancing techniques (e.g., deferrals, government subsidies, etc.). The pro-
ducer will try to borrow money by pledging the presale agreement itself.
However, many U.S. banks will not discount (i.e., lend against) foreign
paper. Alternatively, the producer may be required to obtain a letter of
credit from a foreign buyer. A letter of credit is generally considered more
bankable than a contract to pay the same amount of money. Some banks
specialize in discounting the distribution contracts of foreign territorial
distributors and may require letters of credit.
The lenders judgment. A lender will make an independent judgment as
to whether to lend on a given presale agreement, based on the reputation
and track record of the presale purchasing entity and the terms of the
agreement itself. A letter of credit put up by the presale purchasing entity
would provide the lender with additional security and make it more likely
that the lender would be able to lend on the presale agreement.
Discounting. Once the bank has determined (through weight analysis)
the loan amount, it then discounts that amount to arrive at sums allo-
cated for the production of the lm, a production contingency, loan fees,
the banks legal fees and interest. The bank then sets up a production
account and a reserve account (from which to pay all items other than
the production monies).
The investor alternative. The producer does not always have to take
the presale agreements to lenders but may opt for using them to reduce
the downside risk for investors who nance the lm project. Thus, if for
any reason, the presale contracts are not considered lendable by lenders
(banks and other lending institutions), the producer may want to consider
investor nancing alternatives.
Sales agent fees. Sales agent fees may range from approximately 10 to
15 percent if the sales agent is not able to negotiate any form of guarantee
from the presale purchasing entity (such as an irrevocable letter of credit),
but with some form of nancial guarantee provided by the presales pur-
chasing entity, the sales agents fees may increase to as high as 30 percent.
Cash payments, either at the signing stage or as an advance payable upon
delivery, may also tend to increase the sales agents fees.
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Issues that may be negotiated. The prospective quality of the picture
(i.e., the strength of the package), along with the competitive environ-
ment and the general demand (or lack thereof) for the product in a given
market, will help determine whether the sales agent is able to success-
fully negotiate on behalf of a producers lm. Questions relating to what
rights are included, the lms genre (e.g., action/adventure or comedy),
censorship, price ceilings imposed by local industries, the amount of de-
posits paid by the buyer to the sales agent on behalf of the lm producer,
minimum guarantees to be paid on delivery of the picture and back-end
participation will typically be considered in such negotiations.
A presale strategy. The producer should try to retain as many rights
and territories for sale after completion of the motion picture as possible;
that is, presell only as many rights and territories as necessary to cover
the production costs of the picture.
The role of hype. Some suggest that the desire of the distributors to
distribute a particular lm is to some extent based on industry hype, such
as announcements in the trades, and that such hype, typically generated
by professional publicists, contributes to a certain level of presumed value
for the lm among the distributors.
When to approach sales agents. Obviously the earlier the producer es-
tablishes lines of communication with a reputable sales agent, the better,
since those early conversations with an agent who is out there on the front
lines of the marketplace on a daily basis could provide invaluable guid-
ance to the producer in developing and packaging the lm. Ultimately,
the sales agent will need a fairly complete package to be taken seriously
by potential presale purchasing entities. Thus, a completed and budgeted
script along with rm commitments from a director and marquee
actors (i.e., with recognizable names) constitute the minimum package
with which the sales agent can work. Of course, it also helps if the pro-
ducer, coproducer or executive producer associated with the project has
a reputation for having delivered commercial lms on time and under
budget in the past. The strength of the writer of the screenplay will also
add value to the package.
Know your buyer. The producer will, as a practical matter, have to rely
on the judgment of the sales agent, but it is critical that the sales agent
know how many lms the prospective presale purchasing entity (buyer)
licenses in a year, whether the buyer is well nanced and whether the
buyer has defaulted on a presale agreement in the past. Favorable infor-
mation relating to these questions may decrease the likelihood of the
default disaster discussed below. Obtaining letters of credit would also
help alleviate the problems of a buyer default.
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Some nancing in place. Part of the nancing for producing a mo-
tion picture must be in place before presales can be attempted. In other
words, at a minimum, the screenplay must have already been acquired
or under option to the producer, and that typically involves an up-front,
out-of-pocket expense for the producer (or possibly, investor nancing).
In addition, some payments are likely to be required to obtain real com-
mitments from the director and actors.
The producers package. From a presentation point of view, the producer
needs to work closely with the sales agent in developing an attractive
physical package that the sales agent may use in presenting the project to
prospective presale purchasing or licensing entities. Such a package might
include glossy photos of committed actors and actresses, their credits,
narrative biographies and letters of intent or interest in the project, a
movie poster, a synopsis of the screenplay, the credits and biography of
the director, producer and other committed personnel, the projected cost
of producing the lm, location information, press clippings about those
involved in the project, information relating to any existing distribution
or presale agreements and so forth.
Drafting Checklist for Presale Agreements
Objective delivery. The completion guarantor and producer will want
to insure that the distributor meets its advance payment obligations
once delivery is made. Thus, the delivery schedule and obligations of the
producer must be drafted as objectively as possible.
Script approval. The distributor will generally want an approval right,
that is, the ability to sign off on a specic nal draft of the screenplay.
However, in drafting that provision in the distribution agreement, some
exibility should be provided for the producer in anticipation of required
script changes that fall within a reasonable range of directorial creativity or
that are prompted by unavoidable problems that occur while shooting.
Specied MPAA rating. Generally, the distributor will require that
the producer commit to provide a lm with a specic MPAA rating; for
example, an R-rating. The producer and director must carefully weigh
the risk of not being able to provide a particular rating for a movie based
on the subject screenplay, since failure to comply with that requirement
may allow the distributor to refuse to distribute the lm, that is, avoid
its obligations under the presale distribution agreement.
Television cover shots. Typically, the distributor will ask that the pro-
ducer commit in the distribution agreement to provide a version of the
lm that is suitable for broadcast on U.S. free television. This may be
difcult, since each of the free television networks in the United States
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has a separate standards and practices department that passes on the
content of feature lms to be aired on its network. Some feature lms
(particularly R-rated lms) do not meet the networks more restric-
tive standards. Thus, the producer should agree to provide cover shots
that would be more likely to meet the network standards and should
require the distributor to designate in advance which scenes would
need them.
Production versus distribution expenses. The producer should carefully
review the long list of delivery items that is often part of a long-form
distribution agreement and seek to eliminate items that should more
properly be characterized as a distributor responsibility and expense
rather than be paid for out of the lms production budget. Something
the distributor is responsible for will generally be recouped as a distribu-
tor expense. An item that is improperly characterized as a production
expense, becomes part of the cost of the negative, and interest will be
paid on the cost of all such items until the bank loan is repaid. A higher
total interest cost can thus result.
Running-time requirements. The producers counsel should also watch
for an unduly restrictive ceiling on the running time for the lm, since an
arbitrary limit may saddle a producer and director with an unsatisfactory
creative result or, in the alternative, provide the distributor with grounds
for refusing to distribute the picture.
Negotiations over all the issues discussed above, which tend to increase
the likelihood that a lm will be accepted by the distributor, also increase
the receptiveness of a lender to loan production funds based on a presale
agreement and guarantee. When presale contracts (with guarantees) form
the collateral for a loan, the lender must determine that the collateral and
the transaction are lendable.
Advantages
Presales may raise a signicant portion of production nancing. As an
example, the discounted value of foreign presales (which typically include
video and television rights for that territory) may equal 40 to 60 percent
of a lms production budget. Approximately 85 percent of the foreign
territorial sales of American lms (not just presold rights) come from
eight of the forty countries that typically distribute U.S.-made lms.
Those eight most important foreign territories (listed by market share
and assuming that Canada is part of the domestic market) are Japan,
France, Germany, Britain/Ireland, Spain, Italy, Australia and Sweden,
although these rankings may change from year to year.
Less studio creative intervention. From a creative point of view, provid-
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ing nancing for a feature lm through presales reduces what in many
instances is a problem for some producers and directors; that is, the
oversight and interference of a major studio or distributor in the produc-
tion process. However, lenders will require that a completion bond be
provided, and the completion guarantor will generally have its representa-
tive actively monitoring the production. If problems occur, the comple-
tion guarantors representative will become very involved in day-to-day
decisions that impact the budget, and it is difcult to separate budget
decisions from creative decisions. Thus, discounted presales involving
loans do not necessarily permit the kind of creative control so important
to many producers and directors; that is, much of the studio intervention
is merely replaced with intervention by the completion guarantor.
No other production nancing options may be open. If a producer cannot
obtain studio production nancing, a production-nancing/distribution
deal from other distributors, a negative pickup deal with a guarantee
sufcient to interest lenders, or other collateral besides presales that is
satisfactory to lenders or investor nancing in some form (e.g., a limited
partnership or manager-managed LLC), then the producer who is deter-
mined to make a lm has little choice but to resort to fractionalizing or
splitting media and/or territories and preselling some of those to generate
lendable contracts to raise production nancing through loans.
No condence in the upside. If a producer does not really have con-
fidence in the economic upside potential of the picture about to be
produced, presales make even more sense. And since very few motion
pictures are big box-ofce successes at any level, how can any producer be
that condent of the upside potential of a given lm? Furthermore, since
most producers do not generally participate signicantly in the upside
potential of their own lms, the loss does not become a disadvantage for
them. On the other hand, producers must include those factors in their
analysis of the value of their motion picture when making the original
deal with the distributor.
From the buyers perspective. Through presale agreements, the prospec-
tive presale purchasing entity (licensee or buyer) hopes to secure the rights
to exploit good lms before a competitor has had a chance to license the
same motion picture.
Disadvantages
Collection difculties. Presales are based on contingencies; for example,
the actual collection of moneys due from the providers of presale con-
tracts often turn out to be difcultoften more difcult than collecting
from domestic distributors.
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Market uctuations. The market for presales comes and goes as the
economies of various foreign territories weaken or strengthen and as the
number of available lms in the marketplace in any given year increases
or decreases.
Buyers market. So long as there is such a great disparity between the
number of lms produced and the number and capacity for distributors
to distribute, the market will be a so-called buyers market for distributors
(i.e., the law of supply and demand is working against the producers).
Increased cost of prints and ads make presales less practical. Fraction-
alized and split-rights agreements have become less practical in recent
years because of the increasing relative cost of U.S. theatrical distribution,
including paid advertising and lm prints.
Domestic presales may eliminate certain distributors. U.S. theatrical dis-
tributors often insist upon all, or substantially all, rights to help recoup not
only advances to the producer but also their increased distribution costs.
That is, any ancillary right that has signicant value will be demanded by
the domestic theatrical distributor as a prerequisite of distribution. Thus,
the producer who presells a lms cable and video rights runs the risk of
its being left out of a domestic theatrical release. And since the cable and
video presale contracts will probably require a domestic theatrical release
at a specied number of theatres, no domestic theatrical release means
the cable and video agreements are likely to be voided as well.
Cost-value trends do not favor fractionalized presales. As lm production
and distribution costs have increased, the percentage of revenue generated
through a lms domestic theatrical release has been reduced in relation
to other media or territories. In addition, as the value of cable and video
or DVD rights has increased, domestic theatrical distributors have been
more likely to insist on domestic cable and video rights as part of any
domestic theatrical distribution deal.
More offers means less reason to presell. The more value a lm is pre-
sumed to have, the higher the offers distributors and ancillary buyers are
willing to make to keep their competition from buying the same rights.
But the more offers the producer gets for ancillary rights, the more con-
dent he or she can be that the lm actually has value and that all rights
can subsequently be sold to an important distributor.
Gives away upside potential. Film production companies relying on
presale strategies may succeed in reducing but not eliminating their risk of
taking a loss, while giving away much of a lms potential protability.
Presales bring lower prices. The price that a buyer is willing to pay before
seeing a prospective lm will generally be less than that which the same
buyer would pay for the same lm as a completed motion picture; thus,
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the upside potential is reduced. This means that production companies
relying entirely on a presale strategy will have a difcult time surviving
on a long-term basis.
The A picture dilemma. Many industry observers today suggest that it
is difcult to presell rights in major markets around the world without an
extremely strong lm package, the so-called A picture. But if a producer
has an A picture, why should it be necessary to seek presales? On the other
hand, the stronger motion picture package will generally require more
money to nance; therefore, more presales may have to be made.
Higher cost of capital. Companies relying on presales will inevitably
have a relatively high cost of capital compared to some other forms of
lm nance. For example, in a foreign territory presale, a sales agents fee
will typically be recouped in addition to the costs and fees of the foreign
distributor before the producer will receive payments, if any, beyond the
producers advance.
Takes too much time. Since it generally takes much more time to con-
tact and negotiate with multiple interested buyers of presold rights in the
various media and territories, producers using presales may encounter
a lengthier time lag between the start of production and the creation of
library asset values on lms produced and distributed through presale
arrangements than some other forms of lm nance.
Contractual quagmire. From a contractual point of view, it is difcult
to coordinate the various contractual concerns of the bank, the comple-
tion bond companies, the producer and the various media and territories
when negotiating and drafting multiple presale agreements.
Reversion rights and library values. When preselling rights to a lm, the
production company or its attorney must be careful to coordinate provi-
sions relating to the reversion of such rights to the producer following
exploitation of the lm in various markets and media. If not, the lm is
likely to have less value as a library asset, and confusion over the status
of such rights may make it difcult to include such lm in the sale of a
production companys lm library.
Default disaster. If a licensee (i.e., the presales purchasing entity or
buyer) sees a rough cut of the lm and decides it is much worse than ex-
pected (or otherwise unsatisfactory), the buyer may notify the producer
that it will not be paying the balance of the minimum guarantee and will
forfeit its deposit, if any. In that event, the bank may demand that the
producer repay the loan, and the producer may have to seek payment from
the distributor. If the producer fails to repay the loan, the bank might
foreclose on the negative if it took a lien as further collateral or attach the
lm and its proceeds even if it did not have an original lien.
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Simply not available. The availability of foreign presales vary from year
to year, depending on larger economic issues in each of the countries
that traditionally offer such presales. As an example, as the marketplace
generally is ooded with more and more feature lms, it becomes less
necessary for distributors in foreign territories to prepurchase the rights.
They may opt to simply wait until the lms are completed.
Survival of the weakest. Presales often support projects that perhaps
could not and should not have been made; thus, producers seeking pre-
sale commitments may be looked upon with disfavor in some segments
of the industry.
Macroeconomics. Feature lms nanced in this manner increase the
number of lms produced in a given year and thereby increase the de-
mand for, and thus the cost of, various lm elements that are theoreti-
cally in limited supply (e.g., screenplays, directors, actors, sound stages,
etc.). Also, since there are more lms produced each year than there are
capable and willing distributors available to distribute, the oversupply of
lms contributes to a signicant imbalance in the bargaining strength
between producers and distributors.
The long-term view. Over the long term, the relatively few lms that
are highly protable for a producer using presale strategies are likely to be
insufcient in number or in degree of success to recoup the losses of the
rms many nonprotable projects. In other words, the thinner potential
prot margins of presold lms make it less likely that such a production
company will nancially succeed in the long run.
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22 Gap and Supergap Financing
Gap nancing is a variation of lender nancing on a lm for which the
presale of territorial rights has yet to cover the entire budget (i.e., funds
are still needed to produce the lm and there are also unsold territorial
rights in some of the top ten markets). In that sense, gap nancing is
merely an extension of the presale nancing technique, in which the
bank loans are partly based on unsold territories.
As a preliminary matter, the lms that are eligible for gap nancing
generally must be feature-length theatrical motion pictures intended for
exploitation worldwide through various motion picture distributors and
of a nature that might appeal to international moviegoers.
Major studio/distributors will typically provide the nancing for their
lms as in-house productions or through production-nancing/distribu-
tion deals (see chapters 25 and 35). Some of the production costs for their
lms are nanced as negative pickups, which require third-party bank
loans. On the other hand, a signicant proportion of independently pro-
duced feature lms rely heavily on some form of debt, or what is referred
to in this book as lender nancing.
In the current marketplace, it is also becoming common for bank loans
to be supplemented by equity contributed by investors and by economic
incentives of foreign governments. In point of fact, the nancing arrange-
ments may be the other way around, in that investor nancing and other
forms of lm nance have to be put in place rst, before a bank loan can
be accessed; thus, the bank loan actually supplements the other forms of
nancing. In any case, several forms of lm nance may be required to
cover the entire production budget for todays independent lms.
Independent producers typically utilize the services of sales agents
(some of whom specialize in foreign sales only) to make the arrange-
ments for these distribution contracts and then assign the contracts to a
lender as collateral for repayment of the loaned funds. Many sales agents
are members of the Independent Film and Television Alliance (formerly
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known as the American Film Marketing Association, or AFMA) a trade
association for the independent lm and television industry.
Most of these various forms of lender nancing rely primarily on the
promise of specied payments to be made by distributors (foreign or
domestic) who sign distribution agreements and guarantees (i.e., distri-
bution contracts) executed prior to the due date for the loan repayment.
These distribution contracts grant distributors the right to exploit the lm
(in various media) within their geographic territory for a xed period of
time. Such contracts stipulate a minimum guaranteed amount that the
distributor agrees to pay unconditionally for the distribution rights. While
there may be an advance, most of the amount promised becomes due and
is payable when the lm negative is made available to the distributor,
usually by delivery to a bonded laboratory in the same country.
As noted above, gap nancing refers to bank loans secured by unsold
international and domestic lm rights in situations where the production
budget has not yet been fully covered. Gap nancing typically accounts
for about 20 percent to 40 percent of a lms budget. The bank relies on the
judgment and experience of a foreign sales agent who makes representa-
tions to the bank as to the likelihood of the lm being eventually sold in
the remaining territories. Without such assurances from a foreign sales
agent considered by the bank to be reputable, most banks will not make
such loans. In some cases, the gap may be as high as 50 to 60 percent of
production costs (so-called supergap nancing).
At the peak of the trend for insurance-backed deals some years ago
(see chapter 23), it was not uncommon to see that form of lm nance
covering gaps of 40 percent or more. The more reasonable norm for more
ordinary gap nancing is 20 percent, although a producer who has an
established relationship with a bank going back a few years may cover
bigger gaps in this way. The extent of the gap may depend even more on
the banks condence in the ability of the foreign sales agent to provide
reasonable estimates on future sales in the unsold foreign territories and
on its own research.
In effect, gap nancing bridges the difference between revenue guar-
anteed by presales (or other forms of nance) and the balance needed for
the lms total budget. In a gap nancing transaction, a bank advances
lm production funds sufcient to make up the difference between the
agreed budget of the lm (including all nancing costs) and the other
nancing already in place through equity, license fees, presales and any
other nancing arrangements.
The bank provides cash to produce the lm using distributor contracts
as collateral for the repayment of the loan, along with the completion
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bond to assure that the lms production costs will not go over budget.
The loans are repaid from the amounts received by the producer from
the distributors when the lm is delivered to them.
Bank criteria. In deciding whether to provide a gap loan, the bank will
assess its risks based on several criteria:
whether the future foreign sales estimates are being made by a reputable
sales agent with a solid track record;
whether the sales estimates cover between 150 and 200 percent of the
value of the gap loan under consideration; and
whether the sales estimates make the loan ratios realistic.
Banks involved in gap financing commonly create and maintain
extensive databases of relevant information and often make their own
sales projections based on precedent and their analysis of cast, director,
budget, genre and other factors. If the banks estimates are signicantly
different from those of the sales agents, the transaction is less likely to
be approved by the bank.
Documentation. The lenders for gap-nanced deals (as well as any
of these various forms of lender nancing discussed in this book) will
typically require the following information or documents in addition to
a completed application:
title of lm;
name of production company, jurisdiction of formation, address, phone
number and contact person;
rsum of the lms producer and director;
literary property from which the lm is to be based, including title(s)
and author(s);
copies of chain of title documentation demonstrating ownership of the
script;
full budget breakdown;
cash disbursement schedule;
copies of signed distribution contracts or license agreements for mini-
mum guaranteed advances or, in the alternative, a list of potential pay-
ers interested in the project;
copies of all nancing agreements, production services agreements and
similar agreements made on behalf of the lm;
copies of any contracts with equity investors, if any;
name and telephone number of a contact ofcer at any nancial institu-
tion issuing standby or commercial letters of credit, if any;
description of marketable collateral, if any, to be pledged to further help
secure the loan;
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letter of intent to issue a completion bond from the completion guaran-
tor, if any; and
copy of the business plan or securities disclosure document (private
placement offering memorandum or prospectus), including nancial
projections, if any.
Film nance scams. Note that the above documentation and informa-
tion list is similar to the many lists of criteria circulated on the Internet
(and for years prior to the existence of the Internet) by lm nance scam
artists (or the sometimes unsuspecting nders for scam artists) who
claim to be able to provide the nancing for an independently produced
feature lm. Typically, they insist on an advance from the producer at
the last minute to cover some imaginary administrative fee or other
ctitious fee after the producer has been led to believe that the funding
is in place and the project has been approved. Be aware that the mere
existence of a list of criteria that appears to be credible has nothing to do
with the legitimacy of the prospective lm nancier. In such cases, the
independent producers due diligence investigation of the bona des of
such lm nancing sources must be thorough (see the conclusion for a
discussion of lm nance scams).
Expensive form of lm nance. Gap nancing for a feature lm is ex-
pensive in that banks will insist on several different risk-adjusted fees in
addition to interest. More specically, banks will commonly insist on
a gap nance fee (typically an amount between 5 and 10 percent of the
lms budget);
an arrangement fee (a at fee);
a loan fee (also at fee);
legal fees for the banks attorneys; and
interest (typically the current London Interbank Offered RateLIBOR
+ 2.5 percent).
Risky business. Gap nancing is risky for banks because there is always
the possibility that lms nanced on a gap basis will not be able to repay the
lenders. In the banking world, such arrangements are considered unusual
and exotic (i.e., more risky than necessary), therefore, a signicant number
of banks will not participate in such deals. Many banks simply choose
not to make lm production loans unless the repayment is guaranteed by
presold distribution contracts for various markets around the world.
Without question, banks providing gap nancing are moving beyond
their traditional role by assuming some limited risks with this form of
lending. More specically, these include:
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performance risk. The risk that the lm will not be completed on time
or within budget or be delivered to the distributors pursuant to the
terms of the contract. The banks will typically seek to shift this risk to a
completion guarantor (completion bond company).
marketing risk. The risk that the gap will not be covered prior to the loan
due date by contracts of sufcient value on the unsold territories. This is
a risk typically borne by the lending bank.
credit risk. The risk that the distributors will not pay the balances on
their contracts once the lm is made available to them due to commer-
cial causes (i.e., bankruptcy or liquidity problems) or political events
(currency inconvertibility, i.e., the inability of a foreign distributor to le-
gally obtain U.S. dollars to make payment). This is a risk that the banks
seek to minimize by investigating and making sound judgments about
the creditworthiness of the distributors involved.
Banks have developed additional ways to protect against risk. For
example, some banks do not always provide gap nancing. In some in-
stances, they will access nonbank sources to cover a gap, but still make
direct loans on existing presale contracts, which they consider to be
solid collateral. Also, some banks will outsource the gap nancing for
a single picture, but loan directly on the estimates of reputable foreign
sales agents for a multiple lm package.
In recent years, during a period when several Asian nations were going
through an economic crisis, foreign territorial distributor commitments
that had previously been counted on to contribute some 5 to 6 percent
of a lms budget (e.g., South Korea) did not materialize. As a result,
some of the lms that were nanced on a gap basis did not recoup their
production costs. On the other hand, the banks fees and interest spread
on a gap-nanced lm may be enough to allow the bank to make money
on the deal even though the lm did not recoup.
In an effort to avoid gap-related losses, the banks still willing to cover
a lms production budget gap have had to become more discriminat-
ing about the lms they will nance in this manner. They have started
concentrating on so-called higher-quality projects with known stars. In
addition, many banks have sought to spread the risk of nancing lm
projects through gap nancing a slate of lms as opposed to a single
lm project.
Just as the market for foreign presales comes and goes, gap nancing
does the same. Sometimes, for some banks, it may be considered a main-
stream funding technique that helps to overcome the nicky nature of
the presales marketplace. On the other hand, even though single-picture
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gap nancing may not be completely out of the question, lenders have
tightened their underwriting standards as compared to the early years
of gap nancing and typically will allocate little or no value to countries
with weak economies.
Film nanciers indicate that there is ample bank money available for
loans on lm projects with solid distribution deals. However, the distribu-
tion agreements and guarantees needed to support the bank lending have
become even more difcult to obtain in recent years due to a continued
reduction in the so-called buyer pool (i.e., the number of distributors
considered to be creditworthy in the view of the banks) particularly in
the important U.S. theatrical marketplace.
The number of viable independent distributors has also become
smaller over the years. Some have been made subsidiaries of the major
studio/distributors, and in other cases, an independent distributors ca-
pacity to take on other independently produced feature lms is limited
due to long-term output deals with studio-afliated and other produc-
tion companies.
In addition, the independent distributors in many of the foreign
countries with sufcient moviegoing attendance to support the foreign
presales are less willing to make the presale commitments and provide
the guarantees they formerly provided based on a movie title, a concept
and script and some attached elements, like casting. More recently, these
foreign territorial distributors will insist on seeing a lengthy promo reel
or even a nished lm.
The remaining independent distributors in various foreign countries
are often much more hesitant to make presale commitments based
only on a title, a concept and some casting. As the market for foreign
presales has become weaker, that development has also put a strain on
gap nancing.
All of these factors make it more difcult for independent producers
to arrange for foreign presales and this, in turn, has an impact on the
banking communitys willingness to make production loans of any kind,
much less gap loans. As a consequence, the number of banks willing to
offer gap nancing has been signicantly reduced in recent years.
Advantages
Producers can focus. Gap nancing allows producers to focus on lm-
making instead of selling.
No limits on locations. This form of lender nancing does not typically
impose any limits on where the lm can be shot.
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183
Raises money more quickly. Gap nancing allows a lms production
costs to be nanced sooner, rather than having to wait for the additional
distribution contracts to be executed.
Production on schedule. With gap funding, a lm can begin production
on a rm schedule, eliminating delays that may cause cast members to
drop out.
Disadvantages
Economic sensitivity. Gap nancing is extremely sensitive to the eco-
nomic ups and downs of local economies.
Sales agent estimates. Gap nancing is dependent on the well-informed,
good faith estimates of a reputable foreign sales agent and/or the banks
own research.
More risky for banks. This form of lm nance adds some risk to the
transaction for banks, and banks are not generally in the business of
assuming nancial risk.
Expensive form of lm nance. Gap nancing for a feature lm is some-
what expensive in that banks will insist on several different risk-adjusted
fees in addition to interest.
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184
23 Insurance-Backed Schemes
Bank lending practices for slates of feature lms eventually took the pre-
sale technique and gap nancing to their ultimate conclusionobtaining
insurance to help protect against the risk of loss. With these schemes,
insurance was used to provide nancial backing for gap nancing. So, the
so-called insurance-backed schemes, in one sense, represent a continuing
evolution of lender nancing for feature lm production.
Most of these insurance-backed lm nance schemes occurred back
in the 1990s, more specically between the years 1995 and 1999, when
many feature lm producers were desperately seeking ways to nance
their lms and somebody (possibly insurance brokers working closely
with lm producers) came up with a new scheme to use insurance to
back lm nancing. The idea was that a bank or group of banks (a syndi-
cate) would lend the money needed to produce a slate of some ve to ten
feature lms for an established production company (with distribution
in place); and instead of looking to the distributors payment to repay
the loan upon delivery of the lms (as with a negative pickup), the loan
would come due for repayment out of the lm earnings some three to
ve years after release.
The risk of defaulting on repayment would then be insured against
through an insurance broker with one or more insurance companies
who, in turn, would spread some of the risk with co-insurance or rein-
surance, often in the London insurance market. The basic concept was
that even though the probability of a single lm making a prot was not
good, spreading that risk over a slate of lms somehow improved those
odds. The insurance-backed nancing schemes served as an additional
risk reduction device for banks nancing a slate of lms on a gap basis.
Alternatively, instead of a bank loan, the funds might be raised from
bond investors through securitization (see chapter 24).
These insurance-backed nancing schemes may have been available
and effective for a package of lms where risk could be spread over 6 to
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Insurance-Backed Schemes
185
10 titles to be produced over a two-year period, but it is simply not avail-
able for a single lm project. The minimum budget for such lms was
likely to be in the $3 million neighborhood, and such nancing was only
available to experienced producers with fairly established production
companies. The gap range on such deals was between 20 and 30 percent
of each lms total budget.
Several arguments have been put forward by advocates in support of
the insurance-backed nancing schemes. They contend that by obtaining
the insurance to cover a possible loss on a slate of lms, an experienced
lm producer or production company can transform a budget decit (or
gap) into a bankable asset. Traditionally, in such deals, the producer does
not have to give up much equity, and nancing a slate of lms in this
manner allows the producer to produce more lms; thus, the producer
can hold onto more equity and build the production companys library
much faster. In addition, the expenses involved in this form of nancing
are also borrowed from the bank and the nancing becomes an unofcial
line of credit. Plus, the producer may even be paid his or her producer
fees when the deal closes. In effect, an insurance-based nancing policy
acts as collateral for lending institutions, like a bank or a specialist fund.
The latter can provide the nal production nancing, knowing, or at least
believing, that the policy ensures the loan will be repaid by a xed future
date. Certain brokerage rms had developed relationships with the banks
that would take this paper (i.e., accept it as collateral for a loan).
In many instances, insurance brokers would be working with the lm
producers in putting together these deals. They would line up the insur-
ers and reinsurers and then present the deal as a package to a lender or
investment bank.
Film production companies from England and the United States were
primarily the ones involved in the insurance-backed schemes. Such
companies included Screen Partners, Flashpoint (based on the island of
Jersey), J&M Entertainment, George Litto Productions, Phoenix Pictures,
Destination Films, MGM, Universal Pictures, Paramount Pictures and
Sony Pictures Entertainment. Some of the banks included Chase Man-
hattan Bank, Royal Bank of Canada, Silicon Valley Bank, Fuji Bank,
JPMorgan Chase Bank and Imperial Bank (now Comerica).
The bottom fell out of the insurance-backed gap nancing market
quite spectacularly some years ago, although the need for bank-funded
gap nancing still exists, but with a smaller number of willing partici-
pants and without the insurance backing.
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Lender Financing
186
Advantages
Signicant sums. Large amounts of lm production nancing have
been raised in this manner.
Transforms a decit into an asset. By obtaining the insurance to cover a
possible loss on a slate of lms, an experienced lm producer or produc-
tion company can transform a budget decit (or gap) into a bankable
asset.
Builds library faster. The producer does not have to give up much
equity, and nancing a slate of lms in this manner allows the producer
to produce more lms, hold onto more equity and build the production
companys library much faster.
Cost of capital is also borrowed. The expenses involved in this form of
nancing are also borrowed from the bank and the nancing becomes
an unofcial line of credit.
Producer gets paid. The producer may be paid his or her producer fees
when the deal closes.
Disadvantages
More expensive money. The insurance adds to the cost of lmmak-
ing. The cumulative cost, including bank fees, loan interest, insurance
broker fees, attorney fees, insurance premiums and so forth, can be
substantial.
Complex transaction. The insurance-backed transactions are extremely
complex, requiring the participation of numerous banking, legal and
insurance professionals (who may or may not be so professional).
Out of reach for many lmmakers. This nancing arrangement has gen-
erally not been available for rst- and second-time lm producers or for
lmmakers seeking nancing for a single lm, or even just a few lms.
When they were at the height of their popularity, the insurance-backed
financing schemes offered film producers the freedom to select the
lms to include in their lm production slate (which made sense from a
producers point of view); but in some instances, producers selected their
riskiest projects, because they perceived insurance-backed nancing to
be guaranteed. But that ability to select the lms to be included made
the risk less appropriate for insurance.
There also appears to have been some dispute as to how many lms
were supposed to be included in each slate, because the number of lms
would theoretically change the risks for the insurers. The insurers, bro-
kers and reinsurers were apparently unaware that the excessive discretion
built into the lm distribution agreements made them unsuitable risks
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Insurance-Backed Schemes
187
for insurance (see The Feature Film Distribution Deal: A Critical Analysis
of the Single Most Important Film Industry Agreement). After a time, very
few, if any, of the lm production loans were being repaid. Most of them
defaulted, and even though some of the insurers paid or settled the bank
claims on the insurance policies, some of the reinsurers refused to pay,
claiming fraudulent misrepresentation and nondisclosure of material
facts, as well as breach of warranties relating to the number of lms to
be included in the slates.
Most of these deals ultimately resulted in massive and quite expensive
litigation between banks, brokers, insurance companies and reinsurers
in New York and London. Many of the parties involved, including lm
production companies, went into bankruptcy. It is doubtful that any
bank, broker, insurance company or reinsurer would try this particular
scheme again. This form of lm nance can be added to the long list
of lm-nancing schemes in which Hollywood interests have left their
outsider nancing partners (i.e., contributors of production money) both
empty-handed and with silly grins on their faces.
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188
24 Securitization
Some independent lm producers have expressed interest in a form of
raising capital referred to as securitization. Unfortunately, this form of
lm nance is only available to a very few of the more established lm
Securitization is a process through which an individual or entity pools
the rights to future payments being or to be generated by revenue-pro-
ducing assets and sells this bundle of rights as a security. In other words,
securitization is a sophisticated method of raising capital involving the
taking of a specic group of assets that generate a predictable, steady
stream of revenue, isolating the assets and revenues in a special-purpose
vehicle or company, such as a corporation, limited partnership or limited
liability company, by having the original owner transfer the assets to be
securitized into the special-purpose vehicle and then using those assets
and anticipated revenues to raise capital against the credit of, and secured
on, the future revenues of those assets. The special-purpose vehicle is-
sues debt securities and uses the proceeds to purchase the securitized
receivables from the original owner.
In nancial terminology, these traditionally unused assets are con-
sidered esoteric asset classes. Such assets have included municipal
tobacco litigation settlements, tobacco lawsuit attorney fees, healthcare
receivables, aircraft leases, mutual fund fees, trademark licenses, pat-
ent-related royalties, insurance-related premiums, music royalties and
lm receivables, among others. The basic premise is that if an asset can
generate a predictable, steady stream of revenue, it may be a candidate for
securitization. Long-term assets such as lm rights are most likely to be
nanced through the issuance of bonds, as opposed to the shorter-term
commercial paper.
Companies like the lm industrys major studio/distributors and a few
others, holding a diverse collection of media copyrights and trademarks
that can produce steady, predictable cash ows may be able to access this
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Securitization
189
form of nancing. A few so-called securitizations have involved single-
artist offerings, such as the so-called Bowie Bonds, but these have been
fairly limited to date. Securitizations have also been effected by music
labels, publishing houses and lm studios out of whole media catalogs
comprised of diverse royalty streams. Many in the nancial industry
consider securitizations to be a growth area in the asset-backed securi-
ties market. Securitization allows the companies holding the copyrights
and trademarks to increase their liquidity as well as potentially provide
a lower cost of nancing.
In the context of lm, a distribution company would rst sell the actual
distribution rights to a bankruptcy-remote special-purpose company
(entity or vehicle). The entity is formed to engage in a particular activ-
ity, and only that activity, to ensure that other, potentially money-losing
activities of the lm distribution company itself will not adversely affect
the ability of the special-purpose company to meet its obligations to lend-
ers. Money is then loaned by one or more banks based on the value of the
distribution rights held by the special-purpose entity, rather than on the
nancial health of the distributor itself, thereby isolating risk.
Such a nancing arrangement is highly structured so that it is able
to get a minimum A rating from the rating agencies. Both Moodys
and Standard & Poors assign ratings to commercial paper. That, in
turn, allows the special-purpose company to obtain low-cost nancing
through the issuance of commercial paper in the capital markets rather
than relying on the more expensive capital available through traditional
bank nancing. The commercial paper takes the form of short-term debt
obligations that are unsecured and usually discounted, although some
are interest-bearing. They can be issued directly or through brokers
equipped to handle the back ofce paperwork. The commercial paper is
sometimes backed by bank lines of credit.
According to economists, low interest rates, a slowing economy and the
growing federal budget decit have been major factors in the signicant
increase in asset-backed securities issuance in recent years. This sector
has been seen as an alternative for investors seeking securities that were
safer than those available in the weakened corporate debt market.
Securitization is not a technique suitable for funding the production
costs of a single motion picture and may not even be available for a library
of lms owned by independent producers or distributors. It is a means of
raising capital based on the predictable revenue streams generated from
the exploitation of a group of motion pictures (or other assets) some
time after they have been released and when those revenue streams can
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Lender Financing
190
be demonstrated. Typically, the slate of lms may involve some 25 to 50
motion pictures. The effective collateral is ten years of distribution rights
on an entire collection of lms.
DreamWorks, LLC (DreamWorks), structured a $1 billion securitiza-
tion facility backed by an initial portfolio of 37 live-action and animated
lms that it produced or coproduced. The facility was syndicated through
a group of brokers allowing the special-purpose vehicle issuer, DW Fund-
ing, LLC, to borrow, pay down and reborrow on a revolving basis.
Notable in this lm securitization was the mitigation of the lm pro-
duction and performance risk for future lms that was present in the prior
DreamWorks transactions (described below). A lm is eligible to partici-
pate in the facility only after eight weeks of domestic theatrical release,
thereby ensuring a certain degree of predictability of its future revenue.
DreamWorks had previously utilized a securitization structure to
nance its production of future lms. In that deal, without an existing
catalog of lms, DreamWorks would sell to a special-purpose vehicle
just-completed lms that had yet to be released. Since there was still a
fair amount of marketing to be done for these lms, it was not possible
to render a true sale opinion with respect to them. Notwithstanding
the absence of a true sale, this earlier structure enabled DreamWorks
to obtain lower-cost nancing for the development of its lm catalog.
DreamWorks has since been purchased by Paramount Pictures, a unit
of Viacom, Inc.
In 2003, Vivendi Universal Entertainment completed a $950 million
revolving facility with a consortium of banks backed mostly by distribu-
tion fees and royalties that Vivendi expects to collect from home-video
sales and television broadcasts of movies that it produced, purchased
or will make in the future. The lm catalog currently includes 121 lms
that have been released since 1995. As with the DreamWorks deal, the
anticipated revenues from each of the Vivendi lms cannot be securi-
tized until eight weeks after its theatrical release so as to improve cash
ow predictability.
