An Overview Of Indie Film Finance

By John W. Cones

            Although no one keeps accurate records of such matters, our best estimates are that about 1,000 feature films are produced in the U.S. each year.  We know, for example, that 700 to 800 are submitted to the Sundance Film Festival annually.  Also we know that some 600 or so are submitted to the MPAA ratings board each year, ostensibly because their producers are at least hoping that such films will get a theatrical release.  On the other hand, only about 400 or so actually get released theatrically in the domestic marketplace (U.S. and Canada), so obviously there are about 500 to 600 films produced each year that are not seen in the theatres.

            Of those domestic theatrical releases, about 150 or so are distributed by the so-called major studio/distributors.  The rest are released by distributors not affiliated with the majors.  Unfortunately, for independent films, most of the theatre screens in the U.S. are taken up by major studio product with the result that about 95% of the domestic theatrical gross revenues are generated by major studio releases.  So, there are several hundred independently produced feature films each year, that are scrambling around trying to get a week or two's worth of screen time in the limited number (seldom more than 500 to 600 screens per release) of theatres not showing major studio films.  On the other hand, about half of those 150 or so films released by the major studio/distributors each year are actually produced by independent producers (i.e, without the involvement of the majors).  These completed independent films are acquired for distribution by the distribution arms of the major studio/distributors.

            When the production costs of a feature film are furnished by a major studio (either as an in-house production or a production-financing/distribution deal) such films are clearly major studio productions and cannot be considered independent films, at least from a financial perspective.  In addition, if a major studio/distributor's distribution agreement and guarantee is used to obtain a bank loan to cover the production costs (negative pickup deal), that too (again from a financial perspective) has to be considered a major studio production, and not an independent film.  On the other hand, if an independent producer uses the distribution agreement and guarantee of one or more non-major studio distributors to support a bank's production loan, that would be considered an independently financed feature film, even if it were later acquired for distribution by a major studio/distributor.  In addition, of course, the hundreds of feature films produced each year with pools of funds raised from groups of private investors (again without the involvement of major studios) are independently produced motion pictures.

            The vast majority of independently produced feature films are financed either through (1) some form of lender transaction, (2) an investor deal or (3) a combination of the two.  The lender transactions are generally supported by the distribution agreements and guarantees of one or more distributors, or in the alternative something that serves the same purpose of protecting the bank's interest (i.e, letters of credit, insurance or projected foreign sales estimated by reputable foreign sales agents respected by the lender).  Thus, an independent producer seeking a bank loan to cover some or all of the production costs of a film will either have to obtain a distribution agreement and guarantee acceptable to the lender, a letter of credit, reliable foreign sales estimates (for gap financing) or make arrangements for an insurance-backed scheme (which is both expensive and rarely done for single films).  In addition, the producer will most likely have to go to a completion guarantor and make arrangements to have a completion bond in place so that the bank can avoid the risk that the film may not come in on time and under budget.

            The investor transactions are generally either active investor (non-securities) transactions or passive investor (securities) transactions.  In simple terms, an active investor is  someone who is regularly involved in helping the producer make important decisions with respect to the project.  Obviously for a creative venture like film, having one or two active investors involved in making important decisions may not be desirable at all.  Also, the more active investors you try to put in the deal, the more difficult it is to keep them all truly active  But the active investor scenario can work in some circumstances (e.g., an investor-financed  development/packaging deal funded by one or two active investors).

            In the alternative, the independent producer may want to seek to fund some or all of the required development or production budgets using a large group of passive investors, each of whom is contributing a small portion of the overall cost.  Generally, these deals (either for a single film or a multiple film package) are structured as limited partnerships (LPs) or passive- investor limited liability companies (LLCs).  In both instances, the investors are restricted by law from getting too involved in management, so from a creative point of view, this arrangement is desirable.  Unfortunately, the passive investor vehicles will generally require compliance with the federal and state securities laws, and thus, the independent producer will commonly need the assistance of a securities attorney who specializes in this fairly technical area of the law.