In addition, a royalty and lm securitization scheme was created by the
Australian lm studio Village Roadshow. It established a $900 million
revolving credit facility backed by the studios future distribution revenue
for future lm sequels to The Matrix, Oceans Eleven and Cats & Dogs,
among other lms. The transaction was syndicated and supported by the
application of a triple-A nancial guaranty as well as a $100 million equity
stake contributed by Village Roadshow to support the credit line.
Although the issuance of the Bowie Bonds received signicant media
attention and heightened interest in intellectual property (IP), growth in
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Securitization
191
the area of securitization has generally been cautious. Single-artist deals,
such as the Bowie Bonds, have particularly been limited because of the
practical reality that very few artists with a catalog suitable for securitiza-
tion actually also have a need for the upfront cash generated by it, and those
artists most in need of a large infusion of cash probably lack the required
collection of music copyrights. However, IP securitization in recent years
has experienced growth and innovation, especially where entire media
catalogs have been involved. The assets are copyrights and royalties.
Securitization may continue for media institutions holding copyright
catalogs with a sufcient degree of historical performance and diversity.
Securitization of these revenue streams affords music publishers, record
labels and lm studios a potentially cost-effective manner of nancing.
The trend of whole-catalog securitization is expected to continue into
the future as a viable means of increasing liquidity in the media industry
for a limited segment of the industry.
Advantages
Lower rates. Securitization allows some lm companies to access funds
at less than commercial lending rates.
Tax-free capital. Securitization may be able to provide an immediate
tax-free infusion of capital.
Disadvantages
Not for single lms. It is not suitable for funding the production costs
of a single motion picture and may not even be available for a library of
lms owned by most independent producers or distributors.
Steady revenue. It requires a predictable, steady stream of revenue, some-
thing that most independent lm production companies do not have.
A real long shot. Securitization is not likely to be useful for the vast ma-
jority of independent feature lm producers or production companies.
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Cones Ch24.indd 192 12/20/07 1:52:09 PM
PART FOUR
Studio/Industry Financing
Many independent feature lm and documentary lm producers aspire
to produce at least one major studio release at some point in their career.
Some try to do that too soon. Others are committed independent produc-
ers for life. In any case, that is a judgment call for the individual producer.
This section of the book undertakes a comprehensive examination of
lm-nancing options that may be useful to lm producers preparing
for that bigger budget project, options that are more closely tied to the
major studio/distributors and the domestic lm industry.
195
25 Studio Development and
In-House Production
One of the ways a lm producer might seek to get a lm project onto the
screen is to enter the so-called studio system at the earliest opportunity;
that is, at the acquisition/development stage of a lm project. Arguably,
this approach might not be considered a form of lm nance. The term
development in the broadest sense refers to the initial stage in the prepa-
ration of a lm. Development in its more narrow sense comprises those
activities relating specically to taking a concept or idea and turning it
into a nished screenplay. The development phase involves formulating
and organizing the concept or idea for the movie; acquiring rights to the
underlying literary work or screenplay; preparing an outline, synopsis
or treatment; and writing, polishing and revising the various drafts of
the script.
The studio in-house production usually starts as a development deal
initiated by an independent writer, director or producer. The develop-
ment deal typically begins with the pitching of an idea or lm concept to
a studio creative executive and the submission of a synopsis, treatment,
outline or draft screenplay to the creative department of the studio. Re-
gardless of who claims ownership of the original motion picture concept,
if the studio nances the development of the screenplay, the production
of the movie and its distribution, the studio will ultimately own most, if
not all, rights associated with the project.
Elements of the Deal
Committing to production. A major studio/distributor will generally
not commit to the production nancing for a motion picture until a
substantially developed package exists; that is, until at least a rst draft
of a screenplay is completed, a budget has been prepared and a director
and actors have been attached to the project.
The step deal. A studio development deal is generally referred to as a
step deal, because the development nancing is handled in stages. The
196
studio pays the producer and other persons who are contributing to the
propertys development (e.g., writer and director) a salary, and sometimes
expense money, in increments as the project is developed. The rst step
might involve developing an outline of the screenplay; the second a rst
draft of the script; and so forth. The studio will have the right to decline
to develop the project beyond any given stage, if it so chooses.
Ofce on the lot. Some deals are nothing more than handshake arrange-
ments between a producer and a studio executive in which the producer is
provided with ofce space on the lot in exchange for a rst look at whatever
projects are developed by the producer. Having an ofce on a studio lot
gives the producer a certain level of credibility, which in turn presumably
helps him or her acquire, develop, package and nance projects. After
all, a producer with an on-the-lot deal can invite prospective investors
onto the studio lot for lunch at the commissary. Other ofce-on-the-lot
arrangements are more extensive (see chapter 27).
The development deal memo. Typically, the development deal is rst
memorialized in writing by means of a deal memo, which is just an ab-
breviated version of a more formal written agreement (usually in letter
form). It outlines the basic deal points (terms) of the agreement, such
as salary, time schedules, screen credit and percentage participation in
the lms prots. The more formal contract containing the details of the
agreement is negotiated and prepared by entertainment attorneys while
the project is in active development. That agreement might be referred
to as an executive producers agreement, a producers agreement, a
directors agreement or a writers agreement, depending on who makes
the development deal.
Producers salary. The salary that the producer negotiates for the
development deal is typically the full salary the producer would receive
if the movie were actually produced. That gure may be a signicant
amount of money, but the producer must keep in mind that it is highly
speculative whether he or she will ever receive the full amount, because
of the nature of the development process, the unfavorable odds of ac-
tually going into production and the fact that the studio can stop the
process at any stage. Only a small portion of that total salary is usually
paid during development.
Advantages
Studio money. The writer, director, producer or executive producer
who goes to the studio is not usually required to put up any of his or her
own money to nance the development, production or distribution of
Studio Development and In-House Production
197
the lm, although without a track record or relationship with the studio,
the producer may have to incur some acquisition costs.
Major motion picture. In the current motion picture marketplace, the
major studio/distributors dominate in the area of theatrical releases.
Thus, if anyone associated with a particular lm project wants it to be a
so-called major motion picture, it will, as a practical matter, have to be
developed, produced or at least released by a major studio/distributor.
Insider development companies. Certain production and develop-
ment companies whose owners have strong family, religious or cultural
relationships with studio insiders have the best shot at getting studio
development deals and making good money, at least for a while, even if
few or any of their projects are ever green-lighted for production (see
Hollywood Wars).
Bigger budget pictures. A studio can generally provide more signicant
resources to aid in the development of a project, offering the promise
of a higher production budget and the ability to obtain commitments
from bigger name stars at an earlier stage than most other development
nancing sources.
Collaborative process. In some instances, the extensive collaborative
process that studios engage in through the development and production
of a motion picture (e.g., using several different writers, a producer, a di-
rector and studio executives, all contributing ideas during development)
actually results in an improved version of the lm.
Disadvantages
Not good odds. The odds against getting an idea, concept, synopsis,
treatment, outline or script submitted to a studio and accepted as a
development deal (much less given a green light for production) are
tremendous. Major studios receive hundreds of submissions a week and
thousands a year, only to choose a hundred or so for development and a
handful for production.
Relationship-driven business. All other things being equal, the studio
development or production green light will go to the producer who has
the best relationship with the studio or the studio executives making the
commitment on behalf of the studio. Some in the industry characterize
this phenomenon within the realm of studio politics or refer to the
industry as a relationship-driven business. This is also one of the situa-
tions in which Hollywood nepotism, favoritism and cronyism come into
play (see Hollywoods Family Ways: Who Can You Trust Better than
Kin? by Terry Pristin).
198
Danger of theft. It is very difcult for industry outsiders to protect
against theft of ideas, or even the tangible expression of those ideas, while
trying to interest a studio, production company or distributor in a lm
project. The copyright laws provide inadequate protection for writers
and producers in this environment.
An insiders game. Studio nancing at the development or production
stage appears to be pretty much an insiders game; thus, if an independent
producer does not already have a relationship with a studio executive,
the chances of obtaining a development deal are even less likely. Merit
does not always prevail in Hollywood.
Fewer deals available. The major studio/distributors appear to have
cut back in recent years on the number of development deals they will
accept.
Development hell. Most of the time a lm project in development at a
studio never gets a green light for production but remains in development
for what seems like an eternity. This is often referred to as development
hell. Unfortunately, the writer or producer cannot take the project else-
where without the cooperation of the studio.
Turnaround. In some cases, producers may have a difcult time re-
gaining ownership of the original property if it never receives a go to
production. Thus, a turnaround provision with a time limit should be
included in the development deal so the producer can take the property
to another studio or production company.
Producers fee only. Only a few very powerful persons ever obtain a sig-
nicant and meaningful participation in the upside potential of a studio
in-house production that started out as that persons project.
Not adequately developed. Sometimes movies developed by studios are
needed to ll the studio/distributors release slots for a given year and are
prematurely committed to production to meet those needs even though
they are not adequately developed.
Bumped by agency projects. Film projects in development at a studio may
get replaced by fully packaged projects brought to the studio by a powerful
talent agency that has a better relationship with the studio executives.
Studio employee. A person submitting a project to a studio for develop-
ment in effect becomes an employee of the studio and may not only lose
control of the project but may be red under some circumstances.
199
26 Studio Production-Financing/
Distribution Agreements
In contrast to the studio in-house production, which is typically initi-
ated with a pitch, the studio production-nancing/distribution deal
generally starts with the submission of a partially or fully packaged lm
project, including a fairly well developed screenplay. In other words,
the development phase of the project is substantially complete. Thus,
at this point in the life of the project, there is no longer any need for a
development deal. The packaged lm project is taken into the studio by
an independent producer who has already incurred the acquisition and
development costs, or it comes through a talent agency with or without
a producer attached.
A lm package minimally consists of a script, a budget, a shooting
schedule and often commitments by a star or stars and a director. It can
also be enhanced by including deferments (delayed payment of com-
pensation) from a lm lab, performers or a director and having part
of the production funding already raised or committed. Some agents,
agencies, entertainment attorneys and others engage in packaging lm
projects with their own clients. Such transactions may at least partly be
motivated by the desire to maximize the fees they receive and might not
result in the best possible casting for the lm.
Terms of the Agreement
The P-F/D agreement is a contract between the studio/distributor (or
other distributor) and a feature lm producer that sets out the terms and
conditions under which the studio/distributor will provide production
nancing for a motion picture in exchange for the right to distribute the
lm in some or all markets. The P-F/D arrangement is one of the princi-
pal forms of motion picture production nancing, at least for those lms
receiving a major studio/distributor theatrical release.
With the P-F/D deal, the studio assumes the role of the lender of the
production money to the production entity. In addition, the studios
Cones Ch26.indd 199 12/20/07 1:52:03 PM
200
afliated distribution arm handles distribution for the completed picture;
and, of course, theatrical distribution requires an additional expenditure
of substantial sums.
Elements of the Deal
Studio approvals. The items over which a major studio/distributor has
the right to approve or disapprove in the context of a feature lm P-F/D
agreement are referred to as studio approvals. As a general rule, the more
money a producer tries to get from a studio, the more approvals a studio is
likely to impose. Such approvals typically relate to the screenplay, budget,
producer, director, lead performers, start date, running time, Motion
Picture Association of America (MPAA) rating, shooting locations and
production schedule.
Takeover rights. Typically, the P-F/D agreement will provide that the
studio/distributor has the right to take over production of the motion
picture if the cost of producing the lm has exceeded a certain specied
percentage of the budget (for example, 10 percent) or if the production
has fallen behind schedule by a certain number of days. Alternatively,
the studio may require that the producer obtain a completion bond to
protect against the risk of the lms going over budget.
Form of lm nance sought. When approaching a major studio/dis-
tributor or other potential industry funding source, the producer should
have some idea which form of lm nance he or she is seeking and what
the basic advantages and disadvantages are for each. That will help to
make the producers discussions with the potential funding source more
meaningful and to the point. Thus, with a major studio/distributor, the
producer might be seeking a development deal, a P-F/D agreement, a
negative pickup or merely talking with the distribution division about a
possible future acquisition of an independently nanced lm. In many
instances, those choices help to determine which studio employees actu-
ally meet and talk with the producer.
Advantages
Big budget lms. A high-budget feature lm developed by an inde-
pendent producer outside the studio system may have to be produced
under a P-F/D arrangement, since the major studio/distributors are
generally the only entities in a position to accept or control the nancial
risks involved.
Expensive talent. Many of the high salaries demanded by agents on be-
half of their top director, actor and actress clients can only be underwrit-
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Studio Production-Financing/Distribution Agreements
201
ten by the major studio/distributors, who are generally in the best position
to make judgments about the nancial prospects for a given lm.
Producer advances. Producer advances are likely to be larger in the
P-F/D deal than in any other form of lm nance.
Distribution treatment. The studio-nanced motion picture is more
likely to receive favorable treatment in distribution than nonstudio
releases, not necessarily because the lms are better than other releases
but because the major studio/distributors have greater economic power
and leverage with the exhibitors.
Box ofce dominance. Releases from the major studio/distributor have
provided them and their subsidiaries or afliates with an average market
share of approximately 97 percent of box ofce gross in the domestic
theatrical marketplace in the last ten years or so.
Collections. The major studio/distributors also have greater leverage
with the exhibitors when it comes time to collect distributor rentals.
Thus, they are likely to be able to extract a higher percentage of the box
ofce gross from the exhibitors.
Disadvantages
Creative control. Studio/distributors that put up some or all of the
production money for a lm will usually exercise extensive control and
approval over the production process; thus, an independent producer
relying on the P-F/D method of lm nance may be giving up a signi-
cant amount of creative control.
Unconscionable agreements. P-F/D agreements are notoriously one-sid-
ed (in favor of the distributor). Thus, most producers or other net-prot
or net-proceed participants have little, if any, chance of participating
in the upside potential of a motion picture produced in this manner. It
may, in fact, be fair to characterize most of the major studio/distributor
distribution deals as unconscionable, or so-called contracts of adhesion
(see Film Finance and Distribution: A Dictionary of Terms), as one court
has held such agreements to be (see The Feature Film Distribution Deal),
but the studios havent bothered to make changes, because they dont
have to.
Settlement transactions. Notwithstanding the collections advantage
(see above) of the major studio/distributors, the settlement transactions
between the exhibitors and distributors clearly favor the studio-produced
lms as opposed to independently produced lms, even those distributed
by the majors. In other words, certain of the exhibitors and distributors
appear to be colluding to deprive the independent producers and all net-
Cones Ch26.indd 201 12/20/07 1:52:03 PM
202
and gross-prot participants of such independently produced lms from
their prot participations when distributing and exhibiting their lms.
The settlement transaction between exhibitors and distributors appears
to be one of the principal mechanisms used to further such collusion (see
The Feature Film Distribution Deal).
Broad commercial appeal. Small or low-budget lms are generally not
considered suitable for studio nancing using the P-F/D arrangement.
Projects generally accepted for studio nancing in this manner must at
least appear to the studio executives to have a fairly broad commercial
appeal; that is, appeal to the so-called lowest common denominator
audience throughout the world.
Higher interest rates. Interest rates charged by studios on P-F/D deals
are generally higher than the rates charged by banks and other nonstudio
lenders who provide production-money nancing for feature lms.
Longer interest paying period. Not only are the studio interest rates
higher than the rates charged on bank loans, the interest on a P-F/D
loan is incurred during a longer period of time than in a bank-nanced
negative pickup deal. That is because the studio-afliated distributor
generally rst deducts its distribution fee, then recoups its distribution
expenses, then deducts interest incurred to date, before ultimately re-
couping the negative cost of the picture, whereas the bank is paid upon
delivery of the lm.
Conf licts of interest. The inherent conf lict of interest involved in
packaging by entertainment attorneys or talent agents may result in a
less-than-desirable combination of lm elements that are presented to
the studio, sometimes on a take-it-or-leave-it basis. When this occurs,
the agent and the talent he or she represents may benet nancially, but
the studio, its stockholders, the moviegoing audiences and the rest of
the talent arbitrarily excluded from participation in the package may
be harmed.
Little chance of net prots. Prot participation auditors estimate that
major studio/distributor releases generate net prots (or net proceeds)
in only about 5 percent of the cases. Although this is merely an estimate,
no one outside the studios is in a better position to make such estimates
than prot participation auditors. On the other hand, these same auditors
also report that all the lms they audited owed more prot participations
than were reported by the distributor.
Less favorable terms for producers. As a general rule, the more nancial
risk a studio/distributor is asked to take in the production and distribu-
tion of a feature lm, the more likely it is that it will extract more favorable
terms for itself in the P-F/D agreement.
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Studio Production-Financing/Distribution Agreements
203
Overhead charges. The studio/distributor not only will deduct its dis-
tribution fee and expenses, interest and the negative cost from the gross
receipts but will also generally include a specied percentage (usually 10 to
15 percent) of the negative cost of the motion picture as an overhead charge,
which is added to the negative cost and thus incurs additional interest.
Copyright ownership. A major studio/distributor that provides all of the
production nancing along with the distribution expenses for a feature
lm will in all likelihood insist on owning the copyrights to the lm in ad-
dition to distributing the lm throughout the universe in perpetuity. Thus,
the picture becomes part of the studio/distributors library of lms, as op-
posed to being an addition to the library of the independent producer.
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204
27 Studio-Based Production Companies
Studio spokespersons report that all of the major studio/distributor or-
ganizations (Warner Bros., Disney, SONY [Columbia, Tri-Star and now
MGM], Universal, Paramount [now including DreamWorks] and 20th
Century Fox) have relationships with independent producers and their
production companies, which typically include the provision of ofces
on the studio lot. In turn, these producers agree to offer the studio a rst
look at whatever projects they are developing (the so-called rst-look
deal). Each of the more active studios named above reportedly has about
thirty to forty such relationships, which are also sometimes referred to
as housekeeping deals or overall deals. The actual numbers may change
from time to time.
Some industry-insider producers have been known to have a rst-look
deal at one studio, a next- or second-look deal at another studio and a
third-look deal at still another major studio. After all, the studio execu-
tives who are making the commitments quite often shufe back and forth
between the major studios during their careers, creating the impression
that the studio organizations really function as a single unit, particularly
when it comes to competing with outsiders.
The studio contribution in one of the rst-look deals may vary from a
single no-frills ofce to a more elaborate complex of ofces with secretar-
ies, readers, ofce equipment and development or acquisition nancing.
Presumably, producers are able to obtain these rst-look deals based on
their reputations as feature lm producers or on their relationships with
the studio executives who are authorized to make such commitments on
behalf of the studio. The associated development deals are sometimes
granted in conjunction with specic projects that have been pitched to
the studio and accepted as projects under development (see chapter 25),
but others are simply relationships with producers that the studio wants
to support.
To research which companies have studio deals, see the Hollywood
Creative Directory cited at Sources and Further Reading. This directory
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Studio-Based Production Companies
205
provides a list of thirteen hundred production companies, studios, TV/
cable networks; their addresses, phone and fax numbers, produced credits
and staff. In addition, it provides more than fty-one hundred indexed
and cross-referenced names of development and production personnel
and their titles along with the names of companies and talent who have
studio deals. The directory is published and updated every four months
(March, July and November).
Advantages
Relationships in place. Independent producers seeking studio nanc-
ing for their lm projects may nd that aligning themselves with other
producers already on a studio lot will substantially increase their chances
of getting their projects produced.
Using an intermediary. Working with someone on the inside who
can act as a go-between allows the independent producer to seek studio
nancing without placing so much emphasis on getting access to and
developing a relationship with a studio executive.
The indirect approach. It may be easier to get a lm produced by a
studio going through one of the already established rst-look deals than
going directly to the studio. The studio executive may, in fact, ultimately
refer the producer with an interesting project to one of the producers on
the lot.
Disadvantages
Fewer deals available. In recent years, when the major studios were un-
der pressure to lower costs, fewer housekeeping deals have been offered.
Nepotism, favoritism and cronyism. Unfortunately, many of these ar-
rangements for providing independent producers with an ofce on the
lot are awarded to family members or friends of family (see Hollywoods
Family Ways: Who Can You Trust Better than Kin? by Terry Pristin).
In other words, there is no merit system in Hollywood. It is not a level
playing eld. Anyone who thinks otherwise is simply uninformed.
Special relationships. Some producers have been known to place
themselves in an obvious conict-of-interest situation involving a loan
or other form of inducement to a studio executive who may be in a posi-
tion to grant an ofce-on-the-lot or production deal to that producer.
Thus, more ethical independent producers are at a clear disadvantage in
getting the desired studio relationship.
Odds still not favorable. If in fact each of the major studios has some
thirty to forty ofce-on-the-lot relationships with producers who are
obligated in turn to provide the studio with a rst look at the projects
Cones Ch27.indd 205 12/20/07 1:52:32 PM
206
the producers develop, and the studios only release fteen to twenty-four
lms a year (some of which have been produced completely outside the
studio system), the odds of getting a green light on a feature production
using this strategy are also discouraging.
The risk of inadvertent loss. The independent producer organizations
that have relationships with the studios are often not very organized or
well managed; thus, submitting a project to such a group can also result
in loss of the project in other ways (e.g., theft of ideas, wholesale lifting
of dialogue, confusion of ownership during the script re-writing merry-
go-round, etc.).
The development scam. Sometimes an independent producer submit-
ting a developed screenplay to a studio is told that the project needs to
be developed further. The studio producer on the lot then hires another
writer to continue to develop the project, creating a potential ownership
interest in the project that might be ultimately used to squeeze out the
original producer or writer.
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28 Independent Distributors
Independent distributors, by denition, are not regularly or substantially
afliated with a major studio/distributor. In the early 1990s, this group
included such distributors as New Line Cinema, Miramax, Samuel
Goldwyn, Concorde, Castle Hill, First Run, IFEX, Shapiro Glickenhaus,
Expanded Entertainment, Taurus Releasing, Fries Entertainment, Triton
Pictures and Greycat. Unfortunately, many of them have either been
purchased by one of the major studio/distributors or have gone out of
business. Those acquisitions resulted in an increase of box ofce market
share from 92 to 97 percent for the major studio/distributors, leaving an
even smaller portion of the domestic market for the true independents.
For that reason, most independent distributors tend to specialize in
foreign distribution (after all, the vast majority of the desirable theatre
screens in the United States are taken up by major studio products,
regardless of the quality of their lms). Many of the independent dis-
tributors are members of the Independent Film and Television Alliance
(formerly known as the American Film Marketing Association, or AFMA)
a trade association for the independent lm and television industry. The
IFTA, located in Los Angeles, can provide inquiring producers with a
current list of its member companies.
Some independent distributors do have production divisions, but
they do not have the nancial resources of the major studios and thus do
not develop and produce as many in-house lms as the majors, nor do
they offer many P-F/D deals. Thus, generally speaking, an independent
producer is less likely to submit an undeveloped motion picture concept
to an independent production company or distributor and obtain a
development deal, although some low-budget projects would be more
welcome at the independents shop than at the studios.
The independent production companies and distributors also have
smaller amounts of money to commit to P-F/D arrangements and quite
often require conancing deals. This, of course, means that the indepen-
dent producer must provide a signicant portion of the production money
Cones Ch28.indd 207 12/20/07 1:51:48 PM
208
nancing for a picture before the independent distributor will commit
to putting up the balance of the production money along with funds to
cover distribution expenses. Some of the independent distributors will
subcontract with a major studio/distributor for a pictures domestic
release on a rent-a-distributor basis.
Only a few of the independent distributors are considered creditworthy
enough in the eyes of entertainment lenders to support negative pickup
or presale production nancing arrangements (see chapters 20 and 21).
Most of the independent distributors are simply not capable of serving as
sources of production nancing and either acquire feature lm product
using a pure acquisition distribution agreement that then obligates them
to put up some or all of the money to cover distribution expenses or they
accept product on a rent-a-distributor basis, a distribution arrangement
requiring that the independent producer not only nance the production
of his or her lm independent of the distributor but also put up some or
all of the money to cover distribution expenses. In the rent-a-distributor
situation, the distributor, of course, provides its services for a lower dis-
tribution fee and does not recoup any distribution costs since it usually
does not incur any.
Advantages
Available for smaller lms. Independent distributors may nance or
participate in the nancing of a feature lm project that the major studios
are not or would not be interested in, since in the view of the majors the
lm does not lend itself to a large enough budget or does not appeal to a
broad cross section of the moviegoing audience.
More personal attention. Independent distributors can often provide
more specialized handling of independently produced feature lms, if for
no other reason than they have fewer lms during the course of a year to
divide their attention and resources.
Support for the lm. Independent distributors are more likely to work
closely with an independent producer in the release of a picture and to
place a lm in theatres that will allow a picture to nd its audience by
leaving it on the screen for a longer period of time.
Negotiating leverage. The negotiating leverage of an independent dis-
tributor is more closely aligned with that of an independent producer;
thus, the independent producer is more likely to be able to negotiate a
distribution agreement that is not unconscionable (i.e., heavily weighted
in favor of the distributor).
Chances of net prots. Independent producers might reasonably as-
sume that since the agreements negotiated with independent distribu-
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Independent Distributors
209
tors are more likely to be fair than distribution agreements with major
studio/distributors, the chances of a lm distributed by an independent
distributor achieving net prots may be greater than they would with a
major studio/distributor.
Disadvantages
Fewer screens available. Since the MPAA companies (i.e., the ma-
jor studio/distributors) routinely and regularly work with the NATO
members (National Association of Theatre Owners) to arbitrarily limit
the number of screens that are available for non-MPAA lms, theatrical
distribution by independent distributors is pretty much limited to the
so-called art house circuit.
Limited nancial resources. Independent distributors generally do not
have the nancial resources of a major studio/distributor and are thus
less likely to provide development deals, full production nancing on a
P-F/D basis or discountable distribution agreements or guarantees to
support negative pickups or presales.
Bankruptcies. Each year a number of independent distributors go out
of business, making it impossible for them to fulll their nancial obli-
gations to the independent producers of lms currently in distribution.
It is difcult for independent producers to make an informed judgment
about the nancial stability of independent distributors (but see Smaller
pool of revenues below).
Booking limitations. Independent distributors do not have as much
leverage with domestic exhibitors and are thus generally less able to book
lms in the better theatres.
Less collections clout. Independent distributors generally do not have
the collection capabilities of the major studio/distributors and are thus
not as able to gain favorable treatment from exhibitors in the settlement
transaction (see The Feature Film Distribution Deal).
Smaller pool of revenues. Collectively, lms distributed by independent
U.S.-based distributors in the domestic theatrical marketplace on average
only garner about 3 percent of the box ofce gross each year; thus, the pool
of distributor rentals for independently distributed lms is signicantly
smaller than it is for lms released by the majors.
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29 Domestic Studio Facilities
Often in discussions, books or articles relating to the lm industry, the
term studio is used to refer to the so-called major studio/distributor
organizations of afliated companies, most of which own a physical
studio facility, one or more lm production companies, one or more
distribution companies and in some cases even interests in theatre chains;
that is to say, they are vertically integrated. On the other hand, not all of
these so-called majors have always had the sound stages or studio lots
that technically make it possible to accurately refer to the organization
as a studio. Thus, the term studio can be a bit misleading at times. After
all, there are a number of pure studios situated around the country that
are not afliated with production companies, have no distribution sub-
sidiary and certainly own no interest in theatres. Those studios are the
organizations that own and provide (for lm production company use)
the physical locations and other facilities, including soundstages, sets,
prop departments, ofces, commissaries and the like for development,
preproduction, production and postproduction of feature lms, as well
as other lm or video productions.
Some of the local studios were created without the benet of a well
thought-out business plan. For example, most every state in the United
States has a film commissioneither at the state, regional or local
levels. Those lm commissions generally do not get involved in lm
nance other than possibly helping to sponsor an occasional seminar
or encouraging the publication of a directory that may include lm -
nance consultants, attorneys or other specialists who can provide useful
information. The primary mission of the lm commissions is generally
to bring lm production to the state or local community, particularly
productions that already have funding. Unfortunately for those lm
commissions, the number of lms that have nancing and are available
to be shot on location is limited, and thus the lm commission business
has become extremely competitive. As a result, lm commissioners have
had well-meaning discussions with local business people about what can
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Domestic Studio Facilities
211
be done in the state or community to attract more location shoots in their
jurisdiction, and inevitably some of these business people come up with
the bright idea of building a movie studio.
Regardless of whether the above-described scenario was instrumental
in bringing them about, domestic studio production facilities now exist
or are being created in California, North Carolina, Louisiana, Hawaii,
Florida, Texas, Tennessee and other states all around the country. Again,
unfortunately, there simply does not appear to be enough business for all
these studios to prosperthus, the development of the domestic studio
facility deal.
The domestic studio facility deal, much like the foreign facility deal
discussed in chapter 41, involves an offer by a local studio to provide
certain below-the-line goods and services for either below-market prices
or for an ownership interest in the lm or a prot participation in the
lms revenues. Such goods and services might include studio facili-
ties (i.e., soundstages, actor suites and production ofces), production
equipment, local casting, catering services, some local crew persons,
locations, below-cost housing arrangements, postproduction services
and so forth.
The local studio (in cooperation with the local lm commission) ul-
timately hopes to create a reputation for the local community as a good
place to shoot feature lms and thus eventually to create jobs and help
the local economy by bringing in production companies that will spend
money there. However, many feature lms can be shot in a variety of
locales; thus, enterprising independent producers (and the major studio/
distributors) merely keep shopping around for the best deal available on
below-the-line goods and services offered by the domestic studio facilities.
Thus, most of the local facilities never seem to become viable businesses
that can offer their facilities at more protable rates.
Advantages
Production cost savings. The producer is able to shoot a lm and spend
less money on below-the-line budget items.
Improve the studios reputation. The local studios hope that the produc-
tions brought in through facilities deals will create positive word of mouth
for them in the production community and that other productions will
follow (hopefully at regular rates).
Disadvantages
Savings versus quality. The pressure on producers to save money in the
production of lms may have detrimental effects on the quality of the
Cones Ch29.indd 211 12/20/07 1:52:20 PM
212
motion pictures; that is, the equipment, locations, facilities and the like
gained in the domestic studio deal may not be up to par.
Savings not offset. The savings gained in the domestic studio deal may
not offset the cost of transporting and housing the cast and crew that are
brought in from other locations such as Los Angeles.
Self-destruction. Producers always trying to get the best deal may be
shooting themselves in the foot, since if the studios offering such deals
cannot prosper, they will eventually go out of business.
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30 FilmLaboratories
In the rush to compete for lm-processing business, some of the smaller
lm labs have come up with creative ways to bring in new accounts. As
an example, the following may be offered by such a lab:
the lab agrees to provide goods and services valued up to a specied
amount on a deferred or prot participation basis;
the lab will receive a deferred payment or a percentage participation at a
dened stage of the lms revenue stream;
the labs net percentage participation will depend on the value of the
goods and services provided;
the proceeds from sales or distribution will be used to rst pay back the
labs investment (the deferred amount) before that of the other investors
and producers (i.e., the lab has to be in a rst positionrelative to other
investorsto recoup the value of its goods and services);
after all expenses of production and all investments have been paid,
the remaining distributor gross receipts will be considered net prof-
its and divided as received in accordance with the various applicable
agreements;
the lab must be in a para-passu (equal and concurrent) percentage par-
ticipation position with respect to all cash investors;
the producer agrees to use the distribution services of a feature lm
distribution company that is afliated with the lab;
the distributor will have approval rights over the lms nal budget and
script.
The labs goods and services may include negative raw stock, nega-
tive developing, dailies, sound transfers, editorial cutting rooms, lm
projection, lm coding, opticals, titles, sound editorial, negative cut-
ting, ADR and Foley, sound re-recording, optical transfers, color dupe,
inter-positive, inter-negative, rst trial answer print, release prints and
lm-to-video transfer.
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214
Some labs also offer certain lm completion services through an af-
liated company, and if the producer can demonstrate good credit, the
lab may be able to arrange a camera, sound, lighting and grip package
together with electronic editing on a deferred nancing basis.
Knowing that some labs offer such deals, producers looking to nance
the production of a feature lm may want to make inquiries of a number
of labs to determine whether they offer similar arrangements. It should
not be difcult for a lm lab to establish relationships with lm produc-
tion equipment houses and independent distributors, although the terms
of such package deals may vary widely.
Advantages
Lower production costs. Obtaining lab goods and services on a deferred
or prot participation basis lowers the producers (or investors) out-of-
pocket production and postproduction costs.
One-stop shopping. Depending on the particular lab, a number of re-
lated services may be arranged for all at once; for example, lab services,
production equipment rental and distribution.
Disadvantages
Likelihood of net prots. If the producer is locked into a commitment
to use the labs afliated distributor and that distributor is ineffective in
functioning as the lms collecting and disbursing agent, the producer
and any other investors are not likely to see any net prots.
Quality of lab work. A lab that is offering its services on a deferred ba-
sis might suggest that there is some question about its ability to provide
quality results.
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31 Talent Agencies
Talent agencies have traditionally limited their activities to nding em-
ployment for actors, directors, writers and sometimes producers. How-
ever, some of the more powerful agencies in recent decades have begun
to realize that they could substantially increase their fees by attaching
two or more of their own clients to the same lm project (packaging)
and at the same time increase the chances of the lms being made since
a studio might be reluctant to pass on an attractive package offered by
such an agency. It was only a matter of time, then, that these same ag-
gressive talent agencies realized that they could take their involvement
in lm packaging to still another level by also assisting in arranging for
some or all of the production nancing of their packaged lm projects,
independent of, or in conjunction with, a major studio/distributor.
To accomplish this end, some of the talent agencies brought in or de-
veloped in-house expertise in lm nance. Another agency might develop
an exclusive arrangement with a production company acting primarily
as a funding source for an entire slate of lms to be cast with agency tal-
ent. Such arrangements appear to keep the agencies from crossing the
line into production, and thus avoiding conict with the Screen Actors
Guild guidelines.
Although talent agencies are not truly a stand-alone form of lm -
nance, it is important for independent producers to recognize that some
of them can help assemble nancing for a package involving a number of
their clients. The talent agencies do not put up their own money to nance
the production costs of feature lms; instead they become involved in
putting together nancing arrangements that go beyond the traditional
studio sources, such as equity nancing, below-the-line facilities deals,
international coproductions, foreign government subsidies, presales and
so forth.
As recently as 2005, the Gersh agency launched a New York-based lm
nance boutique called Independent Feature Packaging. A former senior
vice president for acquisitions at Miramax Films was brought in to run
Cones Ch31.indd 215 12/20/07 1:51:41 PM
216
the new department. Before that, in late 2004, ICM hired lm nancier
Hal Sadoff to head its international and independent lm department.
Advantages
One-stop shopping. It is now possible for the producer of a lm project
to approach a top talent agency (assuming the project might be of interest
to the agency), not only to get help attaching one actor to the lm but
possibly a director and several actors, while also arranging for production
nancing and distribution through the agencys industry relationships.
More money for the agency. Combining talent and nancing signi-
cantly increases the agencys opportunities to be compensated. Not only
can the agency extract its usual 10 percent commission for each of its
clients in the package under such circumstances, but it may also be able
to build in an executive producing fee for the agency.
Disadvantages
Multiple conicts of interest. Not only is there a built-in conict of inter-
est in a situation where an agency tries to attach two of its clients to the
same project, but such conicts multiply when the agency attaches even
more clients and also helps to arrange the lms nancing. The agencys
interests tend to prevail in such situations, and the interests of others
(nancial or creative), including actors, writers, producers and in some
cases nanciers, are subordinated.
Producer conict. Talent agency involvement in packaging and lm
nance means the agents have moved into an activity traditionally un-
dertaken by producers.
Quality not assured. Neither agency packaging of talent nor assistance
in arranging for production nancing can assure that the best casting for
the picture has occurred because agency packages draw from a smaller
pool of talent (i.e., the agencys own clients).
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32 Actor Financing
Actor nancing of a feature lm means just that: the production costs
are nanced in whole or in part by an actor. Mel Gibsons The Passion
of the Christ is an example (see Sean Smiths article Put Your Money
Where Your Movie Is). However, such instances are rare, particularly
for a big-budget movie. Very few actors have the resources to nance the
production costs of a major lm or the commitment to the project that it
would take. It may be fair to say that such an arrangement is more likely
for lower budget lms. An ensemble group of actors and actresses have
been known to both contribute production funds and raise additional
nancing from investors.
Feature lms at all levels continue to be risky ventures. Even the ma-
jor studio/distributors, a collective of people who presumably have the
greatest expertise in selecting commercial lm projects, turn out to be
wrong most of the time. In any case, actors come forward from time to
time to put up some or all of the money needed to produce a particular
lm that they have a personal interest in, either for the chance to direct
or to appear in a desirable role or out of enthusiasm for the lms un-
derlying message.
Actor Deferments
A more common form of actor nancing for an independently produced
lm is the deferment of some or all of the actors salary for appearing in
it. Sometimes an actor may be able to ask for a larger sum if the salary is
deferred, meaning a specied amount is paid out at a particular stage in the
lms revenue stream as opposed to out of the lms production budget.
Agreeing to a salary deferment may be triggered by an actors desire to
appear in a new kind of role that might lead to other challenging roles or by
a great script or a particularly interesting cast. Perhaps the actors career has
peaked and in order to get certain roles, he or she may be forced to agree
to a salary deferment at some level. A good casting director may provide
Cones Ch32.indd 217 12/20/07 1:54:43 PM
218
the producer with information about an actors needs that will help that
producer arrive at a mutually satisfactory deferral arrangement.
Percentage Participation
Another form of actor compensation that may aid in meeting the nancial
needs for getting a lm produced, and that therefore may be considered
a form of actor nancing, is the continuing percentage participation in a
dened stage of the lms revenue stream (i.e., contingent compensation).
Ben Afeck was reportedly granted some form of percentage participa-
tion in Pearl Harbor, and it apparently worked out well for him (see Tom
Kings article A Big Payday for Pearl Harbor Players: No Salary Upfront
Results in Multimillions Later).
Note, however, that for these purposes, a major studio and afliated
distributor may be able to contract with an actor to pay a percentage of
the distributors gross receipts (a rare occurrence), or a percentage of some
specially dened level of distributor receipts between gross receipts and
net prots (e.g., adjusted gross), but they are not really in a position to
commit to pay an actor a percentage of the lms box ofce gross. That
is because the distributor has to negotiate with theatre chains for its own
participation in box ofce gross, and there is no evidence that exhibitors
and distributors feel such pressure from actors and their agent represen-
tatives that they nd it necessary to give away a percentage of box ofce
gross. Thus, notwithstanding the occasional report in the trades that
some actor was granted a percentage participation in a lms box ofce
gross, it is more likely that the journalist was confused and the actor was
really granted a percentage participation in some specially dened level
of distributor receipts, not even true distributor gross receipts.
Furthermore, without an assumption agreement (in which the dis-
tributor agrees to pay percentage participations) with the distributor, an
independent producer seeking to partially meet his or her lm produc-
tion costs by granting actors a percentage participation can only do so
at that stage in the lms revenue stream that he or she controls. In other
words, an independent producer is not in a position to grant an actor a
percentage participation in box ofce gross, distributors gross or even
an adjusted distributor gross. An independent producer will not control
the lms revenue stream at any of those stages.
It is not even sensible for an independent producer producing an
investor-nanced lm to talk to an actor in terms of points since this
technical term really refers to a percentage of net prots or net proceeds,
another stage in the lms revenue stream not wholly controlled by the
independent producer. Again, the independent producer is very likely to
Cones Ch32.indd 218 12/20/07 1:54:43 PM
Actor Financing
219
have to negotiate with the lms distributor for a percentage of the lms
net prots. Thus, for example, if the distribution deal allows the pro-
duction company to receive 50 percent of the lms net prots, 10 points
(i.e., 10 percent of the lms net prots) would actually equal 20 percent
of the production companys share of gross revenues, and assuming the
production entity is authorized to make certain deductions from its gross
revenues, prior to sharing with other prot participants (i.e., investors),
the actual actor percentage participation in the producers share would
even be greater.
If, for example, the independent lm was nanced with monies raised
through an investor-nanced LLC, it would make more sense to promise
an actor a percentage participation in the managers share of the LLCs
net revenues (sometimes called distributable cash). In this instance, the
LLC manager is the equivalent of the producer or producer group (as
opposed to the investor group), and the producer-manager has control
over the producers share of the lms revenue stream.
Alternatively, the independent producer might negotiate an assump-
tion agreement with the distributor, who would then assume responsibil-
ity for directly paying all net prot participation commitments on behalf
of the producer. If that were the case, offering points or a net prot
participation to talent would make sense.
On the other hand, if the producer were to commit to pay an actor
a percentage participation in the LLCs (or other investment vehicles)
gross revenues (i.e., that portion of the lms net prots or net proceeds
that are paid to the production entity pursuant to the negotiated contract
with the lms distributor), such an arrangement would interfere with
the investor groups ability to recoup and therefore might make it more
difcult to raise the money from investors in the rst place.
Advantages
Another source of funds. True actor nancing at any level reduces the
amount of production funds that have to be raised from other sources.
Lower production cost. Granting actor deferments or percentage partici-
pations in lieu of larger actor salaries to be paid out of the lms budget
lowers the amount of hard dollars needed to produce the lm.
Disadvantages
Creative control. True actor nancing tends to shift a certain amount
of creative control to the nancing actor.
Delayed revenues. Deferral arrangements could also reduce or delay
the amount of lm revenues that ow to the producer.
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220
Risk for all. Percentage participations create additional risk for all
parties, in the sense that an actor may ultimately be compensated more
or less than if paid a stated salary out of the lms budget, depending on
the commercial results of the lms distribution.
Union rules. The voluminous and complex rules of the Screen Actors
Guild may apply to such transactions; thus, producers must investigate
applicable provisions. No attempt is made here to comment on or provide
information relating to union rules.
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221
33 Product Placements
Product placement refers to the practice of arranging to include a portrayal
of a commercial product or logo in a motion picture in exchange for some
form of compensation. The product manufacturer pays the production
company to include its product in the lm. The objective of the product
manufacturer is to manipulate unsuspecting viewers to buy a product
because they associate it with their favorite lm stars or with the glamour
of the movies. The objective of the producer is to help reduce the burden
of production costs for expensive lm projects.
Product placement is little more than a long-standing marketing tactic
applied to movies that may provide some nancial assistance in getting
the motion picture produced. When a product manufacturer places a
recognizable product into a lm, many people in the audience will tend
to look on it favorably, and some will even choose to buy the product.
It has been successfully demonstrated repeatedly that movies inuence
the thinking and behavior of some individuals. Product placement is a
commercial of sorts, without the obvious hard sell of a commercial. In
many cases, it is an implied endorsement by a celebrity, and advertisers
believe such endorsements are valuable.
Sometimes a commercial product is so integrated (product integra-
tion) with a movie that the product supplier becomes a creative partner
in the making of the lm. That apparently happened with the Warner
Bros. movie Youve Got Mail. In that case, AOL executives reportedly
reviewed the script and made suggested changes. The seamless blending
of product and story is, of course, the whole point of product placements.
By subtly weaving a product into a scene, marketers hope audiences will
connect their brand with the glamorous stars or story they are seeing
on the screen.
The practice of product placement has apparently been going on for
many years. Ford Motor Company reportedly paid lmmakers to use
the Model T and Model A in lms made during the silent era. In the
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222
1940s, the advertising agency for diamond giant De Beers arranged for
glamorous lm stars to be draped in its gems on screen. In the early 1950s,
Gordons Gin paid to have Katharine Hepburns character in The Afri-
can Queen toss loads of their product overboard. Also, in the 1950s, Ace
comb sales soared after James Dean used one to comb his hair in Rebel
without a Cause, and Coca-Cola permitted Mickey Rooneys character to
y a small plane into a Coke billboard in the 1963 lm Its a Mad, Mad,
Mad, Mad World.
But the practice of product placement did not really take off until the
early 1980s, with the placement of Reeses Pieces in ET: The Extra-Ter-
restrial. The 1989 movie The Wizard featured kids playing Double Dragon
and Super Mario Brothers 3 on the Nintendo Entertainment System.
Pepsi got a billboard in Final Fantasy. The Jamaican beer Red Stripe was
featured in The Firm. The DeLorean automobile played a prominent role
in the Back to the Future movies. The Shell logo on the handle of the gas
nozzle was prominently displayed in Roman Polanskis The Ninth Gate.
Ray-Ban sunglasses were sported by the stars of Men in Black. Forrest
Gump drank Dr Pepper. James Bond introduced us to the BMW Z3 Road-
ster in Goldeneye, Austin Powers had a Mini Cooper in Goldmember and
Spiderman almost got trampled by a Terminix truck. In The Sixth Sense,
Bruce Williss character opened the medicine cabinet to look for clues to
his wifes state of mind and considered a bottle of Pzers antidepressant
Zoloft. Then, there was that picture-in-a-picture moment in Analyze
This when Robert De Niros angst-ridden mobster character watched a
television commercial for Merrill Lynch investments, right along with
the movies audience.
In addition, the Hollywood-based major studio/distributors conspired
for years with the manufacturers of tobacco products to sell cigarettes to
teenagers, although that is no longer legal.
Product placement has now grown into a multimillion-dollar busi-
ness. Hundreds of brand-name products, including clothing, jewelry,
cars, airlines, liquor, breakfast cereals and cigarettes have been placed in
motion pictures. Now there are several product placement companies
that specialize in arranging for products to be placed in movies, includ-
ing divisions of some of the major advertising agencies. Also, some of
the larger corporations dedicate personnel to scout out opportunities
for product integration or placement in lms, television shows and even
games and music.
The product placement deals tend to take two forms:
showing the product being used in the lm in exchange for a supply of
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Product Placements
223
the product for use by cast and crew (apparently the most common type
of deal) and
direct nancial compensation for the product placement.
Payments for product placement will vary depending on how promi-
nently the product is displayed in the movie, how much time (or how
many times) it is shown, which star the product is associated with,
whether the product is portrayed in a negative or positive manner and
whether the lm is receiving a major release. Of course, there may well
be multiple conicts of interest between the producer and the director
with respect to how prominently a product should be displayed, how
often, how long and so forth. But it has come to be a regular feature of
the lm business.
Product manufacturers have reportedly paid $70,000 or more for a
straightforward placement in a motion picture, but many of the deals
are more complicated and bring in even more money. In some instances,
product placement alone is not enough; it is just part of a larger marketing
tie-in in which a product manufacturer makes a deal with the motion
picture production company to create an ad campaign, a sweepstakes
or some other promotion that complements the studios own marketing
efforts for the lm. The idea is not just to get a product into a lm but to
create a partnership between them and take the promotion beyond the
lm out to the people. These arrangements are often referred to as stra-
tegic alliances, and apparently some lms could not be made without
them. On the other hand, these are not necessarily forms of lm nance
so much as enhancements of the distributors marketing campaign.
Examples of these overall marketing campaigns that included product
placement are the Heineken beer appearances in Austin Powers: The Spy
Who Shagged Me that went along with the promotions in bars, malls
and liquor stores where audiences shopped. Also, Burger King report-
edly spent $15 million on Men in Black II as part of a deal not only to
have their products featured on the screen but for the entire promotional
campaign. It is worth noting also that these were major studio releases,
not independent lms.
Before advertisers will pay for product placements, they need assur-
ances that a lm is going to appeal to a specic target audience, that the
lm will be widely distributed and that it will be well attended. For that
reason, very few independent productions can signicantly benet from
product placements, certainly not the low-budget indie lms. Thus, nei-
ther product placement nor product integration is a signicant source
for lm nancing for most independent feature lms.
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224
Advantages
More realistic. Having actual brands in a movie makes the movie
more realistic (i.e., most people dont drink brand X, they drink Pepsi
or Coca-Cola).
Quick cash. Some claim that product placements are an easy way
to make some quick cash before the movie is even nished, much less
released.
Preferred advertising. Advertisers love it because it is a way to get a great
plug in without the stigma of an actual commercial.
Disadvantages
Not a signicant form of lm nance. Showing a product in a lm in
exchange for the use of the product is not a signicant form of lm -
nance, but it may reduce the cost of the lm if the product is something
needed to produce the lm, and it might help raise a small amount of
production funds.
Timing of payment. If there is no contractual commitment (and some-
times even if there is), placing a product in a lm may not result in a cash
payment until the lm is completed, since the product manufacturer will
want to be reassured by seeing the actual placement in the movie.
Production idealization and distraction. In the real world, products are
not made to stand out as glowingly and deliciously as they are in mov-
ies. Thus, the way movies often idealize a product can be a distraction
to the audience.
Creative issues. Often, lm directors dont like product placements
because it interferes with their effort to make the lm they envisioned.
Moviegoer manipulation. Many movie patrons recognize a product
placement when they see one, and they resent being manipulated in that
manner.
Violation of audience trust. Product placement violates the audiences
trust in the lmmakers and involves a loss of integrity.
Danger to public. Some products (such as tobacco) are so dangerous to
the public welfare that when repeatedly shown being used in a movie by
movie stars, the lm and its producer may be seen as condoning behavior
that is dangerous to the general public.
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225
34 End Users
Presales could conceivably be considered a form of end-user nancing.
However, end-user nancing is more generally associated with a cash
investment by the end user put up in exchange for an equity percentage
participation in the lms revenues in specied territories and media. In
a presale, the end user is not actually putting up any money to be used in
producing the movie but instead is putting up a guarantee to pay a speci-
ed sum of money upon delivery of the lm, and the actual production
money comes from a lender.
Entities that exploit lms in the ancillary markets, for example, video
or cable companies, may prove useful sources of end-user nancing. An-
cillary markets are those geographical or technological areas of demand
for lm product that are auxiliary or supplemental to the theatrical
market. The ancillary markets include foreign, network and syndicated
television, pay cable and home video (including DVD).
Foreign entities, such as television networks, entertainment consor-
tiums, communication conglomerates or theatrical and home video
distributors, who purchase rights to exploit U.S.-made lms in their own
markets provide another possible source for end-user nancing. Some
of those entities are capable of nancing a domestic lm production or
distribution company and may do so in exchange for product ow in their
base territory and some level of participation in worldwide revenues (or
the revenues of specic territories or dividends of the company).
Advantages
In best position. End users in the marketplace, whether foreign or do-
mestic, theatrical, video or cable, are the business entities best positioned
to make money from a movie, since, at the very least, they exercise the most
control over that portion of its revenue stream generated in their home
territory. Therefore, they should be more willing than most to contribute
toward nancing the production costs of a given lm. It then becomes a
Cones Ch34.indd 225 12/20/07 1:55:00 PM
226
question of identifying (1) the end users, (2) how much they should have
to pay for specied rights and (3) what form the investment takes.
Knowing the audience. With end-user nancing, the producers nanc-
ing partner is an industry entity that has expertise at the retail level; that
is, its representatives are on the front lines when it comes to making judg-
ments about the tastes of the moviegoing public. Thus, it may be safe to
assume that such a nancing partner will not invest money in projects
that it does not believe have commercial appeal in its market.
Disadvantages
Piecemeal nancing. This form of nancing typically is piecemeal in
nature; it generally will require obtaining commitments from many end
users (or some end users plus other nancing sources) to cover the costs
associated with producing the picture.
For producers with a track record. Generally speaking, only producers
with proven track records, who have successfully brought recognizable
or commercially successful lms in on time and under budget, are likely
to be able to attract foreign or domestic end-user nancing.
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227
35 Completion Funds
Feature lm completion funds crop up from time to time. Examples
include Cinema America, a $15 million lm-and-video nancing entity
based in Houston and the New York Completion Fund based in Cold
Spring, New York. Film Dallas also functioned as a completion fund for
some of the lms in which it invested in the late 1980s. More recently, the
Catchlight Films, LLC (based in Marina del Rey, California), raised ap-
proximately $1 million for the purpose of helping to complete lms stuck
in the lab. The money that made up this fund was raised from a group
of passive investors, using the manager-managed LLC as the investment
vehicle. Completion funds are designed to provide partial production or
postproduction nancing. Such funds may be provided for lms that
have almost completed principal photography;
are complete except for postproduction;
are complete through postproduction but cannot be taken out of the
lab because lab fees have not been paid; or
need additional funds to pay for that extensive list of distributor deliv-
ery items.
The completion fund managers understandably assert that it is easier
to make judgments regarding the prospects of a lm when it is nearly
complete than at the script stage. Thus, they feel it is safer to invest in
nearly completed lms as opposed to investing earlier. An additional
part of the completion fund strategy is to spread the risk; that is, such
funds seldom put up all of the money required to produce a lm, so they
share the downside risk with other investors or nanciers. Furthermore,
these providers of the nal dollars are usually successful in negotiating
a higher percentage interest per dollar of investment in the lm than
earlier investors because without the last money in, the early money has
no chance of recouping.
It is even possible for independent producers to use investor nancing to
raise money from a group of passive investors to start a small completion
Cones Ch35.indd 227 12/20/07 1:53:23 PM
228
fund of their own. Completion funds tend to get a lot of attention once
they are formed and announced to the lm community. They often have
their choice of many projects in which to participate.
Besides recouping their investment, the managers of completion
funds typically look for a return on their investment of from 30 percent
to 50 percent. On the other hand, the nancing of independent lm
is so risky, it may be unreasonable to expect any participant to accept
a ceiling on their participation. In other words, once a certain return
has been reached, it may be reasonable to reduce the completion funds
participation, but not to eliminate it entirely. That, at least, gives them
an opportunity to continue their participation in the event the lm is a
home run.
Another related type of fund, not otherwise covered in this book, is
the so-called P&A fund. For example, private interests and the State of
Florida created the Florida Film and Television Investment Trust Fund,
which is supposed to have the authority to invest up to $3 million for
prints and advertising on any completed lm that spends 40 percent or
more of its production budget in Florida.
Specic Finishing or Completion Funds
Women in Film nishing fund. The Women in Film Foundation has a
completion fund called the Film Finishing Fund (FFF). It annually offers
grants to assist lmmakers who have completed principal photography
and whose projects will be in postproduction by a specied date (student
projects are not eligible). Producers do not have to be a Women in Film
member to apply for a grant from the fund. The application is available
on-line at the Women in Film homepage. The application provides infor-
mation regarding eligibility requirements and procedures.
Global Film Initiative. The Global Film Initiative has been offering grant
awards since 2003. The privately-funded grant program was inspired by
the Hubert Bals Fund founded by the Rotterdam Film Fest. About 3 lms
per year are selected for grants from about 35 submissions from twenty
or so countries. In addition to nishing-funds grants, the initiative also
acquires several nished lms from developing countries for showing in
the United States through its distribution and education programs.
Next Wave Films. Attorney, writer and independent producer Peter
Broderick, along with a loose-knit group of directors, producers and
lm-industry professionals, using seed money from the Independent
Film Channel, started a completion fund called Next Wave Films in
the late 1990s. As a group, they sought out exceptional ultra-low-budget
feature lms and offered nishing funds. Next Wave would supply up
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Completion Funds
229
to $100,000 each to as many as four lms a year. The group also served
as a producers representative for those features, helping the lmmakers
implement a festival strategy, secure distribution and nd nancing for
subsequent features. To be eligible for nancial support, the lms had to
have budgets of $200,000 or less and the principal photography must have
been completed. Next Wave funding would pay for things like sound and
scoring, editing and a negative cutpostproduction elements that can
frequently cost twice as much as principal photography. But in addition,
Next Wave sought to offer technical advice, industry contacts and other
kinds of intangible assistance. Unfortunately, the fund did not last. It
closed its doors sometime in 2004.
Catchlight Films. Independent producers Trey Wilkins and Jeanette
Volturno (based in Marina del Rey, California) started a completion fund
in 2001 by using a manager-managed LLC as the investment vehicle and
raising approximately $1 million from a large group of passive investors
for the purpose of identifying worthy low-budget lms stuck in lm labs
because the producer could not pay the lab fees. The strategy called for
the investment of limited amounts of funds to help complete such lms
and get them ready for distribution. The fund had some modest success,
but later abandoned the completion fund idea and started investing pro-
duction funds for lms at an earlier stage.
When researching on the Internet, producers may want to look for the
phrases lm nishing fund and movie completion fund.
Advantages
Financing source of last resort. Producers generally approach lm com-
pletion funds because they have run out of money on a lm project that
is nearly complete. Thus, the producer is in a bind, and the completion
fund may represent the only possibility for salvaging the lm project.
Investment versus loan. Many completion funds will invest in lm
projects and thus share in the risk, as opposed to merely lending money,
in which case there is an obligation for the producer to repay such loans
at a specic time.
Disadvantages
Weak bargaining position. Precisely because the producer is having
problems, the completion fund entity is generally in a stronger bargaining
position and thus can extract more favorable terms from the producer
than earlier investors. This means that the producer and possibly the
earlier investors or nanciers may have to reduce their nancial interests
in the backside of the picture relative to the completion fund.
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230
Limited funds. Generally speaking, completion funds will not invest
large amounts of money per lm.
Nothing lasts forever. Many, if not most, of the lm completion funds
that have been created from time to time have faded away after a while.
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PART FIVE
International Finance Options
Many of the so-called foreign or international nance options discussed
in this part of the book were created by local lm industries in various
countries for the purpose of countering the spending power and business
practices of the Hollywood major studio/distributors. These countries
sought to protect their local cinema and culture from Americanization
(see Europes Tortuous Financial Deals; Why Hollywood Rules the
World, and Whether We Should Care; 337 Reported Business Practices
of the Major Studio/Distributors; and Hollywood Wars: How Insiders
Gained and Maintain Illegitimate Control over the Film Industry). On
the other hand, in many instances, some of these same devices have
been used by U.S.-based producers (usually by coproducing with a local
producer) to aid in nancing the production costs of what started out
as an American lm.
It would be unreasonable to expect the information in a book like this
to remain current during the many years it remains on bookshelves in
the face of changing policies, phone numbers, and websites of the coun-
tries that may offer some form of subsidy or tax incentive to lmmakers
(even so, some of the websites are listed in Sources and Further Read-
ing). Instead, this section of the book offers a sampling of these foreign
programs so that lmmakers can decide whether they would want such
a program to be part of their lm-nancing strategy for a particular lm
project. Of course, lmmakers should always seek out the most current
information, which may be obtained through contacting an attorney or
accountant who has expertise in this area; or by doing an online search
using the name of the particular country and such terms as lm fund, lm
tax incentive, lm subsidy, international lm coproduction and so on; or by
contacting the lm commission in the country of interest and inquiring
about the countrys lm subsidy and tax incentive programs, if any.
233
36 Foreign Equity
Foreign-equity financing is funding provided by foreign (non-U.S.)
sources in exchange for an ownership interest or prot participation in
the lms nanced or in the entity producing them. In addition to requir-
ing an equity participation in the lms receipts, foreign equity investors
typically demand that certain territories be reserved for them so they can
further benet from exploiting the lms.
Foreign-equity nancing could also involve raising money by offering
equity ownership interests in a production or coproduction entity, such as
shares of common or preferred stock for a corporate production company,
interests in a limited partnership or units in a manager-managed LLC.
Equity nancing of a feature lm outside the U.S. major studios enables
the producer to nance the lm unhampered by the creative intervention
of studio executives and other pitfalls associated with studio nancing.
The German Wave
In the late 1990s, some German lm companies were actively involved in
equity nancing. They started going beyond purchasing German rights
and began purchasing pan-European rights. Others made substantial
equity investments in lms or provided 100 percent of the budget for
some lms. Some of these German companies set up their own foreign
sales divisions for the purpose of selling the non-German rights they had
acquired, while others invested in or acquired distribution companies in
other countries. These developments occurred at about the same time
that the much-publicized insurance-backed nancing schemes started
to fail (see chapter 23). The Germans zeal for the equity nancing of
foreign lm projects has also subsequently subsided.
The British Cinema Fund
Another source for foreign equity nancing has been the United Kingdom.
The UK Film Council is a government-backed strategic agency for lm
whose main aims are to stimulate a competitive, successful and vibrant UK
234
lm industry and culture and to promote the widest possible enjoyment
and understanding of cinema throughout all regions of the nation.
The UK Film Council offers a limited amount of production funding
through its New Cinema Fund, and independent producers from other
countries may have access to these funds by collaborating with UK-based
coproducers. The annual budget for the New Cinema Fund is quite lim-
ited, however, and it is divided among various projects.
In order for producers who are not UK-based to apply for funding,
they will need to insure that a UK-based coproducer is attached to
the project. If based in another state of the European Union (EU) or
European Economic Area (EEA), the producer can apply in his or her
own name and subsequently attach a UK coproducer. If the producer
is not based in the EU or EEA the application can only be made by the
attached UK coproducer. In both instances the UK Film Council will
make its offer of funding direct to the UK coproducer and may require
the non-UK-based producer to sign the Production Finance Agreement.
Potential UK coproducers may be found in the Directory of UK Co-
producers, made available through the UK Film Council website under
Publications.
The New Cinema Funds promotional literature states that it hopes to
encourage unique ideas, innovative approaches and new voices. The fund
also intends to nance lms with passion and verve that connect with a
broad range of audiences. It supports feature lm production, the making
of pilots to illustrate a projects potential for feature lm production and
short lmmaking through its various shorts schemes.
The following information describes the current UK Film Councils
feature lm production funding program, but the information may only
be current for a limited time, since all such programs often change from
time to time. Thus, other than reviewing this material for purposes of
gaining a general understanding of the way a British lm funding scheme
works, it should not be relied upon as the sole source of information.
Instead, a lmmaker should contact the UK Film Council or its subse-
quent counterpart and obtain the most current version of their equity
funding rules.
In its promotional materials, the UK Film Council indicates that
its New Cinema Fund supports creativity, innovation, new talent and
cutting edge lmmaking. It has an especially strong commitment to
support work from black, Asian and other ethnic minorities. With 15
million British pounds to invest over three years, the New Cinema Fund
claims it is committed to innovative and original material from a diverse
Foreign Equity
235
range of lmmakers. The fund has also embraced new digital production
techniques and formats.
Application requirements. A lm production entity or lmmaker can
apply if it, he or she is
a company registered and centrally managed in the United Kingdom; or
a company registered and centrally managed in another state of the
European Union or European Economic Area; or
an individual aged 18 years and over and a national or resident of the
United Kingdom (or another state of the European Union or European
Economic Area). In this case, if the application is successful, the lm-
maker will be required to form a limited liability company before any
offer of funding is made.
In addition, the project must be intended for theatrical release and be
in the form of a screenplay. In the case of a documentary feature lm,
a detailed treatment will be accepted. If applying for postproduction or
completion support, a DVD or VHS of a rough cut or assembly will be
required. Also, as a general rule, the lm must be intended for production
in the English language (although exceptions may be made under some
circumstances); and the lm must be capable of obtaining theatrical
and video release certicates no more restrictive than BBFC 18 in the
United Kingdom and MPAA R in North America. The lm must be
wholly or substantially capable of qualifying as a British lm. In other
words, the project should be capable of qualifying for certication by the
British Department for Culture, Media and Sport (DCMS). Coproduc-
tions made under the terms of one of the United Kingdoms bilateral
lm coproduction agreements, or under the European Convention on
Cinematographic Coproduction may be considered as British for these
purposes and therefore eligible for UK Film Council funding.
Britainss New Cinema Fund has a stated preference for lm projects
that demonstrate one or more of the following:
diversity, innovation, new and cutting edge lmmaking talent;
a strong commitment to supporting work from across the United
Kingdom and from black, Asian and other minority ethnic groups; and
utilization of the benets offered by digital technology in the making
and showing of lms.
It should also be able to show that:
the project has secured, or is in the advanced stages of securing, the
services of a director and the principal cast for the lm; and
236
the project has secured, or in the opinion of the New Cinema Fund has
the potential to secure, a UK theatrical release or a high-prole digital
release with a distributor or web broadcaster acceptable to the New
Cinema Fund.
The lmmaker must demonstrate a convincing vision for the project
in terms of creative direction, financing structure, distribution and
marketing. The lmmaker will also need to demonstrate an ability to
be instrumental in the realization of such a vision. Projects that cannot
demonstrate the above are unlikely to obtain funding from the New
Cinema Fund.
Level of funding. The level of funding offered varies depending on the
type of production involved.
1. Feature lms may receive between 15 and 50 percent of the pro-
duction budget. Funding will usually be provided by way of an equity
investment in the lm.
2. Pilots are sometimes supported at the discretion of the New Cinema
Fund in order to assess further the potential of a project for production
or development funding by the UK Film Council. The lm council will
fund customary direct production costs (excluding above-the-line costs)
of up to 10,000 for a pilot lm. Pilot lm funding will usually take the
form of equity investment repayable to the UK Film Council upon com-
mencement of principal photography of a feature lm based upon, or
connected to, the pilot lm.
3. Postproduction and completion fund applications will be accepted
for feature lm projects that have begun the production process but are
not yet complete. Producers can apply at any stage of the production or
postproduction process; however, applications for print and advertising
costs only are not eligible. The New Cinema Fund application forms
should be completed and accompanied by a VHS or DVD of a rough cut
or assembly of the lm, a budget for completion, details of how the project
has been funded to date and letter(s) of interest from UK distributors. If
the lm is still being shot, the New Cinema Funds assessment process will
be aided by a selection of footage and the shooting script, if available.
All requests for funding from the New Cinema Fund must be accom-
panied by a completed application form along with the following:
a synopsis of the lm project (maximum of 100 words); and
two copies of the script (with the draft number and date clearly marked
on the front page), page numbered throughout and in the industry stan-
dard format. One copy must be unbound, the other can be stapled.
Foreign Equity
237
In addition, an applying producer may include (as applicable):
the production budget or proposed production budget and cash ow
schedule;
nance summary;
sales agents estimates;
information about the production company;
details of creative elements already involved;
directors creative comments;
shooting schedule;
outline of proposed recoupment structure; and
DVD or VHS of scenes already shot or of examples of the directors
work.
Note that the production budget does not have to be submitted with
the initial application, but if the New Cinema Fund is interested in the
project creatively, it will require a production budget before proceeding
with the application. The New Cinema Fund will expect a production
budget to be based on industry norms and market rates and, where ap-
plicable, to take into account the economic benets of digital production.
The level of production budget should reect the level of recoupment
that the project can reasonably expect to deliver. When the production
budget is submitted (either at the application stage or later at the request
of the New Cinema Fund), it must contain provision for the following
costs and expenses:
clearances of all rights in the lm worldwide in all media in perpetuity
(except for those sums due with respect to music performing rights);
an independent guarantee of completion (completion bond);
all customary production insurances (including errors and omissions)
on which the UK Film Council will require to be named as an additional
insured;
a mandatory contribution to the Skills Investment Fund; and
all the delivery items set out in their Delivery Requirements list, includ-
ing, among others, the access material relating to exhibition for people
with sensory impairments.
Once completed and signed, the New Cinema Fund application form
and supporting materials should be sent to the UK Film Council marked
for the attention of the New Cinema Fund. Materials are sent at the
producers risk, and the New Cinema Fund suggests that original sup-
porting materials not be submitted. Applications can be sent by courier
238
or by post but should not be submitted by e-mail. The New Cinema Fund
reserves the right to request and review any other relevant supporting
material before making a funding decision.
The application will be acknowledged within two weeks of receipt.
The New Cinema Fund will inform the producers as soon as possible if
the application is not eligible. The project will be assessed initially on its
creative merit and its ability to fulll the New Cinema Funds mission.
Applying producers will be informed within eight weeks of receipt of
the application by the UK Film Council whether the fund is interested
in the project or is rejecting it on creative grounds. The selection process
is subjective, and the New Cinema Funds decision is nal. There is no
appeal process open to applicants whose projects have been rejected on
creative grounds.
The UK Film Council is required to retain the application form and
a copy of the script, treatment, DVD or VHS, as applicable, for audit
purposes. Other supporting materials can be returned to the producers
on receipt by the New Cinema Fund of a written request.
If the New Cinema Fund is interested in the project but believes that it
requires further development, it can, with the agreement of the applying
producers, recommend that an application be made to the Development
Fund for funding. In such cases, the decision whether to provide such
funding will be made by the head of the Development Fund.
If the New Cinema Fund believes that the project is unsuitable for
its support but merits consideration by another British funding source
(e.g., the Premiere Fund), it may refer an application to that fund with
the producers prior approval. Alternatively, it may offer funding toward
the production of a pilot lm in order to assess further the merits of
the project.
Producers may also be invited to discuss their projects further, in
which case supporting documentation may be requested. Such support-
ing documentation may include any of the following:
proposed production budget;
cash ow schedule;
nance summary;
sales agents estimates;
information regarding the production company;
details of creative elements already involved;
directors creative comments;
shooting schedule; and
outline of proposed recoupment structure.
Foreign Equity
239
The New Cinema Fund will then work with the Business Affairs and
Production Finance departments of the UK Film Council to assess the
project. The New Cinema Fund may reject an application at this stage and,
if so, the producer will be informed of this decision in writing. The UK Film
Council is not obliged to provide feedback on unsuccessful applications.
Resubmissions. The UK Film Council will accept resubmissions for
funding of the same lm project, but only if there have been signicant
and substantial changes to the script or major new elements have been
attached or secured. Any resubmissions should be accompanied by a new
application form that clearly shows the alterations made, accompanied by
a full explanation of those changes. Resubmissions will not be accepted
without such an explanation.
Offer letter. The UK Film Council will write an offer letter to the pro-
ducers to let them know of the approval of the application and the amount
of funding to be offered. The offer letter will also outline terms and condi-
tions of the funding. The offer of funding will be for a xed period and
for a xed amount and will be conditional upon the producers entering
into a production nance agreement. Once the offer letter is signed and
returned and any conditions specied in the offer letter have been satised
(e.g., other nancing elements have been secured in principle), the UK
Film Council will prepare the production nance agreement.
If both the producer and director on a project are rst-timers (i.e.,
without previous feature film production experience), the UK Film
Council reserves the right to insure that the lm has the guidance of an
experienced executive producer or production company, with the relevant
costs to be included in the production budget.
At this stage, if the producers have applied to the New Cinema Fund as
individuals, they will be required to set up or to act through an existing
production company. If they applied as a company, they may wish to set
up a single-purpose company to produce the lm project, in which case
they must inform the UK Film Council of that intention in writing.
Production finance agreement. The UK Film Council uses its own
production nance agreements, adjusted to the specic requirements of
each project. The council will not begin the cash ow on a project until
the production nance agreement has been executed, all other nancial
and distribution commitments are in place and the funding conditions
set out in the agreement have been satised. The terms and conditions
of each production nance agreement will differ according to specic
arrangements with all the relevant nancing partners and distributors.
Producers are encouraged to obtain independent legal advice before
signing the agreement.
240
Other British funding sources besides the New Cinema Fund include
the Premiere Fund and so-called National Lottery franchise compa-
niesDNA Films Limited, The Film Consortium Limited, Path Pictures
Limited (for the duration of their respective franchises). However, no two
of these funding sources can fund the same project.
Australian Direct Investment
Australia also provides a form of government-supported equity nancing
for feature lms. The Film Finance Corporation (FFC), which is wholly
owned by the Australian government, is the principal agency for fund-
ing the production of lm and television in Australia through direct
investment. The FFC funds feature lms, miniseries, tele-movies and
documentaries. The government supports lm and television production
to encourage diversity and to ensure that Australians have the oppor-
tunity to make and watch their own screen stories. The FFC will only
fund projects with high levels of creative and technical contribution by
Australians, or projects certied under Australias ofcial coproduction
program. Thus, among other requirements, U.S. producers will have to
seek out and coproduce with an Australian producer.
The following are the stated objectives of the Australian FFC:
nance the production of a diverse range of Australian lm and televi-
sion programs;
maximize opportunities for audiences to view FFC-nanced lm and
television programs;
increase the value of production generated by coinvesting with the mar-
ket and maximizing recoupment;
provide a centralized source of market intelligence for the benet of lm
and television industry practitioners;
efciently and effectively manage the FFC and its resources for its share-
holder, the Commonwealth of Australia.
Since its establishment, the FFC has invested in 875 projects with a
total production value of $1.96 billion. The government has funded the
FFC on a three-year basis and has committed to annual base funding of
$50 million. Supplementing its federal government appropriation are the
FFCs share of revenues recouped from projects active in the marketplace.
These funds are used each year to support the production of new lm
and television programs.
The total slate of projects backed by the FFC each year is nanced by a
combination of FFC funds and nance from private investors and other
Foreign Equity
241
marketplace participants (e.g., distributors, broadcasters, sales agents
and state government agencies).
The FFC considers its market partner participation to be critical
because the FFC not only helps to raise funding, but they also provide
opportunities for programs to nd audiences. The FFC considers that
by conancing with theatrical distributors, broadcasters, international
sales agents and other such companies, it is tapping into valuable distri-
bution and exhibition networks that can maximize the audience reach
of its programs.
All Australian lm and television producers and production compa-
nies can apply to the FFC for funding. To be successful, they must meet
the criteria set out in the FFCs investment guidelines, which delineate
the FFCs policies. The policies are revised each year in consultation with
the industry, so it is important that interested producers check the most
current set of guidelines.
The investment guidelines contain different criteria for each of the
four production categories the FFC funds:
feature lms;
adult miniseries and tele-movies;
childrens miniseries drama;
documentaries.
The FFC can provide different types of funding. Under its memoran-
dum of association, it can assist qualifying lm and television programs
by
undertaking investment;
acquiring, obtaining, dealing in and exercising rights;
making or participating in loans (including print and advertising
loans);
providing investment guarantees and underwriting agreements; or
leading or participating in loan syndicates and similar joint ventures.
The FFC does not produce or distribute the programs in which it
invests, nor does it develop projects or select which projects should be
developed. These roles are performed by the Australian Film Commis-
sion, state lm organizations and the private sector.
The FFC operates under a memorandum of association, a ministerial
mandate, a board of directors and a corporate plan. All funding decisions
are made by the FFC Board, which meets every six weeks. Additional
meetings may be convened to consider urgent investment applications.
242
The FFC has ofces in Sydney and Melbourne. The Sydney ofce is
the administrative center, with a full-time staff of more than twenty
individuals. The Melbourne ofce has a smaller staff and handles all
investment applications originating in the Australian state of Victoria as
well as other applications. For further information, go to the FCC website
at http://www.ffc.gov.au.
Isle of Man Financial Assistance
Great Britains Isle of Man in the Irish Sea has in recent years offered a
couple of types of nancial assistance, including an equity participation
and a loan secured by a guarantee or letter-of-credit. Under some circum-
stances, the Isle of Man Film Commission will take a recoupment posi-
tion behind the principal investor, or agree to recoup its investment out
of receipts from the lm in a limited number of territories. A minimum
amount of production spending on the island will be required.
To qualify for the direct investment,
the lm must be an English-language motion picture;
the producer has to set up a single purpose company on the Isle of Man
to meet the local production company requirement;
at least 50 percent of the project has to be lmed on the Isle of Man (but
this percentage is negotiable to meet the requirements of other nancing
sources);
at least 20 percent of the below-the-line budget has to be spent with local
service providers;
both a collection agent and a completion bond need to be arranged for;
and
the producer has to employ at least four local individuals as trainees for
various lm production positions.
One of the principal requirements for the lending program is that the
production be carried out by a production company incorporated on the
island. However, there are no specic content criteria for shooting on
the Isle of Man except for the typical categories of unacceptable material
found in most applications for funds from public bodies (see Sources and
Further Reading for Filming in the Isle of Man: A Survey of Incentives
Available by Helen Tulley).
South African Film Funds
In some instances, private entities join together to create lm funds for
the purpose of attracting lm production to a specic locale. That has
occurred in South Africa, where Shyanne Media and Germanys CD
Foreign Equity
243
Medien and Framewerk have partnered to create a lm nance fund
aimed at drawing production to that country.
Advantages
Local guidance. When the foreign partners are industry insiders in their
home market, they often can provide expertise in exploiting lms in that
territory and in guiding a particular lm production through complex
governmental bureaucracy.
Local favorites. Movies that are considered partly domestic produc-
tions in foreign countries may benet from some favoritism when foreign
partners are aboard.
Disadvantages
Creative control. Depending on the arrangements, the foreign equity
investor becomes the financial and creative partner of the domestic
producer.
Local entity. A common prerequisite for accessing foreign equity
and other forms of international nancing is that the lm be produced
through a truly local entity.
Copyright transfer and taxes. Not only will many of the foreign nance
options require the transfer of copyrights to a local entity, but the transfer
of rights to actually distribute a lm, which may also create an obligation
to pay signicant exit taxes.
Foreign currency. These transactions will require some knowledge of
the current value of foreign currencies with the attendant risk of such
values falling or rising unpredictably.
Financial ups and downs. Inconsistent lm policies from one govern-
mental regime to another, combined with volatile economies, radically
alter the percentage of funds allocated to the cinema out of a governments
total arts budget from time to time.
244
37 International Coproductions
In the more general sense, feature lm coproduction nancing involves
a sharing between two or more producers, production companies and/or
other entities of the responsibilities for the creative decision making and
nancing of a lm production. Numerous items relating to decision-mak-
ing authority on various production questions must also be negotiated to
avoid conict over issues that are inherent in coproduction relationships.