Investor Financing Of Entertainment Projects

• Overview of Film Finance
  • In-House Production
  • Production/Distribution-Financing
  • Lender Financing (Negative Pickup, Foreign Pre-Sales, etc.)
  • Acquisition Deal (Investor or Self-Financing)
  • Rent-A-Distributor Deal
• Purposes of Investor Financing
  • Preliminary/Development/Packaging Deal/Start-Up/Seed Money/Front Money        
  • Production (film/television/video/theatrical, infomercial, Internet)
  • Distribution (prints, ads & other)
• Investment Entities/Vehicles
  • Non-Securities (active investors)
    •  Seeking venture capital with a business plan       
    • Investor Financing Agreement    
    • General Partnership (rarely used)
    • Initial incorporation
    • Active Investor LLC
    • Joint Venture (co-production deals)         
  • Securities (passive investors)
    • Limited Partnership (state created entity; flow through vehicle)      
    • Passive Investor LLC
    • Corporation (state created entity; entity income is taxed)
    • Regular “C” Corporation             
    • S Corps
    • Out of State Corporations
• Type of Securities Offering
  • Public/Registered (disclosure document--prospectus)
  • Private/Non-Public/Exempt (disclosure document--offering memorandum)
• Level of Offering (Federal)
  • Public Offerings
    • S-1 (no ceiling on dollar amount)
    • SB-1
    • SB-2 (not to exceed $25 million)
    • Regulation A ($5 million)
    • SCOR ($1 million corporate stock)
  • Private Placement Options
    • Section 4(2) of the 1933 Securities Act
    • Section 4(6) of the 1933 Securities Act
    • The Intra-State Offering--Section 3(a)(11)
    • Regulation D, Rule 506 (no ceiling on dollar amount)
    • Regulation D, Rule 505 ($5 million or less)          
    • Regulation D, Rule 504 ($500,000 w/o state registration)  
• State Compliance
  • Public/Registered
  • Private/Non-Public/Limited Offering Exemptions   
    • Issuer must comply with all conditions and limitations imposed on the use of the available exemption from registration, in each state in which sales or offers are anticipated, including numerical limitations on the number of investors, ceilings on the amount of money that can be raised, limitations on the manner of conducting the offering, ( i.e., no advertising or general solicitation), notice filing requirements, commission and expense limitations, disclosure requirements, purchaser representations and legend requirements.

Elements of the Draft/Sample Offering Memorandum and Promotional Materials

• Program highlights (selling points)
  • Word Processing, printing and binding considerations (pagination, global search & replace, justified right, fonts, desk top publishing, camera ready copy)
• Disclosure documents: offering memorandum vs prospectus
• Cover page & notice re glossary of terms and capitalization policy
• Summary of the offering (internal and external)     
• Required Notices
• Federal and state notices
• Investor suitability standards/who should invest
• Risk factors (partnership and movie industry)
• Conflicts of interest
• Fiduciary Duty of General Partner
• Business Plan/Proposed Activities
• Current industry developments
• Management of the Partnership (and associated film professionals)
• The Film (script synopsis, production information, audience analysis)
• Distribution approach (including marketing and promotion)
• Offering Information
• Terms of the offering
• Use of Proceeds
• General Partner Compensation
• Allocations and Cash Distributions
• Plan of Distribution of Units
  • Marketing the offering    
  • Upper level management (issuer sales)
  • Affiliated (in-house) broker/dealer firm      
  • Managing & selling broker/dealer group   
  • Broker/dealer due diligence and kits       
  • Finders
• Motion Picture Industry Overview
• Federal Tax Discussion 
  • Partnership Classification          
• Deductibility Considerations
  • Other Tax Considerations          
  • Compliance & Operational Matters         
  • Overall Evaluation of Tax Consequences 
• Miscellaneous Provisions
• Reports to Limited Partners and Others
• Legal Opinions (securities and tax)
• Pending Legal Proceedings
• Financial Statements (GP & LP)
• Access to Additional Information
• Exhibits
• Entity Agreement
  • Form of Counsel’s Tax Opinion   
• Financial Statements
• Financial Projections
• Distribution Agreement
• Industry Articles and/or Press Coverage
  • Subscription Documents/Not Bound