Coproductions can be domestic or international in scope. Distributor-
nanciers sometimes make coproduction deals with one or more parties
for one or more territories so that the risks associated with nancing the
production of the lm will be spread among several parties.
General Purpose
International coproduction agreements allow producers from two or
more countries to jointly produce a feature lm and provide a means to
pool nancial, creative and technical resources from the participating
countries. International coproduction treaties (and sometimes admin-
istrative accords) exist between numerous countries, including Canada,
Australia, the United Kingdom, Italy, France, Germany, Japan, China
and Norway. In order to qualify as an international coproduction, the
lm must meet the requirements set out in one or more of the various
treaties. It then may be eligible for several forms of nancial support in
the applicable countries, such as tax benets; government loans, grants,
or subsidies; and below-the-line or facilities deals. Such arrangements
may also permit a U.S.-based producer, coproducing with producers of
other countries, to exceed television airtime quotas in certain countries
(since the lm may then qualify as a local lm).
Over the years, the phrase international coproduction has not been
all that important or meaningful for U.S.-based independent producers.
The United States has no coproduction agreements with foreign gov-
ernments and offers only minimal tax breaks or subsidies to encourage
foreign lm investment. However, as production nance has become
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International Coproductions
245
increasingly difcult, U.S. independent producers have sought ways in
which to participate in international coproductions.
Among the very rst considerations in determining if a proposed lm
may benet from an international coproductionis whether the script
itself is suitable for shooting on location in one or more of the countries
involved and whether it otherwise meets the creative and economic
requirements of the applicable coproduction treaties. As a general rule,
the international coproduction regulations allow as much as 30 percent
of the lms budget to come from other countries besides those that are
signatories to the international coproduction treaties involved and still
qualify for local subsidies as well as contribute toward fullling national
quota requirements. So a U.S. producer could raise as much as 30 per-
cent of the lms budget (e.g., from a group of passive investors in the
United States) and then seek to qualify it in several other countries as an
international coproduction. In order to qualify, a lm must have a local
producer in each of the participating countries.
Deal terms. International coproduction deals may simply divide ter-
ritories between the coproducers or go so far as to split worldwide prots
from the lm based on some complex negotiated formula. The coproduc-
tion treaties themselves may require that the coproduction agreement
set out the specic arrangements relating to the nancial interests and
liabilities of the coproducers and the apportionment of the receipts gen-
erated by the lm among them.
Added value. The international coproduction may add value to for-
eign rights. As an example, lm rights presold in France might bring $1
million, $3 to $4 million if handled through a U.S.-based international
distributor, but as much as $10 million if the production were an inter-
national coproduction qualifying in France. Also, coproductions may
help provide access to foreign subsidies.
Qualication. Qualifying for nancial support through international
coproduction treaties is difcult and requires that the lm meet the test
of nationality in each of the coproduction territories. Some coproduc-
tion treaties are based on a point system in which a specied number of
points are required to access benets and points are awarded for various
elements of a lm production that use resources and personnel of the
countries involved. Upon application for coproduction status and on
delivery of the lm, all coproductions are subject to audit by the authori-
ties in each participating country to measure the ratio of funding to the
creative input of each coproduction partner and whether such ratios are
consistent with the treaty requirements.
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246
Tax status in the United States. Often the drafters of coproduction
agreements will insert a provision that the agreement is governed by
foreign law and that nothing in the agreement should be construed to
indicate that a partnership or joint venture has been created between the
coproducers. However, such statements do not determine the status of the
transaction or entity for U.S. tax purposes when one of the coproducers
is a U.S. producer. The IRS will determine whether the transaction has
resulted in the creation of a taxable or nontaxable entity or whether it
should be characterized as a loan, an equity investment or merely presold
lm rights.
IRS characterization. On the one hand, the IRS will most likely char-
acterize a coproduction arrangement that permits the coproducers to
actively participate in the production and distribution of the lm and
share in the worldwide prots of the lm as a joint venture (sometimes
referred to as an international coproduction partnership), a corporation
or an association taxable as a corporation. On the other hand, the ar-
rangement involving the sale of territorial rights to a foreign individual
or entity in exchange for part of the production nancing is more likely
to be considered merely a foreign equity investment or presale in which
no taxable entity has been created.
Tax treatment reminder. Joint ventures, limited partnerships and LLCs
are not taxed at the entity level; but corporations and associations tax-
able as a corporation are taxed at the entity level. Producers seeking out
coproduction opportunities should identify attorneys with international
lm coproduction expertise.
Canadian Coproductions
Canada may be the most active coproducing country in the world, with
more than 58 coproduction agreements worldwide. Coproductions are a
key component of Canadian lm and television production and a favored
method of penetrating new markets and facilitating project nancing.
Canadians are very active in the coproduction area and have earned a
reputation for promoting quality projects. Telelm Canada administers
coproduction agreements on the Canadian governments behalf. The
ofcial coproduction agreements enable Canadian producers and their
foreign counterparts to pool their creative, artistic, technical and nancial
resources to coproduce lms and television programs that enjoy the status
of national productions in each of the countries concerned. The volume
of Canadian production activity, amounting to some 100 productions,
has in recent years been close to an average of $700 million a year.
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247
In order to qualify as a Canadian coproduction, the lm needs Cana-
dian or British creative components. In Canada, it is possible to access fed-
eral, provincial and even animation tax credits all on the same project.
In recent years, Canada has had coproduction agreements with all
the following countries: Algeria, Argentina, Australia, Austria, Belgium,
Brazil, Chile, China, Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan,
Kyrgyzstan, Russia, Tajikistan, Turkmenistan, Ukraine, Uzbekistan,
Denmark, Finland, France, Germany, Greece, Hong Kong, Hungary,
Iceland, Ireland, Israel, Italy, Japan, Luxembourg, Malta, Mexico, Mo-
rocco, the Netherlands, New Zealand, Norway, the Philippines, Poland,
Romania, Senegal, Singapore, Slovak Republic, South Africa, South
Korea, Spain, Sweden, Switzerland, United Kingdom, Venezuela and the
former Yugoslavia (including Bosnia-Herzegovina, Croatia, Macedonia
and Slovenia).
For the latest guidelines and requirements relating to Canadian co-
productions, go to the Telelm Canada website.
British Coproductions
To qualify for British coproduction status, each coproducers nancial
contribution needs to be in reasonable proportion to the creative lm-
making contribution from the country he or she represents except in
cases where nancial-only participation is allowed. The nancial-only
participation type coproductions are currently possible only under the
UKFrance and UKItaly agreements and the Co-European (CoE)
Convention. The producer from each country involved in a British co-
production is responsible for raising a share of the total production cost.
The percentages are as follows:
for bilateral agreements, no less than 40 percent;
for convention agreements, no less than 20 percent; and
for multilateral agreements, no less than 10 percent.
The lm will also have to be certied as a British lm. There are two
ways a lm may qualify as a British lm: (1) by fullling the conditions set
out in Schedule 1 to the British Films Act; or (2) by satisfying the terms of
an international coproduction agreement to which the UK is a party. The
conditions to be met under the terms of the British Films Act include
the lmmaker must be, throughout the time during which the lm is
being produced, either a person who is ordinarily resident, or a com-
pany that is registered and centrally managed and controlled, in an EU
member state;
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248
70 percent of the production cost of the lm must be spent on lm-
making activity in the United Kingdom. If the costs of one or two
people are deducted from the total labor costs then the same deductions
must be taken from the total production cost before the 70 percent test
is applied;
70 percent of the total labor cost (minus the cost of one non-EU/EEA
or non-Commonwealth person if desired) must have been paid to
citizens or residents in the EU/EEA or Commonwealth or Association
countries; or
75 percent of the total labor cost, after deducting the cost of two non-
EU/EEA or non-Commonwealth persons (including one actor) must
have been paid to citizens or residents of the EU/EEA or Common-
wealth or Association countries.
No more than 10 percent of the playing time of the lm should be vi-
sual images from a previously certied lm or from a lm by a different
maker. In the case of documentary lms, this limit may be extended if
an acceptable case is made to the British Department for Culture, Media
and Sport.
More detailed information can be found on the UK Film Council
International or British Department for Culture, Media and Sport web-
sites online.
Certication. The British Department of Culture, Media and Sport
issues two types of certicates for lms: an EC Certicate of Nationality;
and a Certicate of British Nature of a Film.
EC certicate of nationality. Some EC countries have quotas on the
number of non-EC lms exhibited in their countries, and exporters of
British lms may require a Certicate of Nationality to qualify for benet
of the screen quota in such countries. A lm must fulll the criteria set
out in the most current EC directive for certication. The criteria typi-
cally include
studio lming must take place in EC territory; however, if outdoor
scenes are lmed in a third country, up to 30 percent of studio scenes
can be shot in the third country;
one of the UK languages (when certicates are issued by the United
Kingdom);
a specied number of nationals employed including: scriptwriters,
music composers, principal cast, executive producer (or production
manager), director of photography, sound engineer, editor, art director
and chief of wardrobe.
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249
If any labor costs for any of the above-listed personnel are paid to a
third-country national,
third-country nationals must not comprise more than two-fths (40
percent) of people employed in all the categories (when the director is a
British or EC national);
third-country nationals must not comprise more than one-fth (20
percent) of people employed in all the categories except scriptwriters
and music composers (when the director is a non-British and non-
EC national). The scriptwriters and composers must be British or EC
nationals.
Citizens of Iceland, Norway and Liechtenstein are now granted the
equivalent status as nationals from EC member states with regard to the
provisions of the directive as part of the European Free Trade Agreement.
Certicate of British nature. To qualify for certication, a lm must
fulll the criteria set out under Schedule 1 to the Films Act. The Depart-
ment of Culture, Media and Sport has the application.
The British Film Council and the government have also been reviewing
the countrys coproduction agreements in order to stop the abuses and in-
consistencies discovered in the existing programs. Thus, Britains coproduc-
tion rules could change in the future. In addition, there is some talk about
the possibility of developing a UK/U.S. coproduction arrangement.
European Convention on Cinematography
The aims of the European Convention on Cinematography (Conven-
tion) are
to promote the development of European multilateral cinematographic
coproduction;
to safeguard creation and freedom of expression; and
to defend the cultural diversity of the various European countries.
In order to obtain coproduction status, the work must involve at least
three coproducers, established in three different parties (countries) to
the Convention. The participation of one or more coproducers who are
not established in such parties is possible, provided that their total con-
tribution does not exceed 30 percent of the total cost of the production.
This is the provision that may allow U.S.-based producers to raise and
contribute that 30 percent. The coproduced work must also meet the
denition of a European cinematographic work set forth in Appendix
II of the Convention.
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250
Once these conditions have been fullled, the Convention assimi-
lates all coproductions, which have been given the prior approval of the
competent authorities of the parties, with national lms (i.e., they are
entitled to the benets granted to the latter). The Convention also covers
the following:
the minimum and maximum proportions of contributions from each
coproducer;
the right of each coproducer to coownership of the original picture and
sound;
the general balance of investments and compulsory artistic and tech-
nical participation;
the measures to be taken by the parties to facilitate the production and
export of the cinematographic work; and
the right of each party to demand a nal version of the cinematographic
work in one of the languages of that Party.
French Coproductions
France has generally been the second most active coproducing country
with more than 40 such treaties, including Canada and Great Britain.
U.S. producers, or other producers from countries not party to these
treaties, can sometimes team up with a Canadian or British producer, in
order to benet from specic sources of funding for lms to be produced
in France.
One such fund that U.S. lmmakers seeking to develop projects in
France may access is administered by the national government. This
fonds de soutien can provide about 15 percent of a lms budget. To
qualify for these funds, the lm must also satisfy a point system based
on its European content (e.g., nationality of the cast, language spoken in
the movie and other criteria).
Australian Coproductions
Film nance in Australia is encouraged in a variety of ways, through
direct investment by the Australian Film Finance Corporation, through
federal and state government tax incentives and through coproduction
arrangements.
The Australian federal government has entered into ofcial coproduc-
tion treaties with the United Kingdom and Northern Ireland, Canada,
Italy, Ireland, Israel and Germany. It has also developed Memoranda of
Understanding (MOU) with France and New Zealand. The treaties and
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251
MOU can be downloaded from the Australian Film Commission website
at http://www.afc.gov.au/lminginaustralia/copros by clicking on the
heading Legislation & Treaties. The guidelines and application form
are also available to download.
The effect of these two arrangements is that a film or television
program approved as an ofcial coproduction is regarded as a national
production of each of the coproducing countries and is therefore eligible
to apply for any benets or programs of assistance available. In Australia,
ofcial coproductions are eligible to apply for 10B and 10BA tax deduc-
tions, the 12.5 percent refundable tax offset (see chapter 38) and invest-
ment from the FFC (see chapter 36).
The Australian International Co-Production Program was established
to facilitate cultural and creative exchange between the coproduction
countries; allow the coproduction countries to share the risk and cost of
productions; and increase the output of high-quality productions.
An ofcial international coproduction must be made under the terms
of one of the arrangements in place between Australia and the copro-
ducing countries. There must be a producer from each of the countries
and a balance between the Australian nancial equity in the project and
the Australian creative components (this is generally a minimum of 30
percent under the treaties and 20 percent under the MOUs). Creative
equity is determined by
a point system for key cast and crew;
an equivalent percentage of other cast and crew;
an equivalent percentage in the amount of money spent in Australia or
on Australian elements within the production budget.
Foreign lmmakers planning to produce a movie in Australia may obtain
a development loan or a production grant from the national government
(also known as the Film Bank), through the International Co-Production
Program (ICPP). The Film Bank has approximately $80 million set aside
to help encourage, develop and maintain a local lm industry. The ICPP
program was created by the various coproduction treaties that Australia
has entered into with Canada, France, Israel, Northern Ireland, the United
Kingdom and other countries. If U.S.-based lm producers, or produc-
ers from countries not a party to these treaties, want to take advantage of
this source of funding, they must partner with a producer from a country
that is party to the coproduction treaty. The Australian Film Commission
administers the International Co-Production Program and can provide
detailed guidelines on how to apply for coproduction status.
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252
Irish Coproductions
Ireland has entered into coproduction treaties with Canada and Austra-
lia. In addition, the country has ratied the European Convention on
Cinematography.
New Zealand
New Zealand has coproduction treaties with a number of countries, in-
cluding the United Kingdom, France, Italy, Canada and Australia. A lm
qualifying as a New Zealand lm becomes eligible for various funding
initiatives, including tax incentives, loan schemes and equity nancing.
Some of such lms may receive funds for project development, initial
casting and location searches. In addition, a qualifying lm may enjoy
the removal of trade barriers and administrative assistance in acquiring
necessary visas and work permits.
However, in order for a lm to be eligible, it must comply with cer-
tain rules relating to production, distribution and the receipt of revenue
generated by the lm. For example, there are percentage requirements
on the production cost contributions for majority and minority copro-
ducers. Also, the addition of sound and effects and the laboratory work
must take place in the majority coproducers country. In addition, the
duplication of copies intended for distribution in that country must
also occur there. And lms made pursuant to a coproduction treaty
must include language to that effect in the screen credits. Furthermore,
the coproducers freedom to determine the allocation of revenues and
potential markets between them is subject to the respective government
agencies in the coproducing countries, and as a general rule these al-
locations must be made in proportion to the respective initial interests
of the coproducers. Finally, all coproducers will jointly own the original
picture and sound negative.
Czech Republic
The Czech Republic has entered into coproduction treaties with Canada,
France and Italy, among other countries. Promoters of coproductions in
the Czech Republic claim that since its production facilities are inexpen-
sive, Czech crews speak English, there are no unions and locations are
picturesque, a qualifying coproduction can save up to 50 percent of the
total below-the-line budget. On the other hand, foreign producers in the
Czech Republic apparently get the same advantages from lming there
as cross-border producers that they would if they qualied as ofcial
coproduction partners.
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253
As is common with international coproductions, the lms revenues
from other territories are generally split between the coproducers in
proportion to their respective investments, and the proportion of con-
tributions may vary from 20 to 80 percent. Also, the copyright is shared
between the coproducers.
An application for certication of a coproduction would need to in-
clude the nal script, documentary proof that the copyright for the lm
has been legally acquired and a copy of the coproduction agreement
signed by the coproducers.
In addition to the Sources and Further Reading, additional informa-
tion on international coproductions for lm may be obtained through
the national lm commissions of the countries of interest (some of which
have ofces in Los Angeles) or through their embassies or consulate
cultural attaches.
Advantages
National lms. International coproduction agreements allow a lm
to qualify as a national lm in all the countries that are party to the
agreement being used. Coproduction lms are therefore eligible for the
benets available for national lms in those countries.
Sharing risks. International coproductions allow producers to share the
substantial economic and artistic risks involved in lm production.
Lower costs. Sometimes, a lm can be produced for less money in
other countries (i.e., lower production and union costs compared to the
United States).
Closeness. A countrys proximity to the United States may be an advan-
tage to a U.S.-based producer seeking coproduction partners compared
to countries that are more distant (thus shooting in Canada or Mexico
may be considered).
Performers, crews and production facilities. Many foreign countries offer
an ample supply of rst-class performers, crews and production facilities.
Government support. Qualifying as an international coproduction may
allow a lm to access various forms of government support.
Access to other nancing options. The international coproduction may
help the producer gain access to other foreign nance options such as
below-the-line deals or government subsidies.
Increased value. Film projects may be more valuable for some purposes
in a foreign country if considered a local project.
Natural coproductions. A feature lm storyline that occurs and can
best be shot in more than one location may naturally lend itself to an
international coproduction.
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254
Increased exposure. Financing and producing a feature lm through
an international coproduction may increase the exposure of the lm in
the countries or regions of the world that are involved.
Disadvantages
Shooting away from home. Any lm production shot on location or
in a studio in a foreign country is likely to require the extra expense
associated with transportation to and from, along with housing for key
cast and crew.
Government rules. Qualifying pursuant to the rules associated with
international coproduction treaties involves compliance with the rules
promulgated by multiple government bureaucracies.
Increased paperwork. An international coproduction imposes a heavy
paperwork burden on the producers as they seek to comply with the treaty
provisions of the governments involved.
More planning required. In addition to all of the planning that goes
into producing a feature lm, an additional layer of careful planning
is required of coproducers to ensure that they are able to adhere to the
requirements set forth in each of the relevant treaties.
Foreign languages. Unless the cast and crew all speak the same lan-
guage, communication difculties might arise.
Loss of creative control. Any international coproduction could bring
about a loss or diminishing of creative control in the sense that com-
promises on the script may be required in order to meet government
mandated requirements.
Withholding problems. A joint venture, limited partnership or interna-
tional coproduction partnership (even though not a taxable entity in the
United States) is obligated to pay quarterly estimated tax payments on
behalf of the foreign coproducer partner, and both coproducers could be
held liable for this obligation as withholding agents (IRC Section 1446). In
addition, the IRS will probably treat such an entity as the employer of all
personnel hired by either coproducer. This may make both coproducers
liable for the entitys U.S. wage withholding obligations.
No U.S. treaties. The United States does not have formalized interna-
tional coproduction treaties with other countries.
Not for U.S. producers. Unfortunately for some U.S. producers, many
of these coproduction treaties are drafted in such a way as to preclude
them from qualifying since the Hollywood-based U.S. lm industry so
dominates the world markets that U.S. producers are not considered to
be in need of assistance.
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255
Genre bias. Just as Hollywood tends to produce and distribute certain
lm genres, international coproductions tend to favor certain genres also,
specically science ction and adventure lms that occur in a ctitious
locale. International coproductions may also be biased against comedies,
since humor does not seem to travel across cultures.
Capable and solvent partners. It is not always easy or possible to nd a
capable coproducing partner who is able to share the risk, who is solvent
and whose own government provides nancial incentives that are both
sufcient and mesh well with those provided by another coproducing
partner.
Added complexity. The international coproduction adds another layer
of complexity to an already complex transaction and will inevitably
require the expertise of an international attorney experienced in this
particular form of lm nance.
Counterproductive. Coproduction deals tend to defeat the protectionist
schemes set up by other countries to prevent their national markets from
being overrun by Hollywood lms.
A nightmare. Even for an ongoing production company, making all
of the necessary arrangements for an international coproduction can
be a nightmare. Whether a lm production companys cash ow is up
or down (or nonexistent), foreign costs can increase as the U.S. dollar
falls in relative value. Subsidy laws are also constantly changing, and
the transactions take a great deal of time to close. Altogether, this com-
bination often results in tighter budgets, fewer lms, higher risks and
increased frustration.
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256
38 Foreign Tax Shelters and Tax Incentives
Once again, it is important to note that prospective lm investors may
need a bit more motivation to invest in a risky lm production; thus,
many foreign governments have provided tax incentives for the purpose
of encouraging nancial support for their local lm industry. To take
advantage of such tax incentives, however, one or more local taxpayers
must be involved (either individuals or entities). Thus again, a U.S.-
based producer will generally need to coproduce a lm with a producer
or production entity based in the foreign country to benet from its tax
incentive programs.
Tax Shelters Dened
Generally speaking, a tax shelter is a transaction by means of which
taxpayers reduce their tax liability by engaging in activities that provide
deductions or tax credits to apply against their tax liability. Thus, the tax
shelter is a method used by investors to legally avoid or reduce taxes. The
specic tax benets provided by the foreign motion picture tax shelters
for foreign investors are
more rapid depreciation, which in some instances can be increased by
borrowing;
deferral of income (tax-deferral deals); and
conversion of ordinary income to capital gains, which is subject to a
lower rate of tax.
A tax-deferral type of tax shelter is very attractive to taxpayers who
have a large, one-time increase in income in a given year and who wish to
defer part of this to future years when their income is likely to be lower.
Tax incentive schemes are generally created by governments to encour-
age the ow of capital into high-risk investments. This, in turn, means
that taxpayers generally are being asked by the government to provide
nancial support for such industries.
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Foreign Tax Shelters
257
General and Specic Laws
The tax laws of many foreign countries permit (and in some instances
specically encourage) motion picture tax shelters or tax-driven motion
picture nancing. Those countries or regional jurisdictions include Aus-
tralia, Belgium, Canada, Denmark, the European Union, Fiji, France, Ger-
many, Hungary, Iceland, Ireland, Isle of Man, Italy, Japan, Luxembourg,
the Netherlands, New Zealand, Norway, South Africa, Spain, Sweden and
the United Kingdom. The Canadian lm tax shelter, for example, is the
result of intentional tax subsidies for local lm production. The German
and Japanese motion picture tax shelters have been the unintended result
of more general tax provisions.
Foreign tax incentives and other programs designed to encourage lm
production in countries other than the United States have primarily been
created in response to the fact that American movies account for a high
percentage of the movies seen in those other countries. For example,
one study revealed that about 80 percent of European box ofce receipts
are generated by American lms, whereas European movies have won
only 5 percent of the American market. Further, such studies tend to
show that of the 100 highest-grossing movies in the world in any given
year, approximately, 88 are likely to be American movies, and 7 more are
likely to be coproductions involving American production companies
(see French Kiss-Off: How Protectionism Has Hurt French Films, by
Tyler Cowen).
Unfortunately, the tax incentives are withdrawn or reduced from
time to time, so it is a never-ending challenge to stay current with the
tax provisions of multiple countries. A selection of these tax incentive
programs are discussed below.
In order to take advantage of most of the tax incentives or subsidies
offered by foreign countries, the production company must be based in
the subject country. However, some of the owners or executives can be
American. In many instances, the company is dissolved when produc-
tion wraps.
Canadian Tax Incentives
The Canadian tax shelter leverage is not as great as the leverage that was
available in the mid-1980s in the United States, and in order for the invest-
ment to pay off, the Canadian lms need to generate a prot. Canadian
tax incentives were granted to Canadian private investors during most
of the 1970s and 1980s. Those tax incentives were then changed so that
they were granted directly to lm producers in the form of refundable
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258
lm tax credits to encourage Canadian content lms. Each lm has
to be produced by a taxable Canadian corporation primarily involved in
the production of lms, it must be commercially exhibited in Canada by
a Canadian distributor within two years of completion and it has to fall
within the category of either a treaty coproduction or a lm production
that meets the point requirements of the regulations. In order for a U.S.-
based producer to benet from these Canadian tax incentives, it may be
necessary to partner with a Canadian production company.
Canada offers two tax incentive programs. One is called the Canadian
Film or Video Production Tax Credit (CPTC), under which the federal
Canadian government provides a refundable tax credit to qualied cor-
porations for the production of Canadian lms or videos. Under this
program the government offers incentives to stimulate job growth by
encouraging Canadians as well as foreign-based lm producers to employ
the services of Canadians. The second is referred to as the Film or Video
Production Services Tax Credit (PSTC) Program. A special rule prevents
producers from being able to claim both the CPTC and the newer PSTC
for the same production; thus, producers have to make a choice.
The CPTC program. The federal content tax credit is calculated as a
percentage of the Canadian labor expenditures incurred by a Canadian
producer in connection with an eligible production. When this credit was
introduced in 1995, the percentage was 25 percent of qualifying Cana-
dian labor expenditures, which were capped at 48 percent of the eligible
production budget, yielding a credit of up to 12 percent of the eligible
production budget. In November 2003, the cap on expenditures was in-
creased to 60 percent of the eligible production budget, yielding a credit
of up to 15 percent of the eligible production budget.
Qualifying corporations. To qualify for the CPTC program, the appli-
cant must be a qualied corporation with a permanent establishment in
Canada that engages primarily in Canadian lm or video production.
Specically excluded are prescribed labor-sponsored venture capital
corporations, tax-exempt corporations and corporations controlled by
one or more tax-exempt persons. In addition, the qualied corporation
must own the copyright in the lm for which a claim is being made.
Qualifying productions. To qualify for the CPTC program, the Cana-
dian Audio-Visual Certication Ofce (CAVCO) must certify that the
production is a Canadian lm or video production, which means one
produced by a prescribed taxable Canadian corporation that is either
a treaty coproduction or that meets the requirements of the income tax
regulations. Coproductions between Canada and another country are
eligible for the CPTC program only when coproduced under an ofcial
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259
treaty. Telelm Canada is responsible for the certication of treaty co-
productions. However, in order to obtain a certicate to access the CPTC
program, the producer must apply directly to CAVCO.
Program administration. The CPTC program is jointly administered by
CAVCO and the Canada Revenue Agency (CRA). CAVCO is responsible
for certifying that the production is a Canadian lm or video production,
estimating the qualied labor expenditure of a qualied corporation and
issuing certicates to allow Canadian producers to claim the production
tax credit.
The CRA is responsible for providing assistance to claimants, inter-
preting and applying Section 125.4 of the Income Tax Act (and all other
provisions in the law and regulations that may have an impact on the tax
credit), reviewing or auditing the federal tax credit (FTC) claims within
a reasonable time frame, assessing T2 Corporation Income Tax Returns
and issuing timely refund checks.
Application procedures. To apply for the CPTC, a qualied corporation
must complete the Canadian Form T1131, Claiming a Canadian Film or
Video Production Tax Credit. The certicate issued by CAVCO, or a
copy of the certicate, must be attached to the Corporation Income Tax
Return (Form T2) for the year along with the Form T1131 (attached to
the top of the T2).
The Canadian PSTC program. The PSTC is calculated as a percentage
of the qualied Canadian labor expenditures incurred by the owner of
copyright in an eligible production, or by a production services provider
engaged by such copyright owner. Following the elimination of produc-
tion services tax shelters in September 2001, the federal government com-
mitted to increasing the PSTC. In February 2003, the PSTC was increased
from 11 to 16 percent of qualifying Canadian labor expenditures.
Qualifying corporations. The qualications for the PSTC program
are almost the same as for the CPTC. The applicant must be an eligible
production corporation with a permanent establishment in Canada that
engages primarily in lm or video production or production services.
Specically excluded are prescribed labor-sponsored venture capital
corporations, tax-exempt corporations and corporations controlled by
one or more tax-exempt persons. In addition, the corporation must either
own the copyright in the lm for which a claim is being made or have
contracted directly with the owner of the copyright, where the owner of
the copyright is not an eligible production corporation.
Amount of tax credit. This refundable tax credit is provided to an eligible
production corporation at the rate of 16 percent of its qualied Canadian
labor expenditures, net of any government assistance, in respect of an
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260
accredited production for services rendered in Canada by Canadian resi-
dents. The rate is different than the one used for the CPTC program.
Qualifying productions. In order to receive the PSTC, an eligible pro-
duction corporation must obtain an accredited lm or video production
certicate from CAVCO. The accredited production must meet a cost
minimum and it must be of an eligible genre as set out in the proposed
income tax regulations. Once again, a special rule prevents producers
from being able to claim both the Canadian Film or Video Production
Tax Credit (FTC) and the PSTC for the same production.
Application procedures. To apply for the PSTC, an eligible production
corporation must complete Canadian Form T1177, Claiming a Film or
Video Production Services Tax Credit. The certicate issued by CAVCO,
or a copy of that certicate, must be attached to the Corporation Income
Tax Return (Form T2) for the year along with Form T1177 (attached to
the top of the T2 return).
Canadian provincial programs. In addition to the Canadian federal
programs, several provinces in Canada also offer tax credit and incen-
tive programs.
The Ontario Production Services Tax Credit provides Canadian or
foreign-controlled production companies with a refundable tax credit
of 18 percent on Ontario labor expenditures for eligible lm or television
productions. There is no limit on the amount of labor expenditures that
may be eligible, and there are no limits on the amount of the tax credit
that may be claimed.
The British Columbia Production Services Tax Credit is a labor-
based tax incentive that provides refundable tax credits to Canadian
or international lm and television production corporations that have
incurred costs in British Columbia. The company does not have to be a
Canadian-owned corporation, and there is no requirement that it have
an interest in the copyright. More recently, British Columbias liberal
government increased its tax credit for foreign production from 11 to 18
percent to match Ontarios credits after the lm and television produc-
tion industry in British Columbia threatened to move projects out of
the province (apparently extortion works). The British Columbia tax
credits also went from 20 to 30 percent on local productions, effectively
countering Ontarios earlier increases.
Quebec also offers a Film or Television Production Services Tax Credit
on labor expenditures, up to a maximum of 14.5 percent of total produc-
tion expense by an eligible corporation, on services provided in Quebec
by Quebec residents or taxable Quebec corporations for the making of
an eligible production.
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261
British Tax Incentives
For many years, the so-called British sale-and-leaseback transaction served
as an important element in British lm nance. More recently, the British
chancellor of the exchequer introduced a new tax relief provision for lm
to replace the tax provisions on which the sale-and-leaseback transaction
was based. Those provisions expired in July of 2005. The new tax break ap-
plies to British qualifying lms with budgets up to 15 million and is worth
20 percent of a lms budget, which a producer can offset against prots, or
it can be surrendered to the Inland Revenue for a cash rebate. Also, under
the new rules, the tax relief will be granted only to a producer, and not
to third-party investors. The new provision has no end-date, as did the
previous tax provisions utilized in the sale-and-leaseback transaction.
This newest scheme is designed to reduce the role of the various inter-
mediaries that have sprung up in the United Kingdom for facilitating the
sale-and-leaseback scheme and to eliminate much of the abuse that has
apparently taken place. In some instances, lm projects with little or no
merit were attracting nancial backing when there was really no expecta-
tion that such lms would be successful or even screened.
Under this newest permutation of British lm tax incentives, lm-
makers will not have to go through a partnership of private investors, but
instead can go directly to the government and obtain a rebate equal to 20
percent of the lms budget.
These changes simply illustrate that tax incentives generally are con-
stantly changing and are therefore difcult to incorporate into any long-
term strategy for lm nance. Section 42 of the nance act, which pro-
vides for a three-year write-off of expenditure on British qualifying lms,
was to remain in place, according to the newer version of the law.
Qualifying as a British lm. As noted above, the lm has to be a qualify-
ing British lm (i.e., it must be completed and certied as being a British
lm by the UK Department for Culture, Media and Sport), and it must
fulll either the conditions set out under Schedule 1 to the current Films
Act or the terms of an international coproduction agreement to which
the United Kingdom is party. There is presently no method available to
obtain certication prior to completion of a lm. In general terms, a Brit-
ish lm is one on which
the producer was, throughout the time that the lm was being made,
a person ordinarily resident in or a company registered and centrally
managed and controlled in a state that is a member of the European
Union or the European Economic Area or with which the European
Convention has signed an association agreement;
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262
at least 70 percent of the total expenditure incurred in the production of
the lm was spent on lm production activity carried out in the United
Kingdom; and
the requisite amount of labor costs represent payments for the labor
or services of Commonwealth or European Union citizens, or persons
ordinarily resident in a country in the Commonwealth or the European
Union.
The percentage of labor costs paid, or payable, to citizens or ordinary
residents of a Commonwealth country or member state must be the
lesser of
at least 70 percent of the total labor costs after deducting the cost of one
non-Commonwealth/member state citizen or ordinary resident; or
at least 75 percent of the total labor cost after deducting the cost of two
non-Commonwealth/member state citizens or ordinary residents, one
of whom must be an actor in the lm.
Also eligible for relief are lms produced under the terms of an ofcial
coproduction treaty between the United Kingdom and another country
or under the European Convention on Cinematographic Co-Produc-
tion. The European Union member countries include Austria, Belgium,
Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,
the Netherlands, Portugal, Spain, Sweden and the United Kingdom. The
so-called European Economic Area countries include Iceland, Liech-
tenstein and Norway. Those countries with associated agreements with
the European Convention include Bulgaria, Czech Republic, Estonia,
Hungary, Latvia, Lithuania, Poland, Romania and Slovakia.
Australian Tax Incentives
The Australian federal government offers several tax incentives for lm-
makers, an offset program and two tax concessions. Australian lm
investment is generally regulated by the Australian Corporations Act
of 2001.
Refundable tax offset for lm production. The refundable tax offset
for eligible lm and television productions is worth 12.5 percent of the
productions qualifying Australian production expenditure and may be
claimed by the production company through the companys Australian
tax return. The offset amount is rst applied against any federal income
tax and other tax liabilities that the production company might have. Any
excess will then be refunded by the Australian Taxation Ofce.
The broad denition of qualifying Australian production expenditure
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263
(QAPE) is goods or services supplied in Australia. This may allow a lm
producer to include all or part of the expenditure on offshore cast and
crew fees.
Key eligibility criteria. The eligible formats are feature lms (including
those shot direct to video), tele-movies and miniseries. The Australian
federal government announced in May of 2004 that television series
would be included.
The key criterion to access the tax offset is a minimum level of quali-
fying Australian expenditure of $15 million (in Australian dollars) on
the production of the lm. Additionally, where the lms qualifying
Australian production expenditure is between $15 million and $50 mil-
lion, that must represent at least 70 percent of the lms total production
expenditure. Where a company has spent 50 million or more on qualify-
ing Australian production expenditure, it will qualify regardless of the
total amount of production expenditure involved.
The 12.5 percent refundable tax offset can represent a cash subsidy of
between 9 and 12.5 percent on the lms total budget, depending on the
extent to which a production shoots and spends money in Australia.
The denition of total production expenditure provides the basis against
which the 70 percent activity test will be assessed, where QAPE is between
$15 million and $50 million. There are a number of costs that are excluded
from the total budget for the purposes of calculating this activity test:
1. nancing
2. development
3. copyright acquisition
4. general business overhead
5. publicity and promotion
6. fee deferments
Each of these items is further dened in the legislation, but if any of
items 25 are incurred in Australia, the costs may be factored back into
the total production costs. The production may also nominate one per-
son whose remuneration is to be disregarded if it is advantageous in the
percentage calculation.
The application for the rebate must be made by an Australian resident
company or a foreign entity with a permanent establishment in Austra-
lia and an Australian Business Number (ABN). The rebate will be paid
directly to the applicant. The application is submitted with a tax return
in the year that the lm is completed. A provisional certicate may be
obtained from the Minister of the Arts. All expenditure must be arranged
by the single entity claiming the tax offset.
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264
A company is not entitled to this Australian tax offset if a provisional
or nal certicate for the lm has been issued under either of the Austra-
lian tax concession programs (i.e., 10BAwhether or not the certicate
is still in forceor if a 10B certicate has been issued and usedsee
discussion below).
An independent Film Certication Advisory Board assesses applica-
tions and advises on the eligibility of lms for certication under the
governments lm tax offset. In addition, the board advises on a range of
policy and industry issues that may affect the offset and that arise from
the impact of the offset on the Australian lm industry.
A fact sheet, guidelines and application form that provide additional
details on applying for the tax offset are available online at www.dcita.
gov.au. The AusFilm website may also make it possible to download
an electronic copy of the application form as a PDF document. In the
meantime, a producer can request an electronic copy via email at lm.
taxoffset@dcita.gov.au. At some point, Australia plans to allow applicants
to complete and submit the application form online.
Australian tax concessions. The Australian federal government also
encourages private investment in screen production through tax incen-
tives under Divisions 10B and 10BA of the Australian Tax Act. However,
projects that access the tax-privileged benets of 10B and 10BA, cannot
also access the 12.5 percent federal cash rebate.
Division 10B allows accelerated tax write-offs for investors in lm and
television projects that meet certain criteria and approvals. It allows a
much wider range of projects to qualify with respect to Australian con-
tent and subject matter than that provided for under Division 10BA. For
a project to receive a 10B certication, it must be made wholly or sub-
stantially in Australia. The major eligible formats under 10B are feature
lms, tele-movies, miniseries and episodic TV series.
The attraction for investors is that they are able to write off their entire
investment over two years, beginning in the nancial year in which the
project is rst completed and exploited for income producing purposes.
There is no minimum or maximum budget requirement imposed on a
qualifying project.
Division 10B, however, is not intended to be utilized as a subsidy on
production costs. It is an incentive for a producer to raise funds for
genuine conancing partnerships and gap equity arrangements, offer-
ing real risk-versus-return possibilities for investors. To raise funds, it
would generally involve structuring a private or public offer to entities or
individuals interested in investing in lm and television projects. Such
Cones Ch38.indd 264 12/20/07 1:51:55 PM
265
investors will usually have Australian taxable income to offset against the
accelerated deductions granted. Thus, a U.S.-based producer may want
to raise a portion of the nancing for a project in the United States, seek
out an Australian coproducer who could raise another portion of the
nancing in Australia and shoot the lm in Australia.
Producers interested in using this tax incentive must submit an ap-
plication to the Department of Communications (DCITA) to receive 10B
certication stating that the project has met the creative requirements
of 10B. The tax ofce then administers the use of the tax benets by the
investors and issues rulings on unacceptable investment deals involving
10B. The tax benets can be subsequently withdrawn from the investors
if the deals fail to comply with the tax ofce guidelines, even if the project
itself complies with its 10B status granted by DCITA.
For detailed guidelines and an application form, see the DCITA website
online at www.dcita.gov.au/Article/0,,0_12_23_4914_103741,00.html.
Division 10BA also allows accelerated tax write-offs for investors in lm
and television projects that meet certain Australian content criteria and
approvals. It allows Australian resident investors and corporations who
are owners of rst copyright of a lm coming within the cultural require-
ments of 10BA to deduct 100 percent of their investment against their other
income in the nancial year the investment is made. Basically, the project
needs to be completed and rst used for exploitation within two years from
the end of the nancial year in which the investment was rst made.
Division 10BA requires a higher level of Australian content and par-
ticipation than 10B, in both the physical production of the project and
the elements contained in the script (i.e., characters portrayed, locations
and storylines). However, it can be utilized on projects made under any
of the international, ofcial coproduction agreements Australia has with
several countries. Projects certied as 10BA compliant are also eligible to
apply for direct equity investment from the federal government funding
bodyAustralian Film Finance Corporation (FFC).
The major eligible formats under 10BA are feature lms, tele-movies
and miniseries. Episodic TV series are excluded under 10BA (although
not under 10B). There is no minimum or maximum budget requirement
imposed on a qualifying project. Like 10B, the 10BA tax concession pro-
vides an incentive for a producer to raise funds for genuine conancing
partnerships and gap equity arrangements, offering real risk-versus-return
possibilities for investors. To raise funds, it would also generally involve
structuring a private or public offer to entities or individuals interested
in investing in lm and television projects. However, unlike 10B, only
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266
Australian resident investors are able to claim the accelerated deductions
granted under 10BA.
Interested producers can submit an initial application to DCITA to
receive a provisional 10BA certicate, to allow them to begin sourcing
investment funds. This provisionally certies that the project will meet
the creative requirements of 10BA. The producer must also apply for
a nal certication under 10BA within 6 months of the completion of
the project. The tax ofce administers the use of the tax benets by the
investors and issues rulings on unacceptable investment deals involving
10BA. The tax benets can be subsequently withdrawn from the inves-
tors if the deals fail to comply with the tax ofce guidelines, even if the
project itself complies with its 10BA status granted by DCITA. Additional
information is provided online at www.dcita.gov.au/Article/0,,0_12_
23_4914_103740,00.html.
State-based incentives and rebates. Several of the Australian states
offer support and nancial assistance in addition to the various federal
rebates and incentives. The state assistance comes in the form of payroll
tax rebates or exemptions, cast and crew wage rebates, location attrac-
tion cash grants and the free or subsidized public service resources. The
range of assistance and qualication criteria varies from state to state,
and more complete details on the incentives may be obtained from each
of the state lm ofces. For more information see http://www.afc.gov.
au/lminginaustralia/govassist/state/apage_7.aspx.
Argentina
Argentina has taken steps to ensure that Argentinian movies can be
produced and compete successfully with U.S. movies being shown on
Argentinian movie screens. Argentina offers exemptions from duties
for celluloid print imports, state subsidies, soft loans and state-backed
international promotion. In addition, the country imposes screen quotas
for locally produced motion pictures, thus allowing for longer runs at
peak moviegoing hours.
Belgium
In Belgium both individual and corporate investors can deduct up to 50
percent of the taxable income of the investor (with a ceiling), and the
investment can amount to as much as 50 percent of the total budget of
a lm production. The producer is allowed to bring together a group of
investors. On the other hand, there is a requirement that the lm has to
generate revenues.
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267
Brazil
Brazilian support for its lm industry includes granting foreign produc-
ers the option to invest in local movies or pay an additional tax on the
revenues they take out of the country, allowing nonlm companies to
invest part of their income tax on local lms and imposing screen quotas
that obligate theatres to play Brazilian motion pictures for a specied
minimum of days.
Brazils Audiovisual Law 8685/93 grants tax incentives that could be
applied by the taxpayers in Brazilian cinematographic audiovisual works,
including feature lms. The incentives are dened in articles 1 and 3 of
the law.
Article 1 establishes that Brazilians can deduct 3 percent from their in-
come tax that is due in any given year, provided that this deducted amount
is deposited in a special account at Banco do Brasil S.A. and utilized to
buy Audiovisual Investment Certicates for a determined production or
a lm of their own choosing, among those projects that have already been
approved by the secretary for audiovisual development in the Ministry
of Culture. The issuance of these certicates is handled by the Stock and
Exchange Committee, and the buyers are entitled to a participation in
the lms revenues according to the offer of each project.
Article 3 establishes that any foreign producer, distributor or interme-
diate who receives any royalties or payments of whatever nature, derived
from the exploitation, sale or licensing of foreign audiovisual works
(theatrical, television, video, transmission of eventssports shows in
Brazil), can deduct 70 percent from the withholding tax applicable to
any credits or remittances of such royalties or payments, provided this
deduction is deposited in a public account to be utilized in a project of a
Brazilian producer for an audiovisual work (feature lm, series, etc.) and
this project is approved by the secretary for audiovisual development in
the Ministry of Culture.
Normally, the withholding tax is 25 percent on the royalties or pay-
ments, credited or executed, and once the decision is made to utilize the
70 percent deduction under the terms of Law 8685/93, from the date of
each deposit, the non-Brazilian (foreigner) has 180 days to elect a project
and allocate the deposited amounts to it. The foreign producers, distribu-
tors or intermediates may choose their projects, and a contract is signed
with the Brazilian producer dening, case by case, their participation
and rights (rst negotiation or rst refusal for distribution, vehicles,
territories, etc.).
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268
The limit for deposits in each project is approximately $3 million in
U.S. dollars, and this amount can not represent more than 60 percent
of the whole budget.
France
In an effort to dissuade productions from ocking to neighboring Bel-
gium, the French have introduced a scheme inventively called bring
back production. Film producers receive a 20 percent tax rebate on
labor and lab costs from the government as long as most of the money is
spent in France and employs a local crew. The ceiling on each lm was
set at $600,000, but has since been raised to $1.25 million. The French
producers organization, Centre National de la Cinematographie (CNC)
has also been working with French banks to create a program through
which the banks can lend against the tax credit.
In France, private individuals and corporations can invest in a lm up
to 50 percent of their tax liability in a given year and write it off 100 per-
cent. Such private investment is limited to 25 percent of the individuals
taxable income. Even though the investment is tax deductible, the prot
the investor may make on the lm investment is subject to being taxed.
Also, the investor is in a rst recoupment position. A group of companies
(known as SOFICA) work as intermediaries in arranging these deals for
producers and taxpayer-investors. In addition, France has more recently
created another form of tax incentive for investing in lm by allowing up
to 20 percent of the total cost of the lm as a tax deduction.
Hungary
Hungary offers a tax rebate scheme in which producers can recoup up
to 20 percent of their production costs spent in that country. There is no
limit on the size of the budgets that may qualify, except that lms with
budgets above $740,000 may claim their rebates more quickly by asking
for quarterly audits, as opposed to the annual audits provided for the
lower-budget lms. No system has been created for making it possible
to use the tax rebates as the basis for bank loans, although such facilities
may become available in the future. In other developments, a large studio
complex has been built near Budapest (at Etyek), and several lm schools
have been established to help meet the need for more crews.
Ireland
In Ireland, private individuals and corporations can deduct 80 percent
of their investment in a qualifying lm from their respective Irish tax
liability. To qualify, at least 60 percent of the lms production costs must
Cones Ch38.indd 268 12/20/07 1:51:56 PM
269
be spent in Ireland and 75 percent of the lm shoot must take place in
Ireland. The legislative provisions are contained in Section 481 of the
Taxes Consolidation Act of 1997 (formerly Section 35 of the Finance Act
of 1987, as amended). Section 481 has been extended to 2008, and the
ceiling on the level of investment that can be raised has been increased.
Because the law allows 80 percent of the amount invested to be written
off, investors look for a return on the net cost rather than on the full
amount invested, and this typically results in a contribution of up to
12 percent to the lms budget. The amounts that can be raised vary by
project size. Most investors seek projects with a possibility of securing
presale agreements that will give them a reasonable return on their net
investment when the lm has been delivered.
Section 481 investment is only available for the production amounts
spent in Ireland. A minimum of 10 percent of the work on the production
of the lm must be carried out in Ireland.
An Irish production company can only raise investor funds when it has
been certied by the minister for arts, sport and tourism, which issues
a certicate when satised that the production of the lm will benet
the national economy and the Irish lm industry. Benets to Irelands
economy result from direct expenditure on Irish services, facilities and
goods, including hotels, transportation and catering. Benets to the
industry include the use of Irish producers, directors, scriptwriters,
principal cast and crew, studio facilities, equipment and postproduction
facilities.
Foreign producers can partner with resident Irish independent pro-
ducers who can offer assistance in maximizing the amount of Section
481 nance for a production, as well as facilitating the smooth operation
of the production schedule.
Irelands Department of Arts, Sport and Tourism is the certifying body
for Section 481 tax relief. Guidelines for applications may be obtained at
http://www.gov.ie/arts-sport-tourism/.
Isle of Man
The Isle of Man offers a 100 percent tax write-off for private investors and
for the producer. It also offers up to 25 percent of the budget as a direct
equity investment (see chapter 36).
Luxembourg
To qualify for Luxembourgs tax incentive program, a producer must
attest to the government that a specied percentage of the production
will be spent in Luxembourg. After evaluating the producers claim, the
Cones Ch38.indd 269 12/20/07 1:51:56 PM
270
government provides the producer with a certication as to the amount.
The producer can then sell this government certication to a bank in
Luxembourg, which uses the certication for its own tax deduction
while paying cash to the producer. In effect, the bank is buying the tax
benet. Per the government regulations, the producer is not supposed
to receive the money until the lm is completed and the actual amount
spent within the country is known, but some Luxembourg banks will
cash ow such lm productions.
The Netherlands
The tax incentive program in the Netherlands requires that single-pur-
pose, limited partnerships be created for lm projects. Private investors
investment in the LP is tax exempt. In order to qualify,
the lm or lms must have at least 50 percent Dutch participation;
the copyright must be held by Dutch interests;
a collection agent must be in place;
a completion bond has to be arranged;
a release guarantee is required;
a sales agent has to be involved;
at least one or two presales outside the Netherlands must be effected;
and
sales estimates for other territories have to be submitted.
New Zealand
Private investors in New Zealand lms may take advantage of special tax
incentives provided in the Income Tax Act 1994. To qualify for these tax
incentives, the lm (or TV program) in question must rst be certied
as a New Zealand lm by the Film Commission because it contains sig-
nicant New Zealand content as set out in Section 18 of the New Zealand
Film Commission Act 1978. Those provisions provide that
1. in carrying out its functions, the Commission will not make nancial
assistance available to persons involved in the making, promotion,
distribution or exhibition of a lm unless it is satised that the lm has or
is to have a signicant New Zealand content;
2. for the purposes of determining whether or not a lm has or is to have a
signicant New Zealand content, the New Zealand Film Commission will
consider
a. the subject of the lm;
b. the locations at which the lm was or is to be made;
Cones Ch38.indd 270 12/20/07 1:51:56 PM
271
c. the nationalities and places of residence of:
i. the authors, scriptwriters, composers, producers, directors,
actors, technicians, editors and other persons who took part
or are to take part in the making of the lm; and
ii. the persons who own or are to own the shares or capital of any
company, partnership or joint venture that is concerned with
the making of the lm; and
iii. the persons who have or are to have the copyright in the lm.
d. the sources from which the money that was used or is to be used to
make the lm was or is to be derived;
e. the ownership and whereabouts of the equipment and technical
facilities that were or are to be used to make the lm; and
f. any other matters that the Commission considers relevant.
Certication allows investors to take a one-year write-off of their
pro rata share of lm production costs at the time of the lms comple-
tion (i.e., when the lm has been completely edited to its nal length).
Of course, New Zealand tax incentives are for New Zealand taxpayers,
meaning that in order to be useful to U.S. producers, some of the produc-
tion funds need to be raised from New Zealand residents. This, in turn,
suggests that a coproduction with a New Zealand production company
capable of providing some of the investor funds might be appropriate.
Mexico
The Mexican Congress has passed an incentive aimed at encouraging
investment in local lms. The incentive allows individuals and entities to
deduct the equivalent value of their investment in a Mexican lm from
their Mexican federal income tax. This deduction is capped at 3 percent
of the total tax bill, and a nationwide annual cap of 500 million pesos
($45 million) is imposed.
In addition, Mexico offers a lm-related scal incentive that gives
foreign productions a full rebate on the countrys 15 percent value added
tax, which is applied to nearly all goods and services.
South Africa
South Africa provides tax breaks for investment in lm through Section
24F of the Income Tax Act of 1962. The law provides for tax deductions
for expenses incurred in the production and postproduction of a lm if
such costs are incurred by the owner of the lm. This South African tax
deduction provides for the full amount of the production and postpro-
duction costs of a lm. To qualify, the taxpayer must be a lm owner,
Cones Ch38.indd 271 12/20/07 1:51:56 PM
272
that is, have sole or a shared interest in the lm. Thus, a U.S. producer
may coproduce with a South African production company. A provision,
however, excludes investors who use loans to be repaid out of the rev-
enues of the lm. In practice, the government generally only grants the
tax deduction if the production is deemed to be a commercial venture
that will make a prot.
The investments structured to take advantage of the South African
tax incentive typically involve a special-purpose entity, such as a lim-
ited partnership. Some variations on the transaction include sale-and-
leaseback arrangements that can help nance or partly nance the lm
production and facilitate cash ow. Independent lm producers benet
because the availability of the tax incentive can be used to help attract
investors. Individual South African lm producers have been offering
nancing opportunities to investors designed to maximize the tax ben-
ets permitted.
In addition, South Africa offers a tax credit that allows foreign produc-
ers to recoup up to 15 percent of their South African expenses, so long
as the production spends at least $3.8 million locally and completes 50
percent of principal photography in the country. The amount available
on a single production is capped at $1.5 million. Banks have not yet cre-
ated facilities for lending against the tax credit.
These tax incentives help South African producers to raise their share
of coproduction budgets for projects produced with foreign producers.
Reports indicate that there are a limited number of quality lm crews
in South Africa and sound stages need improvements. In recent years,
however, production costs have, on average, been about 40 percent less
than in the United States.
South Korea
South Korea offers lm companies a 50 percent reduction in their corpo-
rate tax for ve years. The incentive, however, only applies to companies
with 5 to 10 employees.
Sweden
In recent years, Swedish laws have been structured so that if Swedish
investors bought distribution rights in a lm, that investment would be
100 percent deductible in the year of the investment.
Ever-Changing Landscape
The laws upon which these tax incentives are based are subject to change
from year to year. As an example, Brazil once withdrew its tax incentives
Cones Ch38.indd 272 12/20/07 1:51:57 PM
273
for lms, and the Brazilian lm industry suffered a signicant retrench-
ment. The reintroduction of tax-driven incentives allowing companies
to write off up to 3 percent of their income tax in movie investments
produced a resurgence. The point is, do not expect a book such as this
to serve as the most current source for rapidly changing tax incentive in-
formation, especially in the area of foreign tax incentives. Instead, utilize
the services of an international tax attorney or accountant to conrm
the current rules in the countries of interest, or contact the applicable
government agency itself.
Advantages
Help with the budget. An attractive tax incentive can ease some of
the nancial pressure on a lms budget and be reason enough to move
production to a far-ung overseas location.
Investor interest. Investors may be more inclined to invest if signicant
tax benets are available.
Specialized assistance available. Law and accounting rms with exper-
tise in international tax shelters and tax incentives are available to assist
in structuring lm nance opportunities utilizing such techniques.
Access to tax incentives. Most foreign tax incentives can be accessed
with a local coproducer.
Disadvantages
Benets may be local. The available tax benets of the various tax in-
centive schemes are usually limited to investors who are residents of the
country offering them.
Copyright ownership. The qualified corporation claiming the tax
benet may have to own the copyright in the lm for which a claim is
being made.
Sometimes no cash. With some tax incentives, producers do not actu-
ally receive any cash.
A bureaucratic nightmare. A tax incentive that might look good on
paper can turn into a bureaucratic nightmare with uncooperative of-
cials, unskilled crews and regulations that are intricate and difcult
to understand.
Changing tax laws. The tax laws of each country change from time to
time (sometimes suddenly and often in unpredictable ways); therefore
it is difcult, if not impossible, for any written description of such tax
incentives to stay current without an ongoing subscription service.
Dependence on political climate. The availability of tax incentives may
depend on the political climate in a particular country. Governments have
Cones Ch38.indd 273 12/20/07 1:51:57 PM
274
been known to suddenly close what are perceived to be tax loopholes,
and such actions can leave a producer without the tax benets on which
he or she has relied.
Not good basis for long-term strategy. Because of the ever-changing
nature of these tax incentives, it is extremely difcult for a producer to
primarily rely on tax advantages for any sort of long-term lm nancing
strategy.
Professional help expensive. Most producers will almost certainly
require the assistance of a professional accountant or attorney who
specializes in international tax law in order to properly structure a tax-
sheltered deal for another country, and such specialized assistance does
not come cheap.
Abusive tax shelters. Film tax schemes have been notoriously abused
by some taxpayers who take advantage of special lm subsidies and tax
breaks as lucrative tax shelters. Part of the motivation in such cases is not
investment in the lm industry. Some lms partly nanced through tax
incentives are of such poor quality that they have never been released.
Risky investment. Even with tax incentives, many investors continue
to view investments in the lm industry as risky and many are reluctant
to get involved.
Cost to economies. By allowing a tax deduction for an activity like lm
production, the economy of a country offering such tax incentives is
looking to other taxpayers to make up the difference in its tax revenues;
thus, the impact of such programs can be seen as a cost to the other seg-
ments of the economy.
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275
39 Blocked Currency or Blocked Funds
Although not likely to be a source of signicant nancing, so-called
blocked fundsmonies that cannot leave a country because of currency
restrictionspresent another possible opportunity for an independent
producer whose lm could be shot in a foreign locale. Many developing
countries around the world have very little hard currency in circulation,
and foreign companies operating in these countries are often unable to
convert their retained earnings into hard currency, or to spend these earn-
ings on imported goods and services they need or to repatriate them to the
parent company. When monies earned by foreign companies cannot be
removed from a country (except under limited circumstances) because of
limitations imposed by local law, these earnings are said to be blocked.
The currency restrictions are designed to help the local economy.
Generally, such funds have to be spent within the borders of that
country to buy certain products or materials within that country, or in
producing a product or commodity that can then be taken out of the
country. In most instances, regardless of how much a company buys for
its use in that country, it will still have earnings left over. Accumulating
blocked funds is of little economic value.
Specically in the lm industry, blocked currencies may occur in the
form of lm rentals on U.S. lms released in that country, and often
distribution deals will provide that such funds be deposited in an ac-
count in that country for the benet of the distributor (sometimes for
the benet of the producer).
Blocked funds are also referred to as restricted currencies. Restricted
currencies are more formally dened as foreign currencies that are or
become subject to moratorium, embargo, banking or exchange restric-
tions or restrictions against remittances to the United States.
Blocked funds that accumulate in the bank accounts of U.S. and other
foreign companies in one of these countries can sometimes be used to -
nance a lm, which will generally qualify as a product produced with funds
spent in that country and the lm (i.e., product) can then be removed.
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276
So-called blocked funds deals are a variant method of motion picture
nancing that may be able to provide some below-the-line savings. In a
blocked funds deal, a lm producer purchases blocked funds or currency
at a discounted rate from banks or corporations doing business in a spe-
cic country. The producer may even raise a portion of the nancing from
investors in the United States with the specic strategy of identifying and
purchasing blocked funds in a country suitable for location shooting.
A producer seeking to nance the production costs of a motion picture
through the use of blocked funds must rst determine whether the lm
can be suitably produced in the target foreign country. Then the producer
must locate a sufcient amount of blocked funds in the same country for
the particular production.
In order to locate blocked funds, producers or their representatives
should identify and contact persons functioning as the treasurers or
chief nancial ofcers of U.S. corporations, including lm distribution
companies, that do a signicant amount of business in foreign countries.
Major international law rms and the larger commercial banks with
specialists in this eld may be able to provide useful information and
assistance in putting together such deals. Directly contacting the foreign
banks holding such funds is not generally productive since the banks
themselves would not be able to disclose the names of depositors at the
bank with blocked funds. Some U.S. companies specialize in developing
the worldwide expertise and information to overcome the blocked funds
obstacle. Some of those may be located online.
In an effort to narrow the prospects, the producer may rst want
to determine which foreign countries providing suitable locations and
production capabilities for the planned lm also impose the limitations
on the removal of currency from the country. Then the producer can
try to identify U.S. companies that do a signicant amount of business
in those countries and perhaps conduct an online search for companies
providing solutions for blocked funds or restricted currencies.
It may be possible to obtain a list of U.S. companies doing business
in a given country from the foreign trade commission of that country.
Another approach is to contact the lm commission in that country to
inquire whether its government imposes currency restrictions and what
foreign companies might have blocked funds there (see Ofcial AFCI
Directory in Sources and Further Reading).
Foreign coproduction deals utilizing blocked currencies have been
effected in recent years in Russia, Ireland, the former Yugoslavia and
Algeria. Brazil and India have also imposed restrictions on the amount
Cones Ch39.indd 276 12/20/07 1:54:17 PM
Blocked Currency or Blocked Funds
277
of their currencies that can be converted into U.S. dollars and taken
out of the country, but like tax incentives, these restrictions are con-
stantly changing.
An alternative, which would not involve the requirement that the
producer come up with purchase monies for blocked funds, would be to
convince the corporation holding blocked funds to use such funds as an
equity investment in the production of the lm. However, a company
with blocked funds will not typically want to enter into such a deal with
a producer who does not have a track record for producing lms that
generate sufcient funds to allow the company to recover its investment.
That tends to narrow the eld considerably.
A blocked funds deal is even more attractive in a country where the
U.S. dollar is strong and has a favorable exchange rate with the local
currency. A producer should also seek to negotiate a purchase price with
the companies holding blocked funds that is more favorable than the
ofcial exchange rate. This increases the buying power of the blocked
funds in the foreign country; thus, a producer could ostensibly increase
the production value of the lm even more in such a situation. It is help-
ful if the producer can nd a company that has been sitting on blocked
funds in a given country for a number of years. In that situation, the
corporation with blocked funds may be anxious to convert those funds
into U.S. dollars; in other words, the company holding the blocked funds
is a motivated seller.
Advantages
Discounted monies. Blocked funds are often available on a discounted
basis: for a $1 million investment, it might be possible to produce a $2
million lm on location in a foreign country.
In combination with investor nancing. Blocked funds opportunities
may be combined with a feature lm limited partnership or manager-
managed LLC such that U.S. investor funds are rst used to purchase the
blocked funds at a discount and are immediately leveraged into greater
purchasing power.
Not highly publicized situations. Companies with blocked funds try
to be discreet with regard to whom they disclose the existence of their
blocked funds. They do not want to be ooded with requests for blocked
funds deals. Although that may appear to be a disadvantage at rst, it
may be considered an advantage for feature lm producers since not
many producers are likely to be aware of these opportunities; thus, the
competition for such monies may be limited.
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278
Disadvantages
Blocked funds cost money. The producer will have to have enough
money to purchase the blocked funds at whatever discounted rate they
are offered.
Production problems. Many of the problems typically associated with
any foreign lm production will also be encountered in a blocked funds
deal; namely, restrictive regulations relating to the cast, crew and script,
language barriers, frequent delays, unstable governments, riots, civil war,
less than adequate housing facilities for the cast and crew. Of course, some
of these same problems may be experienced in Los Angeles.
The right amount of blocked funds. The producer will also have to nd
a company that has blocked funds in a given foreign country sufcient
to meet the lm production needs of the particular lm.
Other costs. Unless the producer is able to conduct all of the necessary
research, phone calls, inquiries, negotiations and documentation required
to put together a blocked funds deal, the producers representative, a
blocked funds specialist or an attorney will have to be compensated for
conducting those activities on behalf of the producer.
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40 Foreign Currency
Another modest lm nance benet may be gained through a so-called
foreign currency deala lm-nancing arrangement in which a foreign
country will offer to provide goods and production services for below-
the-line costs for a small amount of hard currency (U.S. dollars). Cur-
rencies may include anything that is in circulation in a given country as
a medium of exchange, including coins, paper money, government notes
and bank notes.
A currency conversion occurs when the money of one country is
exchanged for an equivalent amount of another countrys money. The
measure of value of currencies traded between various countries is re-
ferred to as the exchange rate. An exchange rate is considered favorable
to a particular currency when its purchasing power is on the rise, relative
to the value of the currencies of other countries.
At times, if a countrys currency, relative to gold or the currencies of
other nations, declines in value far enough, the government may be forced
to change the exchange rate unfavorably, in which case a devaluation of
the local currency is said to have occurred. Devaluation can also result
from a rise in the value of other currencies relative to the currency of a
particular country.
The countries that may offer foreign currency deals to lmmakers have
most likely suffered recent or long-term downturns in the value of their
currency and are interested in accumulating hard currency to prop up
their treasuries. Producers interested in this strategy of lm nance will
want to identify international currency traders or international attorneys
who may be able to assist in selecting countries that offer such exchanges.
In addition, a producer interested in such deals may want to monitor the
reported currency exchange rates in business publications.
Once again, in order to take advantage of the currency exchange op-
portunity, the independent lm producer will rst have to raise a suf-
cient amount of U.S. currency so that it can be traded for a signicant
amount of another countrys weaker currency. Then the other countrys
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280
currency can be used to produce some or all of the lm on location in
that country.
Producers who have experience with these sorts of arrangements sug-
gest that in order to justify the use of this nancing technique the desir-
ability of the location must be a more important consideration for the
particular lm than saving money. So, in the event that a lm project is
suitable for shooting in a foreign country, the producer may want to check
the currency exchange rates to see if such a deal might be worthwhile.
Advantages
Possible increased production values. Foreign currency deals may permit
the producer to leverage a quantity of hard currency production dollars
to acquire an increased quantity of goods and services that can be used
in the production of the lm for the same amount of cash.
Combined with international coproductions. The foreign currency deal
is another technique that may be combined with international coproduc-
tions to enhance the value of an internationally produced feature lm.
Disadvantages
Potential problems with foreign locations. Aside from being rare, foreign
currency deals, as with many lm-nancing arrangements involving
foreign locations, typically mean that the lms producer may have to
navigate through a difcult and archaic bureaucratic system, that the
technical production expertise and equipment made available may not
be up to par, that living standards may be unacceptable to many of the
lms above-the-line personnel and that extraordinary logistical problems
may be encountered.
Further devaluation. If the currency was so weak (and the economy so
poor) that the government had to devalue it once, it could happen again,
leaving the producer stuck with increasingly worthless paper.
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41 Foreign Below-the-Line or Facilities Deals
Once again, if some or all of a feature lm or documentary can be shot
in a foreign locale, the producer may want to investigate the availability
of so-called below-the-line or facilities deals.
Some foreign governments from time to time have offered to provide
the crew, locations, local cast, studio facilities and cameras so that a
signicant percentage (sometimes as high as 70 percent) of the lms
below-the-line costs are met. In exchange, these countries usually ask
for distribution rights in their own country, perhaps including the
nearby region.
Of course, a signicant portion of the lm would need to be shot in
the host country to make such arrangements worthwhile. Usually lm
stock is not included, and the cameras may not be very good. Most U.S.
productions utilizing below-the-line facilities deals have also taken their
own lighting.
In the past, below-the-line and facilities deals have been offered in
the former Czechoslovakia, Poland and Russia, but a lmmaker should
always check with the lm commission or agency in a country of interest
to see if such arrangements are available (see Ofcial AFCI Directory).
Some of the below-the-line or facilities deals may be accessed through
international coproduction deals if foreign coproduction treaties are
involved (see chapter 37).
Advantages
Reduced out-of-pocket costs. Since a signicant portion of the below-
the-line budget may be contributed in this manner, the producer does
not have to come up with as much money to produce the lm.
Greater value. The value of the below-the-line facilities offered may
be more important to the producer than the lm distribution rights
given up.
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282
Disadvantages
Sometimes an active partner. If a country provides more than 50 percent
of the below-the-line costs, it is likely to want to have some creative input;
that is, it may become an active partner.
Production problems. Again, many of the problems typically associated
with any foreign lm production will also be encountered in a below-the-
line facilities deal, namely, restrictive regulations relating to cast, crew and
script, language barriers, frequent delays, unstable governments, riots,
civil war and less than adequate housing facilities for the cast and crew.
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42 Foreign Government Subsidies
Another possible part of the lm-nancing puzzle for any given produc-
tion may include foreign government grants. These are specic donations
by foreign governments to lmmakers to assist in the production of a lm
that is deemed advantageous to the country or a given locale within the
country that is served by that government. In other words, production of
the movie will provide jobs and possibly favorable publicity and thereby
help the local economy.
Information relating to foreign subsidy lm programs is available
through each countrys embassy or lm commission (see Ofcial AFCI
Directory). In all likelihood, it would be helpful (and in many cases
necessary) to have a coproducer associated with the lm project seek-
ing funding who is a citizen and resident of the country from which the
grant is being sought.
General Eligibility Criteria
The following is a generic example of the eligibility criteria that must
be met by a production company in order to receive the kind of foreign
subsidies commonly offered:
at least one of the production companies producing the lm must be
established in the country where the subsidy is sought and authorized
to carry out production activities;
the management of one of the production companies must be composed
of citizens of that same country;
the production must also use studios and labs in the same country;
the lm must satisfy a specied number of points on a point system
relating to technical and artistic content;
the total amount of nancial aid that can be granted by the government,
including the production subsidies and other aid, cannot exceed 50
percent of the nal production cost of the lm; and
the production company must invest the granted production subsidy
amounts within a specied period of time.
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284
Canadian Funds
Other than the tax incentives offered through the Canadian federal and
provincial governments (see chapter 38), there are four other Canadian
government programs that benet the television and lm industry:
The Canadian Televison Film (CTF) Fund. The CTF has an annual budget
of approximately $250 million to be used for the purpose of enhancing
the creation and broadcast of high-quality, culturally signicant, Cana-
dian television programs.
Culture Industries Development Fund (CIDF). The CIDF program seeks
to support Canadian cultural production by providing a range of nan-
cial services, especially term loans.
Feature Film Fund. The Feature Film Fund seeks to encourage the
making and marketing of Canadian feature lms that have high box-
ofce potential, while supporting a range of genres, budgets, companies
and regions.
New Media Fund. The New Media Fund is designed to aid in the devel-
opment of Canadian companies and professional associations (orga-
nizations or agencies representing Canadian new media) active in new
media content production and distribution on-line.
German Federal and State Funds
Subsidies have also been provided in the past by the German Film Board.
German movies generally only make up about 12 percent of the countrys
national box-ofce take. Recent increases in federal funding of lm sub-
sidies have provided more funds for producing lms, developing scripts
and supporting new talent.
German Film Board subsidies, however, are generally given to vet-
eran lm producers in that country, and future subsidies are tied to a
producers success at the box ofce. If the moviegoers buy tickets at the
box ofce to see that lmmakers movies, his or her chances for getting
subsidies for another lm are improved. It is likely that a non-German-
based producer would have to partner with such an experienced German
producer to access such subsidies.
As might be expected with any government program, there have
been complaints. Some German producers feel that their federal system
does not work the way it should. As it now stands, a German lmmaker
is eligible to obtain funding from the German Film Board if his or her
lm is seen by 100,000 or more moviegoers. Some German lmmakers
see that as a system that rewards the haves (those with the least need)
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Foreign Government Subsidies
285
and punishes the have nots (those with a greater need for assistance).
In other words, the German national lm subsidies reward commer-
cially successful lms, and in effect, punish new lmmakers without a
track record.
The German Film Board, however, is not the only source of funds
in that country. Each of the German states has its own lm board and
distributes funds also. A lm subsidized by a state program has to be
shot in that same state. On the other hand, at least one of the German
states (North Rhine-Westphalia) signicantly reduced funding for lm
and other media projects in 2003 because of severe budget shortfalls. The
state media funding division had been providing infrastructure and lm
subsides since 2001.
French Subsidies
The French lm subsidy program is centralized. French lmmakers send
their applications to one address at the National Center for Cinematog-
raphy (CNC) in Paris, which distributes nearly all French lm-related
subsidies. The CNC funds production as well as preproduction and
development. The French also grant large sums of money for festivals,
promotion, training new talent and investing in movie theatres.
The French have created a system whereby some 11 percent of box
ofce receipts for all lms exhibited in France is sent back to the CNC,
including the box ofce receipts of U.S. and other foreign lms shown
in that country. In addition, since the French recognize that a signicant
portion of television programming is lm (i.e., television benets from
lm), the French television broadcasters are obligated to contribute to-
ward subsidizing the French lm industry (i.e., about one-third of the
money that subsidizes the lm industry in France comes from the French
television broadcasters).
Austrian Regional Funds
Government-approved lms in Austria once received 80 percent of their
budget from that countrys government, leaving the producer responsible
only for the 20 percent balance. However, Austrias right-of-center ruling
coalition eliminated nearly 40 percent from their federally funded Aus-
trian Film Institute (AFI) in 2001. Subsequently, the countrys regional
lm boards were able to offset those cuts by boosting their own spending.
Thus, in Austria, funds like the Vienna Film Fund have become the main
sources for lm money in that country. These developments further il-
lustrate how unreliable all forms of government subsidies can be.
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286
The Vienna Film Fund provides nancing for projects completed
in association with an Austrian producer. It has a yearly budget of $20
million and requires a foreign producer to develop lms with a local
Austrian lm producer. The Austrian Film Commission maintains a list
of local producers in Austria with international coproduction experience
who are qualied to enter into coproduction arrangements with foreign
lmmakers under the Vienna Fund. Also, each lm project funded by
the Vienna Fund must spend at least 100 percent of the funded amount
in the Vienna community (e.g., lming costs, talent, hotel and travel
expenses, etc.).
Another regional fund in Austria, the Cine Tirol Film Fund, provides
assistance for projects completed in the Tirol region of Austria. The Cine
Tirol Fund, started in April 1998, provides money for lms with one of
the following criteria:
the project is developed in the Tirol region;
the underlying story concerns an event or the people in the Tirol region;
or
a sufcient number of the people who live in the region work on the
project.
The Cine Tirol Fund has a small annual budget (approximately $1.4
million), and there is a ceiling on the amount of money that can be
awarded per lm (about 20 percent of the lms production budget).
Each production company must spend at least 100 percent of the amount
provided within the region. Unlike the Vienna Film Fund, no coproducer
arrangement is required. However, the Cine Tirol Fund is not a grant; it is
an interest-free loan to the production company. However, the production
company is only required to repay the loan if the movie is commercially
successful. And, for that reason, the administrator of the Cine Tirol
Fund requires that producers receiving such grants periodically provide
nancial reports relating to the lms earnings.
Spanish Subsidy Programs
Distribution and screen quotas have been relaxed in recent years in Spain
after the market share of local lms reached 11 percent. Amazingly, such
a low percentage is considered good for Spanish lms in that market. On
the other hand, the Spanish government has been leaning toward cutting
their program of advance subsides, one of the important subsidies for
rst lms in Spain. Instead, the government has been looking to concen-
trate on other subsidies linked to a lms box-ofce performance. Most
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Foreign Government Subsidies
287
observers feel that would work well for the big producers but would be a
disaster for the small production houses.
Jamaican Film Grants
Jamaica has established a grant fund program for foreign lmmakers
interested in developing projects in Jamaica. The Jamaica Film Fund is
administered by the National Investment Bank of Jamaica (a government
entity). Grants can be for as much as 20 percent of a lms production
budget for lms made in Jamaica, although a ceiling may be imposed on
the total amount. The Jamaican Film Commission actually selects the
grant winners. As of this writing, there were no copartner or coproducer
requirements, but check with the Jamaican Film Commission for the
current and more specic guidelines.
The Jamaica Film Fund is designed to encourage the use of Jamaican
technicians and professionals, in addition to help fund projects that por-
tray Jamaica in a favorable light. Who said lm is merely entertainment?
Advantages
Another possible funding source. Government subsidies provide another
possible source of funding for lms that are at least partly shot in the
granting country.
The right movie. The right movie that can be partly shot in the subsi-
dizing country can obtain some nancial assistance in this manner.
International coproductions. A producers chances of obtaining a for-
eign government grant may be increased if the production qualies as a
coproduction in the country from which the grant is being sought.
Disadvantages
Limited funds. All government subsidy programs provide only a limited
amount of funds, which may or may not be enough to fully fund a given
lm production project.
Funding levels change. The level of funding by federal and state gov-
ernment sources do change from time to time, depending on budgeting
factors that may have nothing to do with lm.
Takes a long time. The time it takes to get a decision on funding can
be lengthy.
Foreign locations. Foreign lm subsidies granted by foreign govern-
ments usually require that most of the lm be shot in the subsidizing
country, using almost exclusively native technicians, facilities and actors.
Such requirements may result in a reduction in quality.
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288
Staff expertise. A producer (or someone like the production attorney
or a consultant) seeking to utilize such lm-nancing techniques has
to become very familiar with the foreign regulations governing such
subsidies and the production of the lm.
Violate trade agreements. The subsidy programs that other countries
offer to lure lm production may not be consistent with World Trade
Organization (WTO) trade agreements.
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289
43 Foreign Debt Capitalization Programs
Although of limited use to most lmmakers, foreign debt capitalization
programs might be another component of a production budget for some
independent producers. Quite a few third-world countries owe large
amounts of money to foreign banks, and those countries have adopted
so-called debt capitalization programs in an effort to encourage the
purchase of that debt at a signicant discount in exchange for foreign
currency that can be used for production activities in the debtor coun-
try. The discounts typically range from 40 to 60 percent. The debt will
be exchanged for its full face amount in the foreign currency. Countries
with debt capitalization programs in recent years included Mexico, Brazil,
Costa Rica and the Philippines.
The producer with a motion picture that can be shot on location in a
foreign country and who desires to consider using a debt capitalization
program should rst contact the U.S. ofce of a representative of that
foreign country to inquire whether it has such a program (see Ofcial
AFCI Directory). If such a program is in effect, the producer will have
to complete an application that must then be approved by the foreign
country. Once approved, the foreign currency is contributed to a corpora-
tion incorporated in that country, the stock of which is owned by the U.S.
producer. The foreign corporation then produces the lm in that country.
The completed motion picture is actually owned by the foreign corpora-
tion, but it can be licensed back to the U.S. producer. In some instances,
it is possible for all ownership rights to remain with the U.S. producer.
Depending on the country involved, the specic manner in which the
transaction is structured and the way the U.S. production company con-
ducts its activities, unfavorable tax consequences may arise from a debt
capitalization program. For example, income to the U.S. producer may
be recognized immediately when the purchased debt is converted into the
foreign currency. Also, in some cases, foreign taxes may be imposed on
income earned on the motion picture. Thus, the advice of an international
Cones Ch43.indd 289 12/20/07 1:55:12 PM
290
tax attorney or accountant should be sought in structuring this sort of
lm nance transaction.
Advantages
Economic consequences. The producer is reducing third-world debt
while also making a lm and contributing to the local economy.
Discounted funds. Monies are available at signicant discounts.
Investor enhancement. Plans to take advantage of a specic foreign
debt capitalization program may prove to be an effective selling point to
prospective limited partnership or LLC investors, since their money can
then be leveraged to purchase signicantly greater production values.
Disadvantages
Specialized expertise. Generally speaking, the services of someone
who has expertise in this area of nance will be required. The Debt-for-
Development Coalition, based in Washington, D.C., provides consulting
services relating to debt capitalization programs.
Takes money to get money. The third-world debt has to be purchased,
thus some level of up-front funding is required.
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291
Conclusion: The Broader Film
Finance Environment
A book about lm nance is not complete nor entirely honest unless it
also provides some perspective on the broader lm nance environment.
In truth, all factors that have an impact on the ability of an independent
producer to nance a given lm (i.e., make it easier or more difcult to
raise money for a lm project) are part of that broader lm nance en-
vironment. Thus, this section focuses on the big picture (i.e., on those
factors that clearly have a signicant impact on who gets a lm nanced
and who does not, or why lm nance is often so difcult for many).
Several of the most prominent of these factors are discussed below.
The Law of Supply and Demand
The American lm industry has long been out of balance in a competitive
sense. For many years it has produced far too many movies, many more
than could possibly be distributed theatrically or protably. Too many
lms in the marketplace tends to keep prices low and make it unnecessary
for territorial distributors to pay advances or even commit to purchase
lms prior to their completion. So long as there exists such a profound
imbalance in the supply of motion pictures, lm distributors will con-
tinue to offer contracts of adhesion on a take-it-or-leave-it basis. Many
institutions contribute to the lm industrys imbalance between supply
and demand, including the far too many lm schools, lm festivals and
lm commissions who feed into and support the greed of the Hollywood
major studio/distributors.
Lots of people in the industry talk about this oversupply of feature
lms, but few, if any, individuals or organizations are doing anything
about it. The very rst step in resolving this problem is for some orga-
nization in the industry to step up and undertake an annual study of
just exactly how many lms are being produced versus how many lms
obtain a theatrical release or other distribution, and then to disseminate
this factual information to all concerned interests, including lm schools,
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Conclusion
292
lm commissions and lm festivals, so that, at least, the young people
considering careers as lm producers will have more than mere specula-
tion on which to base that career decision.
The World of Film Finance Scams
There are other aspects of the lm industry environment that indirectly
(and sometimes directly) impact the independent producers ability
to fund lm production activities. Many of these are actually scams
(fraudulent or deceptive acts) at one level or another and are intended to
separate the producer from his or her money. A review of the history of
Hollywood reveals that scam artists were there from the beginning, prey-
ing on unsuspecting producers, actors, actresses and all of the dreamers
seeking fame and fortune in this business.
The following scams are directly or indirectly related to lm nance
and have been occurring in the so-called lm community for many
years. Unfortunately, none of the organizations purporting to represent
various interests within the lm industry have seen t to effectively deal
with such scams. In fact, some of the scams are being committed by lm
industry organizations. Thus, independent producers need to reorganize
and work on these problems affecting their vital interests or, at least, be
aware that such scams are ongoing and try to avoid them.
Studio business practices. Major studio/distributors based in Hol-
lywood engage in hundreds of well-documented unfair, unethical,
unconscionable, anticompetitive, predatory or illegal business practices
that permit the major studio oligopoly to dominate the domestic lm
marketplace, squeeze the lms of independent producers off the avail-
able screens and make it more difcult for independent producers to get
their lms nanced.
Manipulated risk. A signicant part of the risk associated with the
production of independent lms is articially created by the overly wide
releases of major studio/distributor lms and the excessive power of
these majors to get their lms (some of which are of mediocre to poor
quality) on theatre screens in place of independent lms regardless of the
comparative quality of the competing lms.
NASAA survey. The North American Securities Administrators As-
sociation recently released its annual survey of the most common ploys
being used to cheat investors. Six of the ten are being used to cheat inves-
tors in lm deals. Those include unlicensed individuals selling securities,
unregistered investment products, promissory notes, senior investment
fraud, high-yield investment schemes and Internet fraud. Most of such
deals are being offered by telemarketers.
Conclusion
293
Finder scams. Finders sometimes advise independent producers that
they will raise money for the producers lm regardless of whether the
federal and state securities laws apply to the transactions. Finders also
sometimes work the Hollywood networking scene in search of inde-
pendent producers desperately seeking production nancing and offer
to introduce the producer to the manager of an off-shore trust fund
interested in nancing feature lms. Ultimately, all of what appears to
be legitimate activity leads to a request that the producer pay some sort
of fee to the purported nancing source prior to funding. Once that fee
is paid, the nder and all others associated with the supposed funding
effort disappear.
Securities law dodge. Some entertainment attorneys advise independent
producers to ignore the federal and state securities laws when raising
money from a group of passive investors, by using promissory notes that
are repayable out of the lms revenues. Unfortunately, such transactions
involve the sale of unregistered securities.
Misuse of business plans. Entertainment attorneys or other lm nance
consultants sometimes encourage lmmakers to raise money from pas-
sive investors with only a business plan, when a securities disclosure
document is required.
Investor come-ons. Attorneys and lm nance website services some-
times use the suggestion that they may be able to help bring investors to
client lm offerings as a come-on to get the clients offering business (if
the producer hires them), when they either have no intention of bringing
investors to the table or the independent producer has no way of knowing
whether it might happen.
Tie-in arrangements. Entertainment attorneys sometimes offer to pre-
pare a securities offering memorandum for a smaller fee, so long as the
producer agrees to hire them for the production documentation and other
entertainment work associated with the production and distribution
of a feature lm, without being knowledgeable in the area of securities
offerings and also while raising the amount normally charged for the
production work to make up for the smaller offering fee.
Misinformation for dollars. Film industry organizations that spon-
sor lm nance seminars sometimes assemble panels of people who do
not have bona de expertise in a given area (e.g., equity nancing) and
thereby provide not only inadequate coverage of the subject matter but
false and misleading information.
Unreliable information. Attorneys, lm nance consultants and pro-
ducers serving as panelists on lm nance panels sometimes actually
give out erroneous information to unsuspecting independent producers.
Conclusion
294
Independent producers need to step up and demand better and more
reliable information.
Biased seminars. Almost all lm nance presentations are biased in one
way or another. Thats because no single individual possesses bona de
expertise in all areas of lm nance. But some lm industry organizations
cross the line and knowingly provide false and misleading information,
because they are more interested in making money on their seminars
by selling the right to serve as a seminar sponsor to people who do not
have bona de expertise in some of the areas presented. Other groups
are biased in the sense that they consistently provide seminars extolling
the virtues of one form of lm nance (e.g., lender nancing) but fail-
ing to provide equal time for other forms of lm nance (e.g., investor
nancing). Such groups are thus failing to fairly meet the information
needs of their own members.
Hollywood Is an Insiders Game
The Hollywood-based U.S. motion picture industry is dominated by
a small group of so-called major studio/distributors. The studio and
afliate releases are the movies seen by some 97 percent of the domes-
tic moviegoing audience and a signicant percentage of most foreign
audiences. Aside from the fact that various creative people, including
screenwriters, directors, producers and actors, contribute to the content
of individual motion pictures, the people in Hollywood who have the
power to decide which movies are nanced, produced and released, to
determine who gets to work in the key positions on such movies and to
approve of the screenplays serving as the basis for these movies are the
three top studio executives at the major studio distributors. (For more
information on this topic, see my books Hollywood WarsHow Insiders
Gained and Maintain Illegitimate Control over Hollywood and The Feature
Film Distribution Deal: A Critical Look at the Single Most Important Film
Industry Agreement.)
Without a doubt, Hollywood is a very challenging environment for
would-be lmmakers. With most aspects of movie makingfrom nanc-
ing to distributionlargely controlled by a small group of Hollywood
insiders, and with a raft of misinformation, scams, bad advice and other
potential pitfalls looming, the odds are against independent lmmakers.
This book was written to help even those odds, by providing those who
are not insiderswhether they be producers, executive producers, at-
torneys, screenwriters, investors or otherswith information, strategies
and advice that may help them succeed in nancing their feature lms.
Appendixes
Sources and Further Reading
Index
Cones AppA.indd 295 12/20/07 1:54:03 PM
297
Appendix A: Finding Investors
Investors for lm projects may be business entities like corporations or
partnerships, but more often than not they are individual people. Film-
makers often ask where they can nd investors. The answer is that they
are everywhereeverywhere people are found. Filmmakers must under-
stand that there is no particular physical place on earth where investors
interested in investing in an independent lm gather, except occasionally
some of them may attend lm festivals and lm-nancing seminars for
the purpose of learning more about the industry.
Purported lists of investors specically interested in investing in lm
are notoriously inaccurate, out of date and otherwise worthless, and so
are the broader lists sold by list purveyors of so-called wealthy investors.
In addition, a producer must know when it is permissible to cold call a
prospective investor and when such a general solicitation is prohibited by
the securities laws. The relatively new do-not-call restrictions also apply
and severely limit a producers ability to call a prospective investor out
of the blue. Telemarketers often fail to comply with both the securities
laws and the do-not-call limitations, so beware.
The best approach is to be aware of when it is appropriate to approach
prospective investors that you do not know (see Marketing Consider-
ations below), and in your conversations or other communication with
individuals, watch for any of the common motivations often associated
with prospective lm investors that are listed below. At least one of the
keys to nding investors (i.e., looking in the right places) is analysis of
investor motivation. First, do some brainstorming with your associates
regarding what might motivate anyone with money to invest some of it
in your high-risk venture. There may be others unique to a specic lm
project. Some of these descriptions of investor motivation are closely re-
lated and may even overlap. They are presented in no particular order.
Career support. An investor has close ties with the lmmaker and is
interested in supporting the lmmakers career.
Appendix A
298
Glamour. An investor is enamored with the glamour of the lm in-
dustry or the idea of owning a piece of a movie.
Cocktail chatter. An investor feels the investment has a certain amount
of cocktail chatter value, (i.e., its more interesting and fun to talk about
than most boring investments in their portfolio).
Association. An investor wants to be able to spend some time on the
set and rub elbows with the cast and crew (this needs to be carefully
controlled so that it does not get out of hand).
Learning experience. An investor wants to use this investment as an
opportunity to learn about how the lm industry works, so that he or
she can get more involved in the future.
Extras. An investor would like for a son, daughter, niece or nephew to
appear as an extra in the movie.
Appear in movie. An investor wants to appear in the movie as an extra
or in a small part.
Local economy. An investor realizes that by investing in the movie, it
will help bring the movie to a specic locale, which will benet the local
economy.
Movie message. An investor is interested in one or more of the messages
being communicated through this signicant medium for the commu-
nication of ideas (i.e., all movies communicate something).
Tax incentives. An investor is in a position to take advantage of federal,
state, or international tax incentives for lm production expenses.
Screenwriter. An investor is a screenwriter and wants to get his or her
script produced.
Direct. An investor is also a director and (in rare and unusual circum-
stances) may want to direct the movie.
Make a prot. Although not usually the sole reason for investing, even
investors who invest in lms for some of the other reasons may also still
hold out hope that such a risky investment will result in a prot.
299
Appendix B: Limited-Use Business Plans
Filmmakers are often advised to create a business plan to help them raise
money. But it may not be appropriate in many situations. In all fairness,
the business plan is not a nancing vehicle or entity, and investors can-
not invest in one or buy shares in it. However, a business plan can be
used in conjunction with several other investor-nancing techniques to
raise money for lm projects. For example, it can be used with an inves-
tor-nancing agreement to raise money from a single active investor. It
can be used with a joint venture agreement to raise money from another
entity also acting as an active investor or joint venture partner. It can also
be used as a means of identifying possible founding shareholders for the
initial incorporation (a strategy discussed in chapter 5).
Another important use of the business plan is in establishing a preex-
isting relationship with prospective investors for a possible subsequent
privately placed securities offering (see chapters 1012). In this sense, the
business plan becomes a method for conducting a general solicitation
while looking for active investors (see chapters 36), and if the active
investor campaign does not prove successful, then the undertaking,
after a several-week waiting period, can be converted into a securities
offering (seeking passive investors). If the private placement approach is
used for the subsequent securities offering, those persons contacted dur-
ing the active investor general solicitation (using the business plan) may
be approached as prospective investors for the private placement, since
the initial contact with them is likely to be sufcient to establish that a
preexisting relationship exists, which, although not technically required
by the federal securities laws, still is an important element in proving that
no general solicitation occurred during the period in which the securities
offering was being conducted as an exempt/private offering.
The business plan, however, is not all that useful for seeking nanc-
ing from studios or other industry sources. Industry professionals are
more interested in a producers package (i.e., the script, evidence of
copyrights, information relating to attachments and the budget). As a
Cones AppB.indd 299 12/20/07 1:55:23 PM
Appendix B
300
general rule, a business plan is more useful for approaching nancing
sources outside of the lm industry (limited by securities considerations,
as discussed below). Also, a business plan is not appropriate for use in
seeking to raise money from a large group of passive investors, since that
activity tends to involve the sale of a security and a securities disclosure
document is required.
The lm production company business plan can be very similar to the
producers package except that it is usually bound and may be presented
in a more organized fashion (with a cover, table of contents and exhib-
its). The business plan is sometimes the rst step in procuring investor
nancing, whereas the producers package is used for similar purposes
in obtaining funding from a distributor or other industry sources. The
producers package might include, for example, a screenplay, a list of
credits for key persons attached to the project and a proposed budget,
whereas a business plan might include a synopsis of the screenplay, nar-
rative biographies of the key persons attached to the project and a use
of proceeds section, which corresponds closely to the budget top sheet
(except that it includes offering expenses, clearly a nonlm budget item).
A business plan can be as simple or as sophisticated as the producer and
his or her advisers choose to make it.
Completion Bonds
Note that the completion bond is also not a form of lm nance but
merely a nancial arrangement that helps to facilitate certain lm--
nancing transactions. For example, on most lender transactions (i.e.,
negative pickups, foreign presales, gap and supergap nancing and the
insurance-backed schemesall forms of lender nancing), the banks will
always insist that the producer obtain a completion bond to assure that
the bank will not have to worry about the lm going over budget. That is
simply a risk that the bank will not assume. Sometimes the studios will
also choose to purchase a completion bond on some of their lms, and
some independent producers may choose to purchase a completion bond
for an investor-nanced lm. However, the vast majority of the low- and
ultra-low-budget motion pictures produced by independent producers
each year probably do not use a completion bond.
Business Plan or Securities Disclosure Document
Based on numerous conversations with independent feature lm produc-
ers, there appears to be a considerable amount of misunderstanding and
misinformation in the lm community regarding when to use a business
Limited-Use Business Plans
301
plan as opposed to a securities disclosure document to raise money from
investors to develop, produce or distribute one or more independent
feature lms. The following discussion addresses that question.
First, the lmmaker needs to understand what a business plan is and
how it differs from a securities disclosure document. Although there may
be some similarities and overlap between them, these two documents are
not the same things. The differences are both in the content and in the
appropriate uses of the documents.
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: shares in
it cannot be sold. Nobody can invest in a business plan. If it 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 ve-
hicle, can be used to raise money, but only in limited circumstances; for
instance, to raise money from one, two or a few active investors. But it
cannot be appropriately used to actually raise money from a larger group
of passive investors, except in the case of so-called institutional investors
(i.e., organizations that regularly trade large volumes of securities, such as
mutual funds, banks, insurance companies, pension funds, labor union
funds, corporate prot-sharing plans and college endowment funds).
So, whats the difference between an active and a passive investor?
An active investor is someone who is regularly involved in helping the
lmmaker make important decisions with respect to the lm: helping
to select and make changes in the script, to select the director and lead
actors, to choose the line producer and director of photography, to solve
problems that come up during production, to make decisions relating
to distribution, and so forth. The active investors need to be capable of
making valuable contributions on important questions (i.e., they need
to have some knowledge of, and experience in, the lm industry that
is relevant to what the lmmaker is doing) and be actively involved in
helping to make such decisions on a regular basis.
That does not mean they should have veto power, although some inves-
tors who put in most of the money to produce a lm, 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 not have the limited liability protection
that most people who invest a substantial amount in a high-risk venture
Appendix B
302
like an independent lm would prefer to have. That is another factor
to consider when determining whether to use a business plan and seek
nancing from a small number of active investors.
On the other hand, a passive investor is someone who is not regularly
involved in helping to make those important decisions. This is an im-
portant distinction, because it represents the essence of the difference
between a nonsecurities offering and a securities offering. Essentially, any
time lmmakers or producers are seeking to raise money from one or
more passive investors, they are engaged in selling securities, no matter
what you call it. So, their decisions to raise money from active or passive
investors have important implications and consequences.
If you are really trying to raise money from one, two or a few active
investors, who are both capable and willing to be regularly involved in
helping to make important decisions, you can use a business plan com-
bined 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 (other than the institutional investors
noted above), you are required by law to provide those investors with a
properly prepared securities disclosure document (not a business plan)
prior to their investment.
In addition, using a business plan to raise money from a small number
of active investors should not suggest in any way that you are really seek-
ing to raise money from passive investors. In other words, either leave out
the discussion about the specic nancial arrangements or, at the very
least, avoid references to interests in limited partnerships or units in a
manager-managed (passive-investor) limited liability company (LLC).
Furthermore, the language in the business plan should not state or
imply that the investors will not be permitted to be regularly involved
in helping to make important decisions, since that is at the very heart of
what makes them active investors. It may be the better practice to spe-
cically state that the business plan is being used in conjunction with
one of those investment vehicles appropriate 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 possibly may later create a
limited partnership or manager-managed LLC, because that would clearly
indicate 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 a few active investors, because at some undened point, it is no
longer possible to keep a large number of investors actively involved in
a business venture in any meaningful way, and if even one of the investors
is passive, the interest sold becomes a security.
Limited-Use Business Plans
303
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 above, the four vehicles are: (1) the
investor-nancing agreement (for an example, see Film Industry Con-
tracts), (2) the joint venture agreement (an example of which also appears
in Film Industry Contracts), (3) the initial incorporation (see chapter 5 in
this book) and (4) a member-managed (active-investor) limited liability
company (which, in addition to the ling with the states secretary of state,
must also have an LLC operating agreement to be properly formed).
So, to repeat, 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 protec-
tion to your investors and (3) it may be more difcult to nd prospective
investors who are both capable of and willing to be lead investors in a high-
risk investment like independent lm. It is also important to recognize
that by seeking active investor nancing, you are eliminating at least two
of the advantages of a securities offering: spreading the risk among a larger
group of passive investors, none of whom will typically be hurt too badly if
they do not get their money back or make a prot; and, of course, passive
investors do not interfere with the lmmakers creative control.
Now, a quick note about terminology. 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 most 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 lmmakers. On the other hand, private place-
ment offering memorandum, or PPM, is the term used to describe the
securities disclosure document associated with an exempt/private offer-
ing, and this is the securities disclosure document most commonly used
by low-budget indie lmmakers.
Specic rules promulgated by the federal Securities and Exchange
Commission (SEC) and, in some instances, by 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 is why
there is both such a wide disparity in the content of business plans and
why that content is always different in some respect from the content of
a securities disclosure document, even though elements of the two are
the same or similar.
304
Appendix C: Financial Projections
Financial projections are estimates of the future economic performance
of a proposed business or venture. Financial projections are not required
for investor offerings for lm projects regardless of whether the selected
investment vehicle involves the sale of a security or not. However, inves-
tors seem to prefer that a presentation of nancial projections accompany
whatever documentation they receive. Financial projections provide the
prospective investor and the lm producer seeking investor nancing
with an additional point of discussion and serve as an excellent way for
the producer to visualize how lm revenues might ow back to the -
nancing vehicle, the producer group and the investors. In all likelihood,
a producer seeking investor nancing will be asked by investors about
how they will get their money back and make a prot. Thus, it behooves
the producer to do some research about this aspect of the transaction and
to understand and to be able to explain it as clearly as possible.
Where the sale of a security is involved, the SEC has a position on -
nancial projections and offers some guidelines for their preparation and
use. These SEC guidelines may be helpful in the preparation of nancial
projections for both nonsecurities and securities offerings. Pursuant to
the SECs Regulation S-B, Part 228 (Integrated Disclosure System for
Small Business Issuers), Section 228.10(d), the SEC encourages the use
of managements projections of future economic performance that have
a reasonable basis and are presented in an appropriate format.
The following guidelines set forth the SECs perspective on important
factors to be considered in preparing and disclosing such projections.
Basis for Projections
A lm producer (i.e., management, in this example) has the option
to present its good faith assessment of a small business issuers future
performance. Such a person or management, however, must have a rea-
sonable basis for such an assessment. In other words, the calculations and
numbers associated with nancial projections must be based on written
Cones AppC.indd 304 12/20/07 1:54:22 PM
Financial Projections
305
assumptions, and those assumptions must be reasonable in light of cur-
rent circumstances in the industry. Such assumptions cannot represent
wild speculation on the part of the producer regarding the anticipated
earnings of a proposed lm.
Outside Review
An outside review of the lm producers projections may furnish ad-
ditional support in this regard. If a lm producer decides to include a
report of such a review, it should also disclose the qualications of the
reviewer, the extent of the review, the relationship between the reviewer
and the issuer and other material factors concerning the process by which
any outside review was sought or obtained.
Format for Projections
Traditionally, projections have been given for three nancial items
generally considered to be of primary importance to investors: revenues,
net income (or loss), and earnings (or loss) per share or unit); however,
projection information need not necessarily be limited to these three
items. On the other hand, a producer should take care to assure that
the choice of items projected is not susceptible to misleading inferences
through selective projection of only favorable items. It generally would
be misleading to present sales or revenue projections without any of the
foregoing measures of income.
Period Covered
The period that appropriately may be covered by a projection depends
to a large extent on the particular circumstances of the company involved.
For certain companies in certain industries, a projection covering a two-
or three-year period may be entirely reasonable. Other companies may
not have a reasonable basis for projections beyond the current year. To
be meaningful, projections for a lm offering may extend to 57 years.
Also for a lm project, attempting to annualize project expenses and
revenues for each year may create an unnecessary quagmire of informa-
tion that cannot be understood by either the prospective investors or
the producer.
Investor Understanding
Disclosures accompanying the projections should facilitate investor
understanding of the basis for, and limitations of, projections. The SEC
believes that investor understanding is enhanced by disclosure of the
assumptions that in managements opinion are most signicant to the
Appendix C
306
projections or are the key factors upon which the nancial results of the
enterprise depend, and it encourages disclosure of assumptions in a man-
ner that will provide a framework for analysis of the projections. In other
words, the assumptions on which the calculations and numbers are based
not only should be reasonable, based on what is currently occurring in
the industry, but they should be set forth in writing.
With the ideal of investor understanding in mind, and recognizing
that it is impossible to predict with any accuracy how any independent
feature or documentary lm may perform in the marketplace, it might
be safer to offer several calculations (e.g., using a three-column format
to show Poor Performance, Good Performance and Excellent Per-
formance). That way, it is made clear to prospective investors that the
lm producer, or whoever prepared the nancial projections, is not at-
tempting to predict the future performance of the lm. Instead, he or
she is simply illustrating how the lms revenues may ow back to the
investors and what deductions may be taken from the revenue stream
at various stages along the way, while basing the projections on certain
reasonable and written assumptions that accompany the actual numbers
and calculations.
The Amount of Detail
Film producers often make the mistake of trying to provide too much
detail with respect to anticipated revenue streams when preparing nan-
cial projections associated with investor nancing of a lm project. In
many such instances, neither the producer nor the prospective investors
understand such complicated projections and the money paid for them
is wasted. In any case, such elaborate projections do not necessarily come
any closer to accurately projecting the nancial results of a lm project
than the format recommended here. In addition, the lm industry is
notorious for failing to provide useful, relevant and accurate informa-
tion about the nancial performance of prior feature lms, much less
for the markets and media beyond the theatrical marketplace, and worse
yet for the independent sector. For that reason, it may be impossible to
nd reliable information regarding anticipated revenues from each of
the individual markets and media through which a lm might generate
income. Merely assuming a reasonable level of overall performance for
a lm (as it is exploited in all markets and media throughout the world)
and then deducting the expected (and reasonable) fees, expenses and
percentage participations from the revenue stream, as it ows back to
the investor group, may be a more rational approach.
307
Appendix D: Securities
Marketing Considerations
Sometimes independent lm producers and their advisers blur the lines
between marketing considerations and compliance obligations when sell-
ing securities, partly because the two commonly overlap, but sometimes
because neither the producer nor the lm nance adviser are aware that
the producer is even selling a security. The rules relating to the sale of a
security (i.e., manner of offering) differ signicantly from how a nonse-
curities investment may be marketed. And the specic rules relating to
the manner of offering, particularly for the sale of a security pursuant to
a private placement/exemption, differ depending on the specic exemp-
tion being used. So the producers decisions relating to which investment
vehicles or entities are to be used and the specic approach to lm nance
that is being used will help determine what marketing techniques may
be appropriate.
As used here, the term marketing considerations refers to the appro-
priate ways in which securities are offered or sold. The emphasis is on
compliance with the law, as opposed to selling techniques. Nevertheless,
keep in mind that, as has been said, securities are generally not bought,
they are sold. On the other hand, there are plenty of books available on
how to sell almost anything. This section is about how to sell securities
in a legitimate manner, so that no laws or SEC rules are broken and the
lmmaker can avoid a nasty legal entanglement or a huge, unpayable
debt to investors.
Essentially, securities (whether corporate shares, interests in a limited
partnership or units in a manager-managed LLC) are sold in three dis-
tinctly different ways: broker/dealer sales, issuer sales and nder sales.
Broker/Dealer Sales
The SECs Regulation D, Rule 502(c), places certain limitations on the way
in which sales of securities can be marketed pursuant to this exemption.
The following discussion provides the text of the Regulation D provi-
Cones AppD.indd 307 12/20/07 1:53:53 PM
Appendix D
308
sions relating to the manner of offering, along with certain of the SEC
staff s interpretations of such provisions, and is followed by discussion
of related issues.
Limitation on manner of offering. Except as provided in Rule 504(b)(1),
neither the issuer nor any person acting on its behalf shall offer or sell
the securities by any form of general solicitation or general advertising,
including, but not limited to, the following: (1) Any advertisement, article,
notice or other communication published in any newspaper, magazine, or
similar media or broadcast over television or radio: and (2) Any seminar
or meeting whose attendees have been invited by any general solicitation
or general advertising.
Rule 504(b)(1), referred to above, provides that the provisions of Rule
502(c) do not apply to offers and sales of securities under Rule 504 that
are made exclusively in one or more states, each of which provides for
the registration of the securities and requires the delivery of a disclo-
sure document before sale, and that are made in accordance with those
state provisions. This Rule 504 exclusion would not apply to offerings
relying on state exemptions from registration (i.e., private placement
offerings).
According to the SEC staff in an opinion letter (SEC No-Action Letter,
E. F. Hutton & Co., December 3, 1985), procedures for a planned private
offering would not run afoul of Rule 502(c) so long as the issuers or the
broker/dealer rms preexisting relationships with the offerees were not
established through a recent general solicitation. The offerees need not
have invested previously in securities with the issuer or the broker/dealer
rm. In addition, the staff conceded that substantive relationships may
be established with persons providing satisfactory responses to question-
naires designed to elicit their sophistication and nancial circumstances.
Such Suitability Questionnaires and New Account Forms, however,
must provide sufcient information for the broker/dealer rm or issuer
to make the suitability evaluation.
In a similar no-action letter made available the same day (SEC No-
Action Letter, Bateman Eichler, December 3, 1985), the SECs Division of
Corporation Finance advised the rm of Bateman Eichler that its pro-
posed solicitation, which would be generic and not make reference to any
specic investment currently offered or contemplated for offering by the
company, would not involve an offer of securities. Bateman Eichler had
represented in its inquiry that it would maintain records of all mailings
so that no person who was originally contacted through the generic mail-
ing would receive offering materials for a specic investment currently
Securities Marketing Considerations
309
offered or contemplated. The mailing included a questionnaire designed
to elicit nancial and other information about the prospective customer
to enable the broker to evaluate the suitability of future investments. The
SEC advised Bateman Eichler that later offers to persons who responded
to the mailings would not be deemed a general solicitation as a result of
the initial solicitation, provided that a substantive relationship had been
established with the offeree between the time of the initial solicitation
and the later offer.
Another SEC no-action letter (H. B. Shaine & Co., Inc., May 1, 1987)
confirmed that satisfactory responses by strangers to an adequate
questionnaire will itself establish the requisite preexisting substantive
relationship.
Also, it would appear that an isolated slip-up in the offering process
(e.g., an inadvertent cold call by a broker) probably does not constitute a
general solicitation that would destroy the Regulation D exemption, since
the SEC has opined (Securities Act Release No. 6825, March 14, 1989) that
if an offering is structured so that only persons with whom the issuer
and its agents have had a prior relationship are solicited, the fact that one
potential investor with whom there is no such prior relationship is called
may not necessarily result in a general solicitation.
The issuer or broker/dealer rm should maintain control over the
number and qualications of investors to whom limited partnership in-
terests (or units in a manager-managed LLC) will be privately offered. The
more registered representatives participating in the offering, the greater
the potential for attracting unsophisticated or otherwise unqualied
investors and, hence, the greater the need for a uniform and documented
system of making such offers.
To accomplish the goals of control over the investor pool and uni-
formity in their methodology, the issuer or broker/dealer rm should
develop offering and investor selection procedures. These procedures
should ensure that offering materials are sent only to prospective offerees
with whom the issuer or broker/dealer rm has established a business
relationship or who have indicated they wish to form a relationship such
that the rm knows the prospective investors suitability. Such proce-
dures not only comply with but exceed both the statutory and regulatory
requirements imposed on the manner of offering securities in exempt
transactions, according to the SEC staff.
No investor should be offered securities in a private placement type
offering unless the issuer or broker/dealer rm has on le a new account
form or something similar and a fully completed suitability questionnaire
dated within the last year.
Appendix D
310
Furthermore, to ensure the private nature of the offering, strict and
uniform distribution procedures should be maintained. The issuer or
broker/dealer rm should provide detailed instructions to each upper-
level manager, selling agent or registered representative regarding the
categories of persons who may be contacted regarding a private offering.
Only authorized preoffering and offering materials should be provided
to the prospective investor.
If a prospective investor expresses an interest in a future offering,
a condential private placement offering memorandum should be as-
signed to the registered representative for delivery to that party when
the memorandum is ready.
For 5 years following the sale of such securities, the issuer or broker/deal-
er rm should maintain the following information for each purchaser:
source of contact or referral;
nature of the relationship with the offeree;
previous investments with the issuer or broker/dealer;
list of the informational materials provided; and
copy of the clients suitability questionnaire relied on.
Offerees should be prequalied on either the basis of information ob-
tained through a preexisting business relationship or the data provided
by the suitability questionnaire and the new account form indicating
that the offeree not only desires to form a business relationship with the
issuer or broker/dealer rm but also has the requisite sophistication and
nancial resources to be a suitable purchaser.
The SEC staff emphasizes the importance of the existence and substance
of prior relationships between the issuer or its agents and those being so-
licited. It is crucial, the staff points out, that (1) substantive relationships
be created with offerees and (2) that the relationships be preexisting (i.e.,
exist prior to a solicitation relating to a specic private offering).
As any such relationship may have been established as a result of a
general solicitation or advertising, it is important that there be sufcient
time between establishment of the relationship and an offer so that the
offer is not considered made by general solicitation or advertising. In the
SEC staff s view, if the relationship was established prior to the time the
broker/dealer rm began participating in the Regulation D offering, an
offer could be made without violating Rule 502(c).
Catherine McCoy, associate director (legal) of the SEC Division of
Corporation Finance, summarizes staff positions in SEC no-action let-
ters on interpreting Rule 502(c) as follows:
311
There is no requirement for a preexisting relationship between the person
making an offer to sell securities and the offeree. Rather, a preexisting
relationship is one factor among others to be considered in determining
whether a general solicitation has been avoided. A broker/dealer rm does
not have to have sold deals to an investor before selling the Regulation D
offering, but should have gathered satisfactory responses to information-
gathering techniques that indicate the broker/dealer may sell the security
in an exempt transaction to the investor.
The SEC no-action letters referred to do not take any position on the
number of offerees. However, such letters address the stage when the
offeror is soliciting potential offerees and not a later stage when actual
offers are made.
Issuers may have a more difcult time in trying to copy the factual
circumstances involved in these no-action letters, which were aimed at
broker/dealers. Issuers should only solicit potential offerees at a time when
the issuer is not actually conducting an offering, unless the preexisting
relationship already exists.
Suggested Regulation D Soliciting Procedures
1. Upper-level management of the issuer, registered representatives
or selling agents should inquire as to the prospective investors general
interest in the type of investments being considered by the issuer or
broker/dealer rm.
2. A new account card and prospective offeree suitability questionnaire
or similar information should be completed and placed on le with the
issuer or broker/dealer rm.
3. A designated principal of the issuer or broker/dealer rm must
later examine the new account card and prospective offeree suitability
questionnaire and determine whether the prospective investor is suitable
for the subsequent private placement offering. Such approval should be
noted on the card.
4. If the designated principal approves the prospective investor as suit-
able, then and only then should an offering memorandum be checked
out to upper-level management, the agent or representative for delivery
to the prospective investor.
5. Once a specic offering has begun, no new account forms or suit-
ability questionnaires dated after the date the issuer or broker/dealer rm
begins its participation in such offering (and therefore no prospective
investors represented by such forms and questionnaires) should be ap-
Appendix D
312
proved for the offering that has commenced. Such prospective investors
must wait until a later offering is begun.
6. A date for the issuer or the broker/dealer rms participation in
each offering must be established.
7. Dates should be afxed to each new account form and suitability
questionnaire.
8. The designated principal should initial the approved space on each
prospective investors new account card and indicate the offering for
which each such prospective investor is approved.
9. Any preoffering materials, such as a corporate brochure, should be
approved by counsel and should not include any information that could
be construed as relating to a subsequent private placement.
10. Upper-level management of the issuer, registered representatives or
selling agents should stop making contacts with new prospective offerees
at least several weeks before the issuer or broker/dealer rm starts selling
a specic private placement offering.
Compliance recommendation. Review all procedures and activities
relating to the private placement offering and be certain that the conduct
of such offering is in compliance with the above stated rules. Also review
all provisions of Regulation D and discuss with counsel any activities
relating to the conduct of the private offering that may raise Regulation
D compliance questions.
NASD Guidelines on Compensation
The NASDs Rules of Fair Practice (which specically apply to public
offerings, but which may be applied informally by some state regulators
to private placements) provide that NASD member broker/dealer rms
or persons associated with such rms must not participate in a public
offering of a direct participation program (such as a limited partnership
or LLC offering) except in accordance with the NASDs Rules of Fair
Practice, Appendix F. These rules provide limitations on the amount of
money that can be expended on such an offering: No [NASD] mem-
ber [broker/dealer rm] or person associated with a member shall . . .
participate in a public offering of a direct participation program if the
organization and offering expenses are not fair and reasonable, taking
into consideration all relevant factors (Appendix F, Section 5).
In determining the fairness and reasonableness of organization and
offering expenses, the arrangements are presumed to be unfair and un-
reasonable if the total amount of all items of compensation from whatever
source payable to broker/dealers or afliates thereof that are deemed to
be in connection with or related to the distribution of the public offering
313
exceeds currently effective compensation guidelines for direct participa-
tion programs. Also, the NASD presumes offering arrangements to be
unfair and unreasonable if organization and offering expenses paid by
a program in which a NASD member rm or an afliate of a member
rm is a sponsor exceeds currently effective guidelines for such expenses.
The NASD guidelines regarding compensation are 10 percent of proceeds
received, plus a maximum of 0.5 percent for reimbursement of bona de
due diligence expenses. The NASD guidelines limit offering expenses
(i.e., organizational and syndication costs) to a total of 15 percent (Sec-
tion 5, Appendix F).
The NASD also considers it unfair and unreasonable for commissions
or other compensation to be paid or awarded either directly or indirectly
to any person engaged by a potential investor for investment advice as
an inducement to that person to advise the purchaser of interests in a
particular program unless such person is a registered broker/dealer or a
person associated with such a broker/dealer.
Furthermore, all items of compensation paid by the program directly
or indirectly, from whatever source, to broker/dealers or their afliates,
including, but not limited to, sales commissions, wholesaling fees, due
diligence expenses, other expenses, broker/dealers counsels fees, securi-
ties or rights to acquire securities, rights of rst refusal, consulting fees,
nders fees, investor relations fees and any other items of compensation
for services of any kind or description, which are deemed to be in connec-
tion with or related to the public offering, are taken into consideration
in computing the amount of compensation.
Compliance recommendation. In contracting with broker/dealer
rms, make sure that the terms and actual implementation of the sell-
ing broker/dealer or managing broker/dealer agreements comply with
these NASD rules for public offerings, or if in a private offering, use
these rules as a guide and look to the state exemptions for guidance as
to limitations or ceilings imposed on broker/dealer commissions or the
total offering expenses (including commissions). Some states apply the
public offering guidelines to private placements on an informal basis;
therefore it may be necessary to call the securities regulators and inquire
about such limitations.
Private Securities Transactions
In dealing with persons who hold themselves out as broker/dealers or
registered representatives of a broker/dealer rm, the NASD Rules of Fair
Practice, Article 3, Section 27, prohibits transactions in which an associ-
ated person (a person associated with an NASD member broker/dealer
Appendix D
314
rm) is selling to public investors on behalf of another party (e.g., as
part of a private offering of limited partnership interests or LLC units,
without the participation of the persons employer rm). In the view of
the NASD,
such transactions present serious regulatory concerns because securities
may be sold to public investors without the benets of any supervision
or oversight by a member rm and perhaps without adequate attention
to various regulatory protection such as due diligence investigations and
suitability determinations. In some cases, investors may be mislead into
believing that the associated persons rm has analyzed the security be-
ing offered and stands behind the product and transactions when in
fact the rm may be totally unaware of the persons participation in the
transaction. Under some circumstances, a rm may be held civilly liable
for the actions of their associated person even though the rm was not
aware of such persons participation in the transaction (NASD Notice to
Members 85-21).
1. Applicability of the rule. This rule would apply to any situation in
which an associated person of a member proposes to participate in any
manner in a private securities transaction. Private securities transaction
is dened broadly and specically includes private placement offerings.
2. Written notice requirement. The rule requires an associated person
to provide written notice to the NASD member broker/dealer rm with
which he or she is associated prior to participating in any private securi-
ties transaction. The notice must include a detailed description of the
proposed transaction and the individuals proposed role therein. Because
the rule treats compensatory transactions differently, it would also be
necessary for an associated person to state whether he or she will receive
selling compensation in connection with the transaction.
3. Transactions for compensation. The most serious regulatory con-
cerns relate to situations in which an associated person is receiving selling
compensation and therefore has an incentive to execute sales, perhaps
without adequate supervision and without adequate attention to suit-
ability and due diligence responsibilities. The rule requires that, in the
case of transactions in which an associated person has or may receive
selling compensation, an NASD member broker/dealer rm receiving
written notice from one of its associated persons should respond in writ-
ing, indicating whether the rm approves or disapproves of the persons
participation in the proposed transaction. If the rm approves of the
persons participation, it is then required to treat the transaction as a
transaction of the rm, to record the transaction on the rms books and
315
records, and to supervise the persons participation in the transaction to
the same extent as if the transaction were executed on behalf of the rm.
If the rm disapproves of a persons participation, the associated person
is prohibited from participating in the transaction in any manner.
4. Denition of selling compensation. The denition of selling compen-
sation is broad in scope and includes any compensation paid directly or
indirectly from whatever source in connection with or as a result of the
purchase or sale of a security (Rules of Fair Practice, Article 3, Section
27). This denition includes compensation received or to be received
by one acting in the capacity of a salesperson or in some other capacity,
including in particular the capacity of a general partner. The denition
is intended specically to address a practice in which associated persons
function as general partners or managers in forming limited partnerships
or manager-managed LLCs and then sell limited partnership interests or
LLC units in private securities transactions.
Compliance recommendation. If the issuer is considering using the
services of a person who is associated with a broker/dealer rm, make
sure that the rules stated above relating to private securities transactions
are followed.
Issuer Sales
The issuer of the securities to be offered by a lm or video limited part-
nership (limited partnership interests) is the partnership, including for
practical purposes its general partners and the upper-level management
of the general partner, if any. The issuer of the securities to be offered
by a lm or video manager-managed LLC is the LLC itself, including for
practical purposes its manager and the upper-level management of the
manager. Issuer sales of limited partnership interests or LLC units are
permitted under certain circumstances. However, if any such person or
entity engages either for all or part of his time, directly or indirectly,
as agent, broker or principal in the business of offering, buying selling
or otherwise dealing or trading in securities issued by another person,
then that person or entity may be considered a broker/dealer and as such
may be required to register with the SEC, the NASD, and in each state in
which such activities occur. See the denition of dealer in the Securities
Act of 1933, Section 2(12) and the denitions of broker and dealer in the
Securities Exchange Act of 1934, Section 3(a)(4) and (5).
The Securities Exchange Act of 1934, Section 15(a)(1), requires anyone
dened as a broker or a dealer to register: It shall be unlawful for any
broker or dealer . . . to make use of the mails or any means or instrumen-
tality of interstate commerce to effect any transactions in, or to induce
Appendix D
316
or attempt to induce the purchase or sale of, any security . . . unless such
broker or dealer is registered.
The issuer sales rule. Neither the ofcers or directors of a general part-
ner nor an individual general partner for a limited partnership offering,
and neither the ofcers or directors of an LLC manager or an individual
LLC manager should be considered broker/dealers if their activities are
in compliance with provisions of the Securities Exchange Act of 1934,
Rule 3a4-1.
The General Rules and Regulations promulgated under the Securi-
ties Exchange Act of 1934, Rule 3a4-1, sets forth the circumstances under
which the associated persons of an issuer of securities may be deemed
not to be brokers and therefore do not have an obligation to register
as brokers. An associated person of an issuer of securities will not be
deemed to be a broker solely by reason of his participation in the sale of
the securities of such issuer if the associated person
is not disqualied pursuant to the so-called bad boy provisions (see
NASAAs Model Accredited Investor Exemption in chapter 13);
is not compensated in connection with his or her participation by the
payment of commissions or other remuneration based either directly or
indirectly on transactions in securities;
is not at the time of his or her participation an associated person of a
broker or dealer;
primarily performs, or is intended primarily to perform at the end of
the offering, substantial duties for or on behalf of the issuer otherwise
than in connection with transactions in securities;
was not a broker or dealer, or an associated person of a broker or dealer,
within the preceding 12 months; and
does not participate in selling an offering of securities for any issuer
more than once every 12 months.
Thus, persons or entities that have not engaged in any of the prohibited
activities within the time period may engage in the sale of securities on
behalf of an issuer, and the issuer of the security may rely on the preex-
isting relationships of such persons for purposes of a private placement.
Thus, for marketing purposes, the pool of prospective investors for such
an offering can be signicantly expanded through reliance on the issuer
sales rule.
Compliance recommendation: Review all relationships with all persons
associated with the issuer or its general partners (or managers) that fall
within the scope of these rules and make sure their status and activities
are in compliance with this issuer sales rule.
317
Finder Sales
There seems to be quite a bit of misinformation on the streets regarding
the use of nders in a securities offering, such as with feature lm or video
limited partnerships or manager-managed LLCs. Finders are persons
who assist an issuer in some way in identifying a prospective investor.
Finders are not licensed as broker/dealers or registered representatives
of a broker/dealer rm, and they generally seek to be compensated for
their activities in a transaction-related manner (i.e., a commission).
Some will even ask for retainers up front, which in many instances is no
more than a scam.
Bad advice
Here is an instance of bad advice that was given in the area of nder
sales. One unidentied author posted an article at the Securities Law In-
stitute site titled Capital Formation via Private Placements (the article is
located at http://www.securitieslawinstitute.com/Capital%20Formation
%20Release.html).
In the article, the statement is made that a nder may be a company,
service or individual such as a broker/dealer who may receive a fee in
connection with the solicitation of potential investors. Quite to the con-
trary, it would be far better to draw a clear line between the denitions
of nders and broker/dealers; after all, they are distinctly different and
those distinctions are important for purposes of securities law compli-
ance. It is perhaps fair to state that a nder may be a company, service,
or individual who receives a fee in connection with the solicitation of
potential investors, but it is hardly accurate to suggest that broker/dealers
are merely one form of nder.
It is also fair to suggest that nders may be compensated for helping to
identify possible investors in nonsecurities transactions, but when the sale
or offer of a security is involved, a virtual mineeld of federal and state
statutory, regulatory, and case-made law is applicable. It is also important
to note the differences between the federal and state laws on nders. The
online article cited above is based entirely on federal law and thus does
not fully cover the subject. Unless a securities offering is exempt from
state jurisdiction pursuant to Regulation D, Rule 506, and NSMIA (see
chapter 12), state law generally prohibits any form of transaction-related
remuneration to be paid to persons not licensed as broker/dealers or
registered representatives of broker/dealers (i.e., nders).
Securities broker/dealers are generally rms, not individuals. The
principals of these rms are trained, tested and supervised by the Na-
tional Association of Securities Dealers, and their activities are regulated
Appendix D
318
by the SEC. The individuals who work for SEC- and NASD-qualied
broker/dealer rms are generally referred to as registered representatives.
These individual registered reps (as they are called) are trained, tested,
licensed and supervised by the broker/dealer rm for whom they work.
All securities sold by these individual registered reps must be approved
for sale by the broker/dealer rm. Individual registered reps cannot sell
securities that have not been approved by the rms due diligence ofce
(see Private Securities Transactions above).
On the other hand, nders are not necessarily trained, tested, licensed,
or supervised by anyone. Many of them do not know whether they are
selling a security or not and do not even care. A careless nder can easily
get an issuer of a security in trouble with the law.
Part of the confusion seems to stem from the fact that the federal
Regulation D exemptions do not specically limit who may be paid com-
missions. In addition, the Form D and the S-18 disclosure guidelines make
specic references to nders, suggesting that it might be permissible to
use their services. However, as noted above (see Issuer Sales), the federal
securities laws (as well as the state laws) require the registration of those
acting as brokers or dealers, and many of those performing the services
of a nder may well be in violation of such registration requirements.
A similar problem of analysis occurs in the online article Legal
Lens: Bringing in the MoneyLegal Issues on Working with or Being a
Finder in the Film Business written by Boston entertainment attorney
Vinca Liane Jarrett (see Sources and Further Reading). The article and
its conclusions are entirely based on federal law. State law is not even
considered. The federal law relating to nders is also more lenient than
state law. Thus, it is important for producers to consider whether their
particular offering is subject to state law jurisdiction before following the
suggestions found in such articles.
In point of fact, many of the state exemptions relied on in a private
placement specically prohibit the payment of any form of transaction-
related remuneration to persons who are not licensed as broker/dealers.
The language of the specic exemption in each state must be examined.
For example, in Michigan the available transactional exemption requires
that A commission is not paid or given directly or indirectly for solic-
iting any prospective purchaser in this state, except to a broker/dealer
registered pursuant to this act which is not afliated with the issuer or
its afliates (Michigan Securities Act, Section 451.802[b][9]).
A violation of such a prohibition may void the exemption from
registration and thus place the issuer in the position of having sold an
319
unregistered security. It would be an understatement to report that an
issuer cannot rely on a nder to always properly advise the issuer as to
whether the nder is in compliance with the federal and state securities
laws that legally regulate his or her activities. In fact, this author has on
several occasions requested that nders who proposed to raise monies
for client producers provide a legal opinion regarding the legitimacy of
their status, and not one of them has stepped forward to provide such a
favorable legal opinion to date.
Compliance recommendation. Do not use the services of nders in
states other than California (see discussion of nders in California be-
low) without a counsels opinion as to the status of nders pursuant to
those states securities laws and specically the provisions of those states
exemptions from registration being relied on for the offering.
Finders fees in California. Quite often in California the prospective
general partner or manager (and producer) in a feature lm or video
limited partnership or LLC offering will want to know (1) whether com-
pensation in some form may legally be paid to a person in California
for the sale in California of a limited partnership interest or LLC unit
in a privately placed feature lm or video offering if such person is not
licensed as a securities broker/dealer, or an agent of a broker/dealer, or an
agent of the issuer of such securities; (2) under what circumstances such
compensation may be paid; (3) what form of payment is permissible; (4)
what amount of payment is appropriate; and (5) what other considerations
the issuer of such securities should take into account.
For purposes of this discussion, a privately placed limited partnership
or LLC offering is dened as one exempt from registration in California
pursuant to Section 25102(f) of the California Corporations Code (the
Code) and at the federal level, pursuant to Regulation D. Such unli-
censed persons are referred to as nders and their compensation as
nders fees.
Californias limited offering exemption (Section 25210(f) of the Code]
provides that persons acting on behalf of an issuer shall not effect any
transaction in, or induce, or attempt to induce, the purchase or sale of
any security in the state of California unless such agent has complied with
such rules as the California Securities Commissioner may adopt for the
qualication and employment of such agents.
The California Code, Section 25003, in dening an agent, excludes
from such denition any individual who only represents an issuer in ef-
fecting transactions in securities exempted by Section 25102. Therefore
it appears that under California law, issuer sales of limited partnership
Appendix D
320
interests or LLC units exempt pursuant to the California Limited Offering
Exemption, Section 25102(f), do not fall within the denition of agent and
therefore are not required to be registered or qualied as such.
In addition, Californias Section 25102(f) and the regulations promul-
gated thereunder, unlike many other state exemptions from securities
registration, do not provide any limitations on who may be paid com-
pensation for the sale of securities pursuant to such exemption. Thus,
in California, it would appear at rst blush that the Limited Offering
Exemption is not voided if compensation is paid to unlicensed persons
(i.e., nders).
California case law, however, narrows the issue relating to this discus-
sion by holding that one who negotiates the sale (even in a single or iso-
lated sale) for an issuer of securities must be licensed as that issuers agent
(Evans v. Riverside International Raceway (1965), 237 CA2d 666, 47 Cal
Rptr 187). In addition, the California courts have held that an unlicensed
person acted as a broker (and therefore would be required to be licensed
as a broker) where such person was authorized to procure prospective
purchasers with whom the issuer could negotiate for a sale thereof and
assisted in the sale of the security by offering it at a certain price to the
purchaser and negotiating with the purchaser for such sale over a period
of months (Rhode v. Bartholomew (1949), 94 CA2d 272, 210 P2d 768).
In Nationwide Investment Corporation v. California Funeral Service,
Inc. ((1974), 40 Ca3d 494, 114 Cal Rptr 77), an investment company that
negotiated the purchase of all the outstanding securities of another
company on behalf of a client pursuant to a written contract was held to
have acted as a securities broker/dealer and was therefore subject to the
licensing requirements set out in Code Section 25210, even though the
securities themselves were exempt from the registration requirements.
Under such circumstances, the written contract was void and unenforce-
able, and the investment company could not recover compensation for
its services as a so-called nder.
The Rhode v Bartholomew case, cited above, provides additional
guidance by pointing out that a person who merely brings a buyer and
seller together so that they are able to make their own contract without
any aid from that person may be regarded as a middleman but will
be considered a broker if he or she takes any part, however slight, in the
negotiations. Also, in McKenna v. Edwards ((1937), 19 CA2d 327, 65 P2d
810), the court held that a person not engaged in the business of dealing
in securities, whose only activity consisted of (1) soliciting a purchaser, (2)
conveying to the issuer the suggestion of a possible buyer and (3) arrang-
ing for a conference between the seller and the prospective purchaser (in
321
which the person did not participate and that resulted in an agreement for
the sale of the security) was entitled to promised payment for the services
rendered, even though that person had no brokers license.
In addition, in the cases of Tenzer v. Superscope, Inc. ((1985), 216 Cal
Rptr 130) and Lyons v. Stevenson ((1977), 65 Cal App 3d 595, 135 Cal Rptr
457), the courts continued the approach that the question of whether a so-
called nder acted as a broker is a question of fact, requiring an examina-
tion of the persons conduct after the introduction of the buyer and seller,
to determine whether that person participated in their negotiations.
All of these cases seem to focus primarily on the question of whether
and under what circumstances one acting as a nder may successfully
sue for compensation offered or promised by an issuer in the sale of a
security. The issue of whether the payment of such compensation to nd-
ers may void the exemption from registration for the security transaction
is not addressed, presumably because the California Limited Offering
Exemption (Section 25102(f) of the Code], as mentioned above, does not
contain such prohibitory language. In addition, none of these cases seems
to focus on the question of other potential risks to the issuer of utilizing
the services of a nder (i.e., a person not licensed as a broker/dealer).
The primary risk to the issuer, other than possibly voiding the ex-
emption in many other states (but not necessarily in California), is the
question of the issuer being responsible for the proper supervision of
the activities of the nder with respect to the statements made by the
nder regarding the offering of such security in procuring a prospec-
tive purchaser. Clearly the issuer is responsible for any misstatements of
material fact made by a nder to a prospective purchaser on which such
prospective purchaser may have relied in the purchase of the security, and
such misstatements of material fact may provide a subsequent purchaser
with grounds for a civil right of rescission of the purchase contract based
on securities fraud.
California securities regulators have informally expressed the opinion
in private conversations with the author that they consider it virtually
impossible or at least very unlikely for a nder to keep his or her activities
within the narrow parameters of this so-called nders exemption. Thus,
even though the statutory and case-made law seem to suggest that there
is a very narrow opening for the use of nders in the sale of a security in
the state of California, the state regulators charged with the responsibility
of enforcing state law on the matter seem to disagree.
More recently, the California legislature has, in effect, codied the
case law relating to nders and made the applicable provisions even more
strict. Assembly member Correa introduced AB 2167 to amend Section
Appendix D
322
1029.8 of the California Code of Civil Procedure, effective January 1,
2005, authorizing an action for rescission of the sale or purchase of a
security resulting from sales activities for which a broker/dealer license
is required. In addition, under existing California law, an unlicensed
person who causes injury as a result of engaging in specied activities
for which a license is required is liable for treble the amount of assessed
damages. Thus, utilizing the services of unlicensed persons (i.e., nders)
in the sale of a security no longer seems to be a good idea in California,
if it ever was.
Telemarketers. Note that telemarketers are not the same as SEC/NASD-
qualied securities broker/dealers or the registered representatives of such
broker/dealer rms. Telemarketers may or may not be securities issuers.
There is no securities law compliance regulation, licensing, training or
supervision provided for telemarketers. Thus, in order to conduct legiti-
mate sales of securities, telemarketers would either have to fall within the
guidelines for nder sales or issuer sales.
Traditionally, telemarketers go far beyond what is permitted pursuant
to nder sales in presenting the investment opportunity to their prospec-
tive investor clients, so that also does not seem to be a viable option. Even
worse, a telemarketing organization operating independent of an issuer
of securities and being compensated for the sale of securities in a transac-
tion-related manner (i.e., taking a percentage of the money raised, which
is the traditional method for compensating such persons) does not t
within the issuer sales rule either, because it does not involve upper-level
management of the issuer, transaction-related remuneration is involved
and possibly more than one securities offering may be conducted in a
12-month period.
Thus, it would appear that bringing telemarketers in to raise money
through a securities offering is problematic. Further, it may be expecting
too much to ask that telemarketers observe conditions and limitations
associated with the sale of securities, since they are much more sales ori-
ented than compliance oriented. In addition, telemarketers these days also
have to be concerned with the do not call rules relating to cold calls.
Compliance recommendation: Do not use finders in California in
the sale of private placements unless the above limitations have been
thoroughly discussed with such nders and a written pledge has been
extracted from them that they will comply with the stated guidelines.
Such written agreement should include an indemnication provision in
favor of the general partner or LLC manager (and producer), for what it
is worth. An issuer may want to further insulate an offering of securities
by limiting the use of nders to Regulation D, Rule 506, offerings made
323
in conjunction with NSMIA. Another possible strategy is to limit sales
activities to persons who are upper-level management of the issuer and
who meet the other requirements of the SECs so-called issuer sales rule
previously discussed.
Selling Securities over the Internet
Many independent lm producers seeking nancing for their feature
lms now believe that the Internet is the answer. Some of them have
sought ways to use the Internet in raising money without considering
the securities law implications, while others recognize that the securities
laws do apply in certain situations. The truth is that the sale of securities
over the Internet raises several very specic and unique problems with
respect to compliance with both the federal and state securities laws,
and the SEC is not only actively monitoring the Internet but has brought
criminal charges against issuers violating those laws with Internet sales
or offers.
As a general rule, the offer and sale of securities is subject to the regula-
tion of both federal and state jurisdictions. Both the federal government
and the various states reserve the right to regulate the offer and sale of
securities to protect their citizens from unscrupulous individuals seek-
ing to promote the sale of worthless paper. Each state has a regulatory
authority (with names that vary from state to state) that oversees the
offer and sale of securities, much like the federal government has the
SEC, and all of them seek to prohibit fraud and misleading practices in
the sale of securities. For a current listing of the state regulatory agencies,
visit NASAA.org online.
A states jurisdiction is triggered whenever an offer to sell a security
occurs in that state. Regardless of whether the offeror or the offeree is in
that state, an offer occurs there when it either originates in or is directed
to and received in that state. Because of the pervasive reach of the Inter-
net, an offer to sell a security posted on the Internet would, by that line
of reasoning, trigger the jurisdiction of every state in the United States
as soon as the information is posted online.
As noted elsewhere in this book, securities can be offered and sold
generally (and on the Internet) if they are rst registered with each of the
applicable state and federal jurisdictions as public (registered) offerings.
Public (registered) offerings permit the use of all forms of advertising
and general solicitations, so Internet sales and offers are allowed. The
alternatives to the initial requirement of securities registration occurs
when the offer and sale of securities complies with all of the conditions
and limitations imposed on one or more of the available exemptions from
Appendix D
324
the securities registration requirement (private placements/exempt offer-
ings). The private/exempt offerings generally do not allow advertising or
general solicitation; thus, except in the special circumstances discussed
below, Internet sales are not permitted for private/exempt offerings.
The most recent regulatory wrinkles are the so-called public/private
hybrid offerings, but those also technically fall into the category of ex-
emptions. The same is true for the covered securities offered and sold in
compliance with the federal exemption (Regulation D, Rule 506), pursuant
to the National Securities Market Improvement Act, or NSMIA (i.e., state
jurisdiction is preempted by the federal law). So, the initial choice is still
the same with Internet sales. Securities either need to be registered or their
offer and sale must qualify for available exemptions from the registration
requirement. Now, however, the kind of exemptions that are available has
been expanded to include some that allow a limited form of advertising
and general solicitation, including sales and offers over the Internet.
As noted earlier, the registration of securities is expensive, time-con-
suming and complex, so that option is not commonly used to raise the
nancing for independently produced feature or documentary lms. If the
public (registered) offering option is chosen, then the issuer must follow
the written rules applicable to either the S-1, SB-1, SB-2, or Regulation A
federal lings, combined with the applicable state registration require-
ments, or for public (registered) offerings of $1 million or less, the state
SCOR form, combined with Regulation D, Rule 504, at the federal level (see
chapters 1417). These registered offerings can be offered over the Internet
pursuant to the specic rules associated with each form of registration.
If the issuer or producer wants to conduct a multistate offering and can
limit the offering to $1 million or less, the NASAA Model Accredited In-
vestor Exemption (a public/private hybrid offering) is available. A limited
amount of information can be posted in any form of advertising, including
on the Internet, and sales can be effected through the Internet (see chapter
13). The California Section 25102(n) exemption, however, is of little use
in multistate lm offerings and not even that helpful for intrastate lm
offerings because of the limitations of the relevant federal rules.
On the other hand, the producer or issuer who needs to raise more
than $1 million from private investors may choose to comply with all of
the conditions and limitations imposed on the use of Regulation D, Rule
506. Such securities are considered covered pursuant to the NSMIA,
and thus state jurisdiction (other than the requirement of a notice ling
on such sales) is preempted by federal jurisdiction.
In a series of cases involving Internet sales, the SEC ultimately deter-
mined that Internet sales for a private placement can be permitted if,
325
pursuant to a Regulation D, Rule 506, offering, all prospective offerees
of the securities are precertied as either accredited (see the Regulation
D denition of accredited investor), or as nonaccredited but sophisticated
(i.e., investors who either alone or together with their purchaser repre-
sentative have such knowledge and experience in nancial and business
matters that they are capable of evaluating the merits and risks of the
prospective investment), through the use of a generic questionnaire
posted on the issuers Internet website. A generic prospective investor
questionnaire does not refer to any specic securities transaction. It sim-
ply inquires about the accredited status or sophisticated investor status
of prospective investors for purposes of qualifying them for the offering,
which they have not yet seen.
Once prospective investors have been prescreened and judged quali-
ed, then the offering information can be made electronically available
to them through the use of passwords. In other words, the actual of-
fering memorandum (securities disclosure document) is posted on the
producers or issuers website, but on a password-protected page, which
is not accessible to anyone unless and until they have been prescreened
and qualify as either accredited or nonaccredited but sophisticated, and
otherwise meet additional investor suitability standards for the offering
(e.g., the investors investment must not exceed 10 percent of his or her
net worth). For additional information, see Joseph J. Kornblums online
article Offering Securities on the Internet.
Unfortunately, the Internet does not solve the basic problem of inde-
pendent lmmakers seeking investor nancing for their project; that is,
the investment they are offering is still highly risky, they may not have
big-name actors attached to the project, and they are not likely to have
any distribution plans in place. Even though the theory of selling on the
Internet makes some sense, because it can give a lmmaker who does not
know a lot of people greater access to more prospective investors, years
of practical experience suggest that the independent lmmakers who are
successful at raising money from investors have done so in face-to-face
meetings with people they and their associates knew before the start of
the offering. One likely exception to that rule, based on practical experi-
ence, is the lm with a message that some people are passionate about
and want to see communicated through lm.
Electronic Delivery of Securities Disclosure Document
Recognizing that its own antifraud rules require that all material aspects
of the transaction be disclosed in writing to prospective investors prior
to investing, the SEC has reasoned, by drawing an analogy between the
Appendix D
326
distribution of securities information by electronic means and through
the print medium, that it would view information distributed through
electronic means as satisfying the delivery of transmission requirements
of the federal securities law if such distribution results in the delivery to
the intended recipients of substantially equivalent information as these
recipients would have had if the information were delivered to them in
paper form (SEC Release #337233, Section II.A, October 6, 1995).
In the same ruling, the SEC goes on to say that electronic disclosure of
information must provide adequate and timely notice to investors, afford
effective access to the information, and give reasonable assurance that
the information in fact has been delivered. For example, merely posting
a document on a website will not constitute adequate notice, absent evi-
dence of actual delivery to the investor. This requirement of evidence
of actual delivery may be satised by two paper methodsletter or
postcardbut also a directed Internet message (e-mail) can satisfy such
actual delivery requirements.
If an investor consents to electronic delivery of the nal disclosure
document for an offering by means of a website but does not provide an
electronic mail address, the issuer may post its nal disclosure document
on the site and mail the investor a notice of the location of the disclosure
document on the Internet along with the paper conrmation of the sale.
(SEC Release #337233, Example 10).
It is also necessary that investors have access to required disclosure that
is comparable to postal mail and that the investor has the opportunity
to retain the information or has ongoing access equivalent to personal
retention (SEC Release #337233, Section II.A, Note 22).
Issuers should have reasonable assurance, akin to that found in postal
mail, that the electronic delivery of required information is satised. The
delivery requirements can be satised by the investors informed consent
to receive information through a particular electronic medium coupled
with proper notice of access (SEC Release #337233, Section II.C). Suf-
cient evidence of delivery can also include
an electronic mail return receipt or conrmation that a document has
been accessed, downloaded or printed;
the investors receipt of transmission by fax;
the investors accessing by hyperlink of a required document; and
the investors use of forms or other material that are available only by
accessing the document.
A document posted on the Internet or made available through an
on-line service should remain accessible for so long as any delivery re-
327
quirement under SEC rules applies (SEC Release #337233, Section II.A,
Note 26).
The SEC requires issuers to make paper versions of their documents
available where there is computer incompatibility or computer system
failure or where consent to receive documents electronically is revoked
by the investor (SEC Release #337233, Section II.B).
The SEC permits an offering to be limited entirely to persons who
consent to receive a disclosure document electronically, but if it is not
so limited, a paper version of the disclosure document must be given to
broker/dealers to be made available to investors (or be made available
to investors by the issuer) who do not have online access (SEC Release
#33- 7233, Section II.B).
State compliance. As noted earlier, Congress has preempted state
regulation of those security offerings that are exempt from the 1933 act
registration by virtue of SEC exemptions adopted pursuant to Section
4(2) of the 1933 act (the exemption for nonpublic/private offerings). In
effect, this deprives states the authority over certain private placements,
including those made in reliance on the SECs Rule 506 of Regulation D.
Even so, states have retained the right to require notice lings for such
offerings. The federal preemption of state jurisdiction for such offerings
is based on the authority provided by the National Securities Markets Im-
provements Act of 1996 (NSMIA). In any case, publicly accessible website
postings may not be used as a means to locate investors to participate in
a pending or imminent U.S. offering.
Accredited and sophisticated investors. The SEC has taken the position
that the prequalication of a number of accredited or sophisticated inves-
tors on a website and electronically notifying them in a secure manner of
subsequent private placements would not involve a general solicitation
or general advertising within the meaning of Rule 502(c) of Regulation
D, and therefore would allow the building of investor data-banks for
private offerings under the SECs Regulation D [IPOnet, SEC No-Action
Letter, 1996 WL 431821 (S.E.C.) July 26, 1996; Lamp Angel Capital Elec-
tronic Network, SEC No-Action Letter Sec. L. Rep (CCH 77,305, October
25, 1996; Technologies, Inc., SEC No-Action Letter, May 29, 1997].
The SECs response to the IPOnet no-action request indicated that the
following procedures would need to be in place:
both the invitation to complete a purchaser questionnaire used to deter-
mine whether an investor is accredited or sophisticated and the ques-
tionnaire itself must be generic in nature and not reference any specic
transactions posted or to be posted on the password-protected page of
the issuer;
Appendix D
328
the password-protected page will be available to a particular investor
only after a determination has been made that the particular investor is
accredited or sophisticated; and
a potential investor could purchase securities only in transactions that
are posted on the password-protected page after that investor has been
determined to be qualied for the offering by the issuer.
A sophisticated investor must have a history of venture capital and
restricted investments.
Nonaccredited investors. While the IPOnet no-action letter makes
repeated reference to sophisticated investors, it does not specically
address an Internet-based offering to nonaccredited investors. Presum-
ably, the logic of the IPOnet letter would also apply in the context of an
offering to nonaccredited investors (i.e., investors who do not t within
the denition of accredited investors under Regulation D) if they have
been determined to meet the suitability standards for the particular
offering. However, this set of facts was not addressed by the SEC in the
IPOnet letter.
Credit card sales. The SEC has provided a no-action letter relating
to credit card sales of securities. The SEC provided an exemptive order
for Technology Funding Securities Corp. (a nondiversied investment
company under the 1940 Act) allowing the company to accept payment
for its fund shares over the Internet by means of credit card [Technology
Funding Securities Corp., SEC No-Action Letter, May 20, 1998).
The SECs staff approval stressed that the credit card purchases would
be allowed under the following circumstances:
credit card sales occur only through the Internet;
a prominent warning is displayed on the website to dissuade investors
from carrying a balance on their cards as a result of a purchase of the
securities;
another statement is prominently displayed showing how related inter-
est costs could exceed any increase in the value of the securities; and
the issuers selling employees are not compensated on the basis of shares
(or units) sold.
Limit on number of investors. Also note that Section 12g of the 1934
Securities Act provides that issuers of securities cannot sell any class of
security to ve hundred or more persons without registering such security
by ling a registration statement with the SEC.
Preoffering and supplemental materials. Written materials used by lm
producers to communicate with prospective investors prior to the start
329
of a securities offering (e.g., a business plan, executive summary, four-
color brochure, etc.) should not include any information which could
be construed as relating to a subsequent private placement offering (i.e.,
nothing should be stated in the preoffering material that indicates that the
issuer is even contemplating a subsequent offering to passive investors).
Thus, no mention should be made regarding limited partnership units
or interests in a manager-managed LLC. Further, no language should
be provided suggesting that the amount of money being sought will be
accepted from a large group of investors in small amounts. In addition,
the use of any preoffering materials to raise money from one or two ac-
tive investors needs to be discontinued 3 to 4 weeks prior to the start of
a subsequent private placement offering.
Often issuers of securities are concerned that a properly drafted of-
fering memorandum (i.e., with the risk factors section in the forepart
of the disclosure document as required) will not serve as an effective
selling document. In such instances, they sometimes seek to supplement
the offering memorandum with other materials, commonly a four-color
brochure or portfolio. Such supplementary materials are part of the of-
fering materials and still must comply with the antifraud provisions.
Thus, the language contained in such materials should be reviewed by
securities counsel in order to protect the interests of the issuer and help
prevent the dissemination of misleading materials.
As a general rule, the fewer offering materials utilized the better. Limit-
ing the offering materials to the offering memorandum, its accompany-
ing exhibits and a separate packet of subscription documents would be
safest. The better practice is to work with securities counsel in balancing
the information in the disclosure document appearing in internal and
external summaries of the offering, or in the exhibits section, so that
the attractiveness of the offering is enhanced without conicting with
securities disclosure obligations. In timing the use of offering summaries,
a program-highlights sheet or other sales materials should be strictly
controlled in accordance with the above suggested procedures.
331
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359
Index
accountant, 11, 13, 57, 60, 65, 68, 71, 74, 87,
93, 143, 231, 273, 274, 290
accounting fee, 77, 82, 137, 140
accredited investor, 67, 68, 70, 73, 99102,
108, 109, 11113, 115, 116, 119, 12227,
316, 324, 325, 328
acquisition, 4, 40, 50, 63, 81, 124, 145, 152,
157, 161, 163, 195, 197, 199, 200, 208, 263;
cost of, 197
acquisition/distribution agreement, 157,
161, 163, 208
active investor, 7, 39, 40, 42, 43, 46, 4748,
5951, 52, 54, 55, 5963, 64, 66, 67, 78,
89, 133, 299, 3013, 329
active partner, 58, 282
actor, 22, 36, 41, 55, 159, 170, 171, 176, 195,
200, 211, 21520, 248, 262, 271, 287,
292, 294, 301
actor nancing, 21719
actor replacements, 159
actor suites, 211
actress, 171, 200, 217, 292
ADR, 213
advance, 158, 16062, 166, 169, 171, 174,
175, 17880, 201, 291
advertising, 25, 32, 35, 36, 43, 99, 100, 106,
108, 116, 119, 123, 125, 127, 13133, 136,
140, 158, 174, 222, 224, 228, 236, 241,
308, 310, 323, 324, 329
AFCI. See Association of Film Commis-
sioners International
AFMA. See American Film Marketing
Association
agency project, 198
agent, 36, 114, 168, 170, 178, 199, 200, 202,
214, 216, 218, 242, 254, 270, 309, 310,
311, 315, 319, 320, 338, 341
aggregate offering price, 100, 106, 109,
110, 118, 120, 132
allocation, 56, 57, 238, 252
American Film Marketing Association
(AFMA), 3, 178, 207, 330, 344
American Stock Exchange, 143, 144, 145
ancillary markets, 225
ancillary rights, 158, 174
annual: nancial statements, 84; meet-
ing, 60; report, 15, 93, 143; shareholder
meeting, 45, 84; statement, 93
antifraud: provisions, 70, 100, 101, 107,
109, 121; rule, 68, 83, 97, 100103,
10710, 113, 125, 325
A picture, 175
approval right, 56, 171, 199, 213
approved script, 158, 160
arbitration, 57
Article 20, 164
articles: of incorporation, 80, 81, 84; of
organization, 60, 64, 71, 72, 77
articial pickup, 147, 16465
artistic control, 164
arts, 13, 15, 26, 243, 263, 269
asset, 11, 45, 46, 51, 52, 123, 142, 14951, 155,
156, 161, 163, 175, 185, 186, 188, 189, 191
assignee, 76
Association of Film Commissioners
International (AFCI), 3334, 276, 281,
283, 289
assumed name, 44, 45
attach, 17, 41, 47, 61, 89, 175, 182, 195, 199,
215, 216, 234, 239, 259, 260, 299, 300, 325
attorney: entertainment, 36, 71, 75, 154,
155, 196, 199, 202, 293, 318, 367; fees,
77, 81, 82, 108, 111, 123, 136, 138, 160,
154, 186, 188; international, 255, 279;
Cones Index.indd 359 1/8/08 2:30:29 PM
Index
360
attorney (continued)
securities, 65, 68, 78, 89, 107, 108, 111,
113, 136, 138, 140, 154; tax, 87, 273, 290
attorneys opinion, 129, 130, 136, 139
audience, 3, 19, 202, 208, 22124, 226, 234,
240, 241, 294
audit committees, 144
Australia, 172, 190, 24042, 244, 247,
25051, 252, 257, 26266
back-end participation, 154, 170
backside of a picture, 229
bank, 65, 72, 83, 149, 15153, 156, 157, 159,
160, 163, 166, 167, 169, 175, 17787, 189,
190, 202, 251, 268, 270, 272, 275, 276,
287, 289, 300, 301, 332, 333, 343, 349,
354; account, 36, 56, 72, 80, 261, 371;
legal fees, 155, 169; loan, 150, 151, 158,
163, 166, 172, 177, 178, 184, 202, 268;
notes, 265, 279
bankruptcy, 66, 181, 187, 189
bargaining position, 229
base territory, 225
below-market interest rate, 150, 156
below-the-line, 31, 55, 211, 242, 244, 252,
253, 276, 281, 282; facilities deals, 215,
281; union crews, 164
bidding war, 163
binding, 77, 82, 130, 133, 137, 140
blind pool, 116, 121, 128
blocked: currencies, 275, 276; funds,
27578
blue-sky laws, 67, 99, 108, 111, 113, 114,
128, 144
board: of directors, 45, 6063, 73, 8082,
84, 91, 241; resolutions, 45, 75
bond, 81, 160, 163, 173, 178, 184, 18891,
222
booking, 209
borrower, 15052, 154, 156
box ofce, 168, 173, 187, 201, 207, 257,
28486; gross, 201, 209, 218
Britain, 172, 235, 242, 249, 250
British Columbia, 260
broker/dealer, 77, 82, 129, 137, 14044,
30722; commission, 82, 140, 313
budget overrun, 156
bureaucracy, 94, 243
bureaucratic system, 280
business plan, 42, 49, 50, 59, 60, 68, 89,
124, 133, 180, 210, 293, 2997, 329
buyer, 141, 152, 168, 169, 170, 17375, 182,
267, 306, 320, 321; default, 170
bylaws, 61, 80, 81, 83, 84
cable company, 166, 174, 205, 225
calendar year, 12, 85
camera ready, 82
capital, 22, 26, 30, 44, 47, 53, 54, 57, 61, 62,
70, 71, 75, 77, 81, 83, 84, 86, 8892, 101,
128, 142, 175, 186, 188, 189, 191, 256, 258,
259, 271, 321; contributions, 75; gain,
57, 70, 84, 86, 242, 256; loss, 77, 83
case law, 96, 99, 320, 321
cast, 30, 31, 159, 160, 179, 183, 212, 215, 227,
223, 235, 248, 250, 251, 254, 263, 266,
269, 278, 281, 282, 298
casting director, 217
C corporation, 6, 7, 42, 78, 80, 84, 86, 87
censorship, 170
certicate, 25, 32, 7476, 80, 93, 94, 234,
248, 249, 259, 260, 263, 264, 266,
269; Brazilian audiovisual invest-
ment, 267; of British nature, 248, 249;
for Canadian lm or video, 259; of
exemption, 25, 32; of Good Standing,
93; of incorporation, 80; insurance,
159; of limited partnership, 74; of
nationality, 248; of registration, 94;
share, 80, 81; theatrical and video
release, 235
chain of title, 179
chattel paper, 150
Civil War, 278, 282
class of stock (securities), 65, 85, 86, 87,
97, 100, 124, 253, 314, 328
clearance, 159
closely held corporations, 83, 335, 349
conancing, 207, 241, 264, 265
cold calls, 133, 322
collaborative process, 7, 197
collateral, 145, 14952, 155, 156, 163, 166,
169, 172, 173, 175, 17779, 181, 185, 190
collection, 24, 31, 173, 188, 190, 191, 195,
209, 242, 270
collections, 201, 290
Index
361
commercial: appeal, 202, 226; bank, 152,
276; lm, 170, 217; quality, 160
commissaries, 210
commissions, 24, 34, 77, 82, 129, 137, 140,
196, 210, 253, 291, 292, 313, 316, 318
common stock, 85, 86, 128, 143
completion: bond, 160, 163, 173, 17981,
200, 237, 242, 270, 300; company, 181;
fund, 41, 22730, 232; guarantee, 162;
guarantor, 156, 163, 165, 171, 173, 180,
181; services, 214
concept, 50, 102, 113, 115, 182, 184, 195, 197,
207
conict of interest, 5, 144, 202, 216, 223
consideration, 11, 16, 59, 81, 89, 117, 121,
125, 155, 158, 224
contingency, 158, 159, 169, 173
continuity, 76
contract rights, 150
contractual quagmire, 175
control, 11, 13, 23, 36, 43, 52, 60, 63, 75, 78,
80, 82, 90, 92, 99, 104, 137, 14042, 150,
155, 164, 198, 200, 201, 218, 219, 225,
231, 301, 309
convertible debt security, 142
coproducer, 17, 170, 234, 250, 254, 265, 273,
283, 286, 287
coproduction: agreement, 235, 24447,
249, 253, 261, 265; treaties, 244,
250252, 254, 262, 281
copyright, 25, 56, 159, 188, 189, 191, 198,
203, 243, 253, 25860, 263, 265, 270,
271, 273; ownership, 203, 273
corporate: borrowers, 154; debt, 81, 85,
189; formalities, 84; kits, 81; main-
tenance, 66; powers, 93; production
company, 59, 138, 151, 156, 233; rates,
45; seal, 80, 81; stock, 6, 7, 59, 60, 80,
82, 105, 132; vehicle, 84, 154
corporation, 6, 7, 19, 29, 42, 45, 46, 57,
5966, 69, 71, 76, 78, 8089, 93, 94,
116, 117, 128, 131, 135, 136, 137, 139, 140,
144, 151, 155, 188, 240, 246, 250, 25860,
265, 273, 277, 289, 308, 310
cost of capital, 175, 186
cover shots, 171, 172
creative, 39, 44, 55, 56, 58, 66, 73, 78, 88,
91, 150, 155, 162, 164, 165, 172, 173, 195,
201, 204, 213, 216, 219, 221, 224, 233,
23638, 240, 24347, 251, 254, 265, 256,
282, 294, 303; control, 44, 55, 56, 58,
66, 73, 78, 150, 155, 164, 165, 173, 201,
219, 243, 254, 303; decision, 173, 244;
department, 195; executive, 195
credit, 15, 25, 2632, 49, 56, 152, 153,
16870, 179, 181, 185, 186, 18890, 196,
214, 242, 25860, 268, 272, 328; card,
153, 328
creditor, 13, 53, 154
crew, 28, 30, 31, 164, 211, 212, 223, 251, 254,
263, 266, 268, 269, 278, 281, 282, 298
cross-collateralization, 168
currency, 35, 181, 243, 27577, 279, 280, 289;
conversion, 279; restrictions, 275, 276
dailies, 213
deal: memo, 196; points, 196
death, 57, 66
debentures, 81
debt, 45, 53, 75, 80, 81, 83, 85, 86, 91, 142,
149, 150, 153, 154, 177, 188, 189, 289, 290,
307; capitalization programs, 289,
290; security, 142
debt-for-development, 290, 356
deductions, 12, 2124, 32, 45, 56, 86, 219,
248, 251, 256, 265, 266, 271, 306
default, 150, 151, 170, 175; disaster, 170,
184, 189
deferral, 77, 169, 218, 219; of income, 256
deferred basis, 214
delivery, 11, 14, 40, 41, 77, 100, 109, 117,
149, 15760, 162, 16870, 172, 178, 184,
202, 211, 225, 227, 237, 245, 308, 310, 311,
325, 326; requirements, 100, 159, 162,
237, 326; schedule, 160, 171
depreciation, 22, 57, 256
devaluation, 279, 280
development, 2, 4, 7, 8, 13, 14, 19, 2832,
4044, 47, 50, 59, 63, 65, 66, 81, 8991,
123, 124, 132, 147, 14951, 153, 155, 162,
182, 190, 195200, 2047, 20911, 236,
238, 249, 251, 252, 263, 267, 284, 285, 290;
costs, 151, 153, 199; deal, 41, 162, 195200,
207; nancing, 89, 195, 197; hell, 198;
loan, 150, 251; money, 50, 89, 15; offer-
ing, 40; phase, 4, 195, 199; scam, 206
Index
362
director, 2931, 55, 62, 88, 124, 159, 160,
17072, 179, 195, 196, 197, 199, 200, 202,
216, 217, 223, 235, 239, 248, 249, 298,
301, 310
directors agreement, 196
directory, 90, 204, 205, 210, 234, 276, 281,
283, 289
disability, 57
disbursing agent, 214
disclosure document, 57, 60, 62, 65, 68,
70, 73, 75, 77, 82, 89, 97, 99, 100, 107,
109, 110, 112, 117, 120, 125, 126, 129,
13032, 135, 138, 139, 180, 300303, 308,
32527, 329; guidelines, 10711, 304,
318; obligations, 70, 102, 109, 110, 315,
329; requirements, 88, 102, 106, 109,
111, 117, 125, 139, 135, 139
discountable, 209
discounted: monies, 277; value, 172
discounting, 169
Disney, 204
disputes, 56, 58, 159
dissolution, 57, 66, 76
distribution: advance, 160; agreement,
26, 146, 149, 15764, 167, 168, 171, 172,
208; company, 175, 189, 213, 225; costs,
174, 194, 202, 203, 208; expenses, 147,
172, 202, 203, 208; fee, 190, 194, 202,
203, 208; rights, 157, 167, 168, 178, 189,
190, 272, 281; subsidiary, 210
distributor: approval, 158; commitment,
161, 162; gross receipts, 213, 218; rent-
als, 201, 209
dividends, 62, 83, 84, 86, 225
domestic: exhibitors, 209; marketplace,
4, 168; producer, 243; release, 208;
releasing costs, 167; rights, 167; studio
production facilities, 211; television
rights, 167; theatrical advertising, 158;
theatrical distributor, 174; theatrical
marketplace, 166, 167, 201, 209; theat-
rical release, 174, 190; video, 167
double taxation, 76, 83, 87
downside risk, 161, 169, 227
draft, 171, 195, 196, 236
due diligence, 77, 82, 137, 180, 313, 314,
318
editorial cutting rooms, 213
electronic: editing, 214; price quotations,
143
employee, 26, 27, 29, 46, 76, 83, 90, 136,
140, 145, 164, 198, 200, 272, 328
employment, 2830, 54, 215, 319
end user nancing, 22526
entertainment: attorney, 36, 69, 71, 75,
15455, 196, 202, 293, 318; lenders, 157,
208
equipment, 14, 25, 28, 45, 204, 211, 212,
214, 269, 271, 280
equity investment, 88, 149, 150, 233, 236,
246, 255, 269, 277; participation, 149,
228, 233, 242; percentage participa-
tion, 225; transaction, 149
escrow account, 160
exchange, 71, 35, 49, 60, 68, 70, 91, 141,
14346, 196, 199, 221, 222, 224, 225, 233,
246, 251, 267, 275, 277, 29381, 289, 303,
315, 316; rate, 277, 279; trading, 141
Exchange Act, 70, 315, 316
executive producer, 1, 7, 170, 196, 239, 248
exempt offering, 43, 67, 69, 70, 95, 102, 107
exemptions, 2, 5, 43, 46, 54, 68, 77, 83,
95, 96, 97, 99101, 1037, 112, 115, 117,
119, 121, 123, 125, 127, 128, 266, 308, 313,
31820, 323, 324, 327
exhibit, 68, 159
exhibition, 8, 164, 237, 241, 270
expanded entertainment, 207
facilities, 25, 55, 145, 21012, 215, 244, 252,
253, 268, 269, 285, 272, 278, 281, 282,
287; deal, 28182
family, 12, 59, 170, 197, 205; income, 87
fax, 18, 77, 205, 326
feature lm production, 88, 92, 108, 111,
128, 137, 156, 184, 230, 235
ctitious business name, 44
ling fee, 81, 118, 119
lm commission, 24, 210, 211, 231, 241,
242, 251, 270, 276, 281, 283, 286, 287;
laboratory, 159; processing, 213; prod-
uct, 222, 225; projection, 213
nancial: guarantee, 168, 169; institu-
tion, 28, 85, 179; obligations, 209;
Index
363
projections, 77, 82, 136, 139, 180,
3046; resources, 207, 209, 246, 310;
statements, 77, 82, 84, 131, 135, 139, 143
nanciers, 2, 61, 182, 216, 227, 229
nancing: agreement, 6, 44, 47, 4951, 54,
55, 59, 89, 133, 299, 303; source, 169,
180, 197, 226, 229, 242, 293, 300
nder, 129, 279, 293, 307, 31722
nders fees, 129, 313
rst: draft, 195, 196; look, 196, 204, 205;
position, 213
scal year, 85
xed repayment date, 150
at fee, 77, 82, 180
Florida, 2425, 211, 228
ow-through tax vehicle, 65, 78, 83, 86
foreign: buyer, 169; coproduction, 276,
281; corporations, 84, 93; currency,
243, 279, 280, 289; debt capitalization,
289, 290; distribution, 26, 207; enti-
ties, 115, 225; equity nancing, 233;
equity investment, 233, 246; facility
deal, 211; government subsidies, 23,
215, 283, 285, 289; governments, 23,
177, 244, 256, 281, 283, 287; investors,
256; paper, 169; presales, 7, 147, 166,
168, 172, 176, 181, 182, 300; rights, 245;
sales agent, 168, 178, 183; shareholders,
85; tax, 256, 257, 259, 261, 263, 265, 267,
269, 271, 273; territories, 166, 168, 172,
174, 176, 178
forfeiture, 93
Form D, 25, 81, 106, 114, 129, 318
Form S-1, 136, 13840
Form U-7, 12830, 132
founding shareholders, 59, 63, 81, 82,
299
fractionalized, 168, 174
fractured-rights deal, 167
France, 172, 244, 245, 247, 25052, 257,
262, 268, 285
franchise tax, 29, 66, 77, 81, 84, 93
fraud, 45, 70, 107, 108, 113, 120, 124, 192,
321, 323
free television, 171
friends of family, 205
fringe benets, 76, 83
general: corporate nance, 62; partner,
42, 51, 5255, 65, 7476, 315, 316, 319,
322; partnership, 42, 47, 49, 5254, 57,
58, 64, 66, 67; solicitation, 59, 60, 84,
98, 99, 106, 115, 120, 127, 133, 136, 140,
297, 299, 308, 309, 310, 311, 324, 327
genre, 170, 179, 255, 260
Germany, 172, 242, 244, 247, 250, 257, 262
government: grants, 283; loans, 244;
notes, 279; subsidies, 21, 23, 25, 27, 29,
31, 3335, 37, 169, 215, 253, 283, 285, 287
governmental bureaucracy, 243
green light, 197, 198, 206
grip package, 214
gross receipts, 32, 66, 160, 203, 213, 218
guarantee, 75, 83, 149, 151, 153, 15763, 168,
169, 172, 173, 175, 211, 225, 237, 242, 270
guarantor, 151, 156, 163, 165, 169, 171, 173,
180, 181
guild, 215, 220
hard: assets, 149, 163; currency, 275, 279,
280
high budget, 200
Hollywood Creative Directory, 204
home video, 166, 190, 225
housekeeping deals, 204, 205
housing, 211, 212, 254, 278, 282
hybrid: exemptions, 2, 43, 46, 6769, 95,
115, 117, 121, 123, 125, 137; offerings, 69,
324
hype, 170
IATSE (International Alliance of Theat-
rical and Stage Employees), 164
IFEX, 207
imputed interest, 150
income tax, 13, 25, 26, 27, 2932, 58, 65,
76, 84, 86, 87, 244, 259, 260, 262, 267,
270, 271, 273
indemnication, 57, 322
independent: distributor, 157, 182, 207,
209; lm, 35, 7, 36, 39, 4043, 51, 68,
69, 70, 72, 91, 98, 127, 147, 155, 157, 163,
177, 178, 188, 191, 207, 216, 219, 228, 264,
272, 279, 297, 302, 303, 307, 323; pro-
ducer, 43, 44, 61, 62, 94, 150, 154, 164,
Index
364
independent (continued)
198201, 203, 205, 2068, 218, 219, 228,
275, 291, 293; production company,
207; video companies, 167
individual rates, 45
industry: funding source, 200; insider,
204; sources, 41, 299, 300
informational tax return, 56
inheritance, 13, 45
in-house production, 164, 177, 19598
initial: incorporation, 47, 49, 5963,
81, 89, 133, 299, 307; incorporation
strategy, 60, 63; public offering (IPO),
136, 137, 140
insider, 99, 137, 140, 197, 204, 231, 243
insiders game, 198, 294
institutional investors, 88, 301, 302
insurance, 83, 85, 88, 159, 164, 178, 18487,
188, 233, 237, 300, 301; certicates, 159;
company, 99, 187
integration: product, 221, 222, 223; secu-
rities, 106
interest rate, 150, 153, 154, 156, 189, 202
Internal Revenue Code, U.S., 11, 14
Internal Revenue Service (IRS), U.S., 22,
57, 76, 80, 83, 8586, 150, 246, 254
international: attorney, 255, 279; copro-
duction, 6, 41, 54, 89, 215, 231, 233, 235,
240, 24455, 265, 271, 276, 280, 281,
286; currency traders, 279; law rms,
276; rights, 16768; tax, 7, 273, 274, 298
intrastate offering, 67, 1034, 119
investment: company, 116, 121, 320, 328;
contract, 155; funds, 6, 266; tax credit,
25, 26, 28, 3031; vehicle, 4244, 48,
54, 66, 67, 7274, 78, 89, 128, 227, 229,
205, 3024
investor: nancing agreement, 6, 44, 47,
4951, 54, 55, 59, 89, 133, 299, 303; of-
fering, 7, 41, 304
IPO. See under initial
Ireland: and coproductions, 247, 25052,
276; and tax shelters, 257, 262, 268,
269; and U.S. lms, 172
irrevocable letter of credit, 169
IRS. See Internal Revenue Service
issuer of securities, 69, 70, 77, 82, 9698,
100108, 109, 11012, 114, 11625,
13133, 135, 138, 139, 142, 143, 190, 305,
30712, 31524, 32629; disqualiers,
107, 110, 112; sales, 307, 31516, 31920,
32223; sales rule, 316, 322, 323
issuing entity, 97, 106, 108, 111, 113, 136,
138, 137
Italy, 172, 244, 247, 250, 252, 257, 262
Japan, 172, 244, 247, 257
joint: income, 109; net worth, 109;
venture, 6, 41, 42, 47, 49, 5258, 60,
89, 133, 149, 246, 254, 271, 299, 303;
venture agreement, 6, 56, 57, 299, 303;
venture partner, 57, 58, 60, 299
joint and several, 55
laboratory, 159, 160, 178, 199, 213, 214, 227,
229, 252, 268; fees, 227, 229; letter, 160
language barriers, 278, 282
lead actors, 200, 301
lendable contracts, 173
lender, 16366, 169, 170, 171, 176, 177, 182,
183, 186, 191, 199, 213, 239, 314; nanc-
ing, 2, 3, 6, 41, 83, 84 147, 14958, 160,
162, 164, 166, 168, 170, 172, 174, 17680,
182, 184, 186, 190, 294, 300
lending source, 163
letter: of credit, 152, 153, 168, 169, 170, 179,
242; of intent, 171, 180
leverage, 159, 201, 208, 209, 257, 277, 280,
290
liability: criminal, 54, 70, 102; limited, 2,
6, 22, 27, 29, 47, 50, 55, 57, 58, 64, 65,
71, 74, 75, 78, 88, 90, 235, 301, 302, 303;
personal, 45, 53, 156; partnership, 53;
tax, 26, 27, 29, 76, 256, 268
library asset values, 175
license, 157, 166, 168, 170, 173, 178, 179, 321,
322
licensee, 173, 175
licensor, 152
lighting, 214, 281
limitations on resale, 106
limited: liability (see under liability);
liability company, 2, 6, 22, 27, 29, 47,
64, 188, 235, 302, 303; offering exemp-
tion, 105, 106, 31921; partner, 75, 76;
partnership (L.P.), 6, 22, 29, 42, 44,
Index
365
54, 55, 57, 61, 64, 65, 69, 72, 7478, 86,
88, 90, 95, 105, 116, 130, 132, 136, 139,
161, 173, 188, 233, 254, 272, 277, 290,
302, 307, 309, 312, 31416, 309, 329;
partnership agreement, 74, 75, 76;
partnership certicate, 75, 76
listing requirements, 144, 145
literary property, 55, 56, 179
litigation, 187, 188
loan, 14, 39, 44, 147, 14952, 15456, 160,
163, 166, 169, 172, 175, 17781, 18486,
188, 205, 229, 241, 242, 246, 251, 252,
286; fees, 169, 180
local: casting, 211; company, 104;
economy, 35, 211, 275, 283, 290, 298;
lm production, 33, 94, 257; law, 275;
sales tax, 33, 47
location, 31, 32, 35, 40, 118, 141, 171, 182,
200, 210, 211, 212, 252, 253, 254, 259,
265, 266, 270, 276, 277, 280, 281, 287,
289, 326
long-form distribution agreement, 172
losses, 45, 52, 56, 77, 86, 176, 181
low budget, 9, 36, 50, 62, 71, 100, 134, 151,
155, 202, 207, 223, 228, 229, 300, 303
L.P. See under limited
macroeconomics, 176
maintenance, 45, 56, 66, 78, 84
major motion picture, 197
makeup artists, 164
manager, 54, 55, 64, 65, 66, 7174, 219, 227,
228, 262, 293, 310, 315, 316, 319, 322
manager-managed limited-liability com-
pany, 2, 6, 42, 44, 54, 55, 57, 64, 65, 66,
69, 71, 72, 73, 74, 76, 81, 86, 95, 105, 129,
135, 161, 173, 227, 229, 233, 192, 302, 307,
309, 315, 317, 329
managing underwriter, 142
manner of offering, 104, 106, 3079
marketing costs, 77, 82, 137, 140
market makers, 14143
market share, 4, 172, 201, 207, 286
meal penalties, 164
media rights, 159
member companies, 207
minimum guarantee, 168, 170, 175, 178, 179
mismanagement, 45
Motion Picture Association of America
(MPAA), 34, 160, 171, 200, 209, 235, 347
movie-of-the-week, 27
MPAA. See Motion Picture Association
of America; MPAA rating
MPAA rating, 160, 171, 200
music, 25, 27, 32, 188, 189, 191, 222, 237,
248, 249
narrative biographies, 171, 300
NASAA. See North American Securities
Administrators Association
NASD. See National Association of Secu-
rities Dealers
NASDAQ (National Association of
Securities Dealers Automated Quota-
tions), 7, 68, 141, 14243, 145
National Association of Securities Dealers
(NASD), 77, 82, 142, 143, 31215, 318
nationality, 245, 248, 250
natural persons, 109, 117
negative: cost, 158, 202, 203; cutting,
213; developing, 213; perception, 78;
pickup, 7, 147, 15765, 166, 167, 168, 173,
184, 200, 202, 208; raw stock, 213
nepotism, 197, 205
net proceeds, 49, 136, 139, 155, 202, 218,
219; prot participation, 219; prots,
49, 93, 155, 158, 160, 161, 167, 168, 202,
205, 208, 209, 213, 214, 218, 219; worth,
109, 123, 325
New York Stock Exchange, 144
nonpublic offering, 96, 98100, 105, 106,
108, 111, 113
nonrecourse loan, 150
nonresident alien, 85
nontaxable entity, 246
nonunion movie, 164
nonvoting stock, 82
North American Securities Administra-
tors Association (NASAA), 62, 108,
119, 122, 123, 126, 128, 292, 316, 323, 324
notice of sale, 81, 106
objective: delivery, 171; grounds, 159
offering: circular, 129, 131, 132, 133, 303;
costs, 77, 82; memorandum, 77, 82, 96,
97, 99, 107, 109, 110, 129, 132, 154, 180,
Index
366
offering (continued)
293, 303, 310, 311, 325, 329; proceeds,
65, 77, 103, 104; statement, 131, 132
ofce on-the-lot, 196, 205
ofcers, 60, 61, 63, 8083, 99, 124, 135, 139,
276, 316
omissions, 53, 83, 237
ordinary: income, 76, 256; loss, 76
organizational minutes, 84
organized exchange, 141
OTC market. See over-the-counter
market
outline, 42, 19597, 23739
out-of-pocket, 44, 171, 281
outside directors, 144
outsiders, 35, 75, 83, 198, 204
overages, 168
over-budget costs, 160
overhead, 203, 263
over-the-counter market, 7, 68, 14146
overtime, 164
owners, 2, 7, 4446, 57, 6466, 75, 82, 116,
124, 151, 188, 197, 209, 256, 259, 265, 271
ownership, 43, 81, 82, 83, 84, 91, 92, 179,
195, 198, 203, 206, 211, 233, 250, 271,
273, 289; interest, 81, 84, 92, 206, 211,
233
packaged project, 40, 41, 55, 149, 162, 163,
167, 170, 171, 175, 181, 184, 185, 195, 196,
198, 199, 202, 21416, 299, 300
packaging, 7, 40, 81, 89, 170, 199, 202, 215
216
P&A fund, 228
para-passu, 213
participation, 22, 49, 52, 149, 155, 158, 160,
161, 170, 186, 196, 198, 202, 211, 213, 214,
218, 219, 220, 225, 228, 233, 241, 242,
247, 249, 250, 265, 267, 270, 306, 31115
partnership, 6, 22, 27, 29, 42, 44, 47, 49,
5258, 62, 64, 65, 75, 76, 78, 83, 85, 86,
88, 105, 116, 117, 129, 130, 132, 135, 163,
223, 246, 254, 261, 264, 265, 271, 272,
297, 307, 315; agreement, 52, 53, 7476
passive: income, 45, 86; investor, 7, 39,
40, 42, 43, 46, 46, 48, 50, 51, 55, 59, 60,
6567, 69, 7174, 80, 89, 95, 105, 149,
155, 227, 229, 245, 293, 2997, 329
pay cable, 225
pension, 45, 83, 88, 164, 301
percentage participation, 49, 158, 160,
196, 213, 21820, 225, 306
perpetual existence, 83
personal: guarantees, 83; income, 25, 45;
liability, 45, 53, 156
photos, 171
pick-up price, 157, 158, 162
pitching, 195, 199, 204
polishing, 195
politics, 15, 197
postproduction, 14, 33, 40, 41, 210, 211,
214, 22729, 235, 236, 269, 271
predividend prots, 83
preexisting relationship, 43, 98, 100, 106,
108, 11113, 115, 123, 299, 308, 311, 316
preferred stock, 88, 91, 233
preling, 131, 133
preliminary notes, 107
preproduction, 28, 40, 41, 81, 149, 210, 285
presale, 7, 114, 147, 162, 163, 16678, 181,
182, 184, 208, 209, 215, 225, 246, 269,
270, 300; agreement, 167, 168, 16973,
175, 269; contract, 168, 169, 17274,
181; nancing, 147, 153, 16676, 177;
purchasing entity, 169, 170, 173
presold: lm, 176, 246; rights, 172, 175
press: clippings, 171; releases, 145
price ceilings, 170
principal, 141, 142, 151, 152, 311, 312, 315,
317; cast, 159, 235, 248, 269; ofce,
76; photography, 26, 40, 41, 72, 167,
22729, 236, 272; shareholders, 83
printing, 77, 82, 133, 136, 140
prints and advertising, 228
private: offering, 43, 67, 6970, 81, 82,
9698, 115, 299, 303, 308, 31016, 331;
placement, 60, 62, 69, 70, 77, 82, 83,
96, 99, 1058, 11014, 119, 127, 139, 121,
137, 138, 140, 154, 180, 299, 303, 30714,
31618, 322, 324, 327, 329; placement
offering memorandum (PPM), 154,
303
producer advance, 160, 201
producers: package, 171, 299, 300; rep-
resentative, 229, 278; share, 49, 155,
167, 219
Index
367
producing entity, 76, 83
product ow, 225
production: account, 169; activities, 25,
35, 40, 283, 289, 292; budget, 17, 50,
138, 156, 172, 177, 178, 181, 197, 217, 228,
23639, 251, 258, 272, 286, 287, 289;
community, 23, 211; division, 207;
dollars, 280; elements, 159, 229; entity,
43, 199, 219, 233, 235, 256; equipment,
25, 211, 214; nancing, 4, 40, 41, 47,
56, 89, 152, 16163, 164, 166, 172, 173,
185, 186, 195, 199, 203, 208, 209, 215,
216, 227, 244, 246, 293; loan, 160, 163,
166, 167, 169, 180, 182, 187; money,
41, 61, 154, 156, 173, 187, 188, 199, 201,
202, 207, 208, 225; offering, 41; ofce,
29, 211; personnel, 22, 205; schedule,
200, 269
production-nancing/distribution (P-F/
D) agreement, 161, 162, 163, 168, 173,
177, 186, 199202, 203, 207, 209
prot: margin, 176; participation, 155,
158, 202, 211, 213, 214, 219, 223; partici-
pation auditors, 202
prots, 34, 49, 52, 54, 56, 76, 83, 84, 86, 87,
91, 93, 150, 155, 158, 160, 161, 167, 168,
188, 196, 202, 208, 209, 213, 214, 218,
219, 245, 246, 261
prot-sharing, 46, 76, 83, 301
project nancing, 6, 71, 76, 81, 83, 90, 246
projections, 77, 82, 136, 139, 179, 180, 301,
3046
promotional expenditures, 158
prop departments, 210
prospective purchaser, 102, 117, 118, 120,
125, 129, 318, 320, 321
prospectus, 82, 97, 129, 132, 135, 138, 139,
180, 303
public: announcements, 129; company,
142; offering, 68, 69, 77, 82, 90, 92,
9698, 100, 105, 107, 109, 110, 112, 115,
127, 128, 131, 133, 13640, 144, 312, 313
publicists, 170
publicity, 144, 263, 283
publicly: held corporation, 7, 84, 136, 137,
140, 141, 143; trading partnership, 76
purchaser representative, 112, 325
pure acquisition, 4, 157, 208
records, 15, 25, 56, 76, 82, 84, 226, 308,
315
recoupment, 33, 39, 40, 160, 161, 172,
17476, 181, 202, 208, 213, 219, 227, 228,
237, 238, 240, 242, 268, 272
recourse, 150, 151
regular C corporation, 6, 7, 42, 78, 80, 83,
84, 87
Regulation A, 68, 109, 13134, 137, 138,
140, 324
Regulation D, 5, 68, 73, 99, 101, 102,
10514, 116, 117, 119, 120, 123, 126, 128,
129, 307, 30912, 31719, 32228, 336
Regulation S-B, 68, 109, 111, 13537, 138,
304
regulatory: approval, 107; authorities, 60,
69, 105, 107, 303
relationship, 6, 12, 43, 50, 54, 98, 101, 106,
108, 111, 112, 113, 115, 123, 150, 163, 165,
178, 185, 197, 198, 2046, 214, 216, 244,
299, 305, 30811, 316
relationship-driven business, 197
release: prints, 213; slots, 198
rent-a-distributor, 41, 208
reports to shareholders, 84
reputation, 92, 169, 170, 204, 211, 246
resale, 103, 104, 106, 121, 123, 124
reserve account, 169
residence, 103, 104, 271
resolution, 45, 75, 84
resolving disputes, 56
restricted currencies, 275, 276
retained rights, 159
revenue: source, 167; stream, 49, 83, 153,
158, 167, 189, 191, 213, 217, 218, 225, 306
reversion rights, 175
revolving credit, 152, 190
riots, 278, 282
risk factors, 135, 139, 329
Rule 504, 68, 10611, 119, 123, 126, 128, 129,
308, 324
Rule 505, 68, 10711
Rule 506, 68, 101, 11014, 317, 322, 324,
325, 327, 335
running time, 160, 172, 200
salary, 27, 29, 196, 217, 218, 220
sale-and-leaseback, 261, 272
Index
368
sales: agent, 168, 169, 170, 171, 175, 17779,
181, 183, 237, 238, 241, 270; fees, 169;
tax, 24, 25, 2830, 32, 33
SCOR. See Small Corporate Offering
Registration
S corp, 6, 7, 42, 65, 80, 83, 84, 85, 86, 87
Screen Actors Guild, 215, 220
screen credit, 15, 49, 57, 196, 252
screenplay, 81, 89, 149, 170, 171, 176, 195,
196, 199, 200, 206, 235, 280, 294, 300
screenwriters, 1, 14, 36, 294
script, 27, 40, 41, 55, 59, 62, 81, 89, 15859,
160, 171, 179, 182, 19597, 199, 206, 213,
217, 221, 227, 236, 238, 239, 245, 278,
282, 284, 298, 299, 301; approval, 171;
changes, 157, 159, 171; stage, 213, 227
SEC. See Securities and Exchange Com-
mission
secretary of state, 45, 57, 60, 64, 65, 71, 72,
74, 75, 77, 80, 81, 93, 94, 303
Section 3(a)(11), 67, 103, 119
Section 4(2), 96101, 113, 327
Section 4(6), 99102
secured loan, 149, 150
Securities Act of 1933, 67, 96102, 103, 105,
113, 120, 121, 122, 124, 128, 136, 139
Securities and Exchange Commission
(SEC), 60, 303; attorney, 65, 68, 78, 79,
107, 108, 111, 113, 136, 137, 138, 140, 154;
compliance, 73, 95, 96, 103, 105, 115,
128, 131, 135, 138, 141, 149; disclosure
document, 57, 62, 68, 70, 73, 75, 77,
89, 97, 125, 131, 132, 180, 300, 301, 302,
303, 325; and Exchange Act of 1934,
70, 315, 316; lings, 84, 142; fraud, 107,
108, 321; offering, 6, 40, 59, 60, 62, 63,
6772, 81, 89, 97, 119, 108, 109, 111, 113,
117, 118, 129, 133, 135, 13638, 140, 293,
299, 3024, 317, 322, 329; registration,
40, 69, 96, 98, 103, 105, 116, 128, 129,
131, 138, 144, 309, 320, 323, 324; review,
136, 139
securitization, 2, 147, 184, 18891
security interest, 56, 67, 150
selling: agent, 129, 310, 311, 312; materi-
als, 129
separate entity, 55
settlement transaction, 201, 202, 209
share certicate, 80, 81
shareholder, 59, 60, 62, 63, 66, 8087, 93,
144, 240, 299; agreement, 82, 83
shares, 7, 57, 59, 61, 68, 69, 8084, 95, 121,
137, 140, 143, 233, 271, 299, 301, 307, 328
shooting schedule, 199, 237, 238
single active investor, 49, 54, 59, 60, 299
single-picture nancing, 78
Small Corporate Offering Registration
(SCOR), 68, 12830, 132, 137, 138, 140,
324
sole proprietorship, 6, 4247
sound: re-recording, 213; transfers, 213
soundstage, 25, 31, 176, 210, 211, 272
Spain, 172, 247, 257, 262, 286
specialist, 141, 144, 145, 185, 210, 276, 278
split rights, 167, 168, 174
spreading risk, 7, 40, 98, 181, 184, 227, 244,
303
stagehands, 164
standards and practices department, 172
star, 23, 181, 197, 199, 204, 22124
start date, 200
start-up costs, 45, 93
state law, 31, 52, 56, 64, 67, 7577, 80, 106,
108, 111, 113, 114, 119, 122, 133, 317, 318,
321
step deal, 195
stock, 6, 7, 59, 60, 65, 8082, 85, 8688,
90, 91, 105, 128, 132, 137, 141145, 202,
213, 233, 281, 289; exchange, 7, 68,
14145; transfer log, 80, 81
stockholder, 85, 202
studio: afliated distributor, 202; ap-
provals, 200; deal, 204, 205, 212;
development deal, 162, 195, 197;
employee, 198, 200; executive, 34, 36,
19698, 202, 204, 205, 233, 294; facili-
ties, 25, 21012, 269, 281; nancing, 47,
198, 202, 205, 233; in-house produc-
tion, 164, 177, 19598, 199; insiders,
197; lot, 196, 204, 205, 210; studio/dis-
tributor, 4, 8, 23, 36, 47, 140, 154, 157,
162, 164, 167, 168, 177, 182, 188, 193,
195, 197, 198203, 204, 207, 208, 209,
21012, 215, 217, 222, 231, 291, 292, 294
Index
369
subchapter S, 84, 85
subcontract, 208
subjective grounds, 159
submissions, 29, 30, 31, 195, 197, 199, 228,
239
subordination, 150
subsidiary, 4, 8, 27, 65, 135, 182, 201, 210
subsidies, 2, 3, 6, 7, 9, 1137, 169, 215, 244,
245, 253, 257, 266, 274, 28388
Sweden, 172, 247, 257, 262, 272
syndicated television, 225
synopsis, 29, 171, 195, 197, 236, 300
take-it-or-leave-it, 202, 291
takeover rights, 200
talent, 23, 28, 55, 62, 200, 202, 205, 215,
216, 219, 234, 235, 28486; agency, 198,
199, 216; agent, 202
Taurus Releasing, 207
tax: advantages, 13, 34, 78, 274; attorney,
87, 273, 290; benets, 36, 65, 244, 256,
265, 266, 27274; consequences, 11, 57,
58, 84, 149, 156, 289; credits, 2532, 56,
247, 256, 25860, 282, 286; investment
credit, 25, 26, 28, 30, 31; law, 12, 23, 34,
45, 76, 257, 273, 274; liability, 26, 27,
29, 76, 256, 268; services credit, 26, 27,
258, 260; shelter, 34, 25674; status, 17,
246; taxable entity, 56, 80, 246, 254;
year, 22, 26, 29, 30, 56, 57, 85
taxation, 25, 36, 45, 76, 8387, 94, 262
tax-driven motion picture nancing, 257
technicians, 271, 287
television rights, 167, 168, 172
termination, 57, 86, 87 133
territorial rights, 177, 246
territory, 158, 159, 16668, 169, 170,
17278, 181, 225, 233, 242, 243, 244, 245,
248, 253, 267, 270
test-the-waters, 133
Texas, 33, 211
theatre, 174, 20710, 228, 267, 278, 285, 292
theft, 198, 204
third: party, 51, 53, 56, 150, 152, 157, 160,
168, 177, 261; world, 289, 290
time schedules, 196
title: lm, 26, 27, 179, 182, 185; to literary
property, 56; personnel, 205; of secu-
rity, 117, 118, 132
track record, 163, 169, 179, 197, 226, 277,
285
transactional exemption, 105, 108, 111, 318
transferee, 76, 104
treatment: favorable, 145, 201, 209; lm,
195, 197, 235, 238; tax, 74, 86, 246
turnaround, 198
TV/cable network, 205
ultra-low-budget lm, 9, 155, 228, 300
unconscionable agreement, 161, 201, 208
underlying property, 55, 89, 159, 195, 286
underwriting, nancial, 145, 182, 241
unincorporated production company,
44, 45, 59
union, 164, 165, 220, 252, 253, 301
unregistered security, 54, 102, 110, 149, 319
unsecured loans, 149
unstable government, 278, 282
upper-level management, 106, 111, 113, 115,
127, 135, 139, 311, 312, 315, 322, 323
upside potentia1, 17375, 198, 201
U.S-made lm, 21, 166, 172, 225
use of proceeds, 136, 139, 300
usury laws, 149, 154
video, 2, 25, 2730, 33, 41, 16668, 172, 174,
190, 210, 213, 225, 227, 235, 25860, 263,
267, 315, 317, 319; rights, 167, 168, 174
voting: rights, 85, 144; trust, 82
wardrobe, 164, 248
warranties, 187
warrants, 143
weight analysis, 169
welfare, 38, 224
withholding, 47, 254, 267
word-of-mouth, 211
worldwide: negative pickup, 167, 168;
revenues, 225
writer, 1, 14, 17, 69, 170, 19598, 204, 215,
216, 228
writers agreement, 196
John W. Cones is a securities and entertainment attorney who has
practiced in Los Angeles for nearly twenty years, advising independent
feature lm producers and others on investor nancing of entertainment
projects. The author of fteen books and a member of the California and
Texas bar associations, Cones also hosts a Q&A Internet site on investor
nancing at http://www.meclms.com/coneslaw/nforum.htm.
43Ways to
Finance Your
Feature Film
A Comprehensive Analysis of
Film Finance
Third Edition
John W. Cones
[43 Ways to Finance Your Feature Film] is well suited for independent lm-
makers who wish to learn how lm nancing occurs throughout the indus-
try and how to converse with their attorneys about legal arrangements when
they discover potential investors for their lm projects.
Entertainment and Sports Lawyer
[Cones provides] valuable pointers and insights to the burgeoning producer.
Boxofce
This reorganized and expanded third edition of 43 Ways to Finance Your Fea-
ture Film answers the question that every lmmaker and producer ultimately
faces, the issue that can make or break any venture into the lm industry:
How do I nance my lm?
This guide covers the options for lm nancing in rich detail so that even
rst-time producers and lmmakers will be able to make informed deci-
sions about the best approaches to nancing their lms. An extensive bib-
liography refers readers to additional information about each form of lm
nance. In addition, author John W. Cones counters much of the bad advice
of pseudoprofessional lm nance consultants and points out scams that
may separate unwary lm producers from their money.
Although 43 Ways focuses on nancing feature lms, much of its informa-
tion is relevant to the nancing of other kinds of projects, such as short lms,
documentaries, videos, and multimedia and theatrical endeavors. Anyone
considering making or investing in a feature lm will be well served by this
practical and helpful guide.
JOHN W. CONES, a securities and entertainment attorney based in Cali-
fornia, is the author of The Feature Film Distribution Deal (available from
Southern Illinois University Press). He has extensive experience in the -
nancing of feature lms, television pilots, documentaries, infomercials, live
stage plays, and Internet companies.
Southern Illinois University Press
1915 University Press Drive
Mail Code 6806
Carbondale, IL 62901
www.siu.edu/~siupress
Cones
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Printed in the United States of America
ISBN 0-8093-2693-0
ISBN 978-0-8093-2693-8
FILM
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