Independent film producers routinely raise money from private investors to finance production, marketing, distribution, and other film-related expenses. Because these investments often involve relatively small groups of investors and are structured through production companies or special-purpose entities, producers sometimes assume that securities laws do not apply.
That assumption can be costly.
An investment in an independent film may constitute a security even when the investor receives no ownership interest in the production company.
Whether an arrangement is called a “profit participation,” “investment,” “financing agreement,” “loan,” or something else does not, by itself, determine whether federal and state securities laws apply.For producers raising money for a film, securities-law compliance should therefore be addressed at the beginning of the financing process—not after investors have already contributed money.
When Is A Film Investment A Security?
The federal securities laws apply to a broad range of investment arrangements. A traditional sale of stock in a production company is an obvious example, but securities can take many other forms.
For example, a producer might offer an investor:
- repayment of the investor’s principal plus a percentage of film receipts;
- a percentage of profits from exploitation of the film;
- a preferred return on invested capital;
- an interest in a production LLC;
- a contractual right to participate in film revenues; or
- another arrangement in which the investor contributes money with the expectation of receiving a financial return based substantially on the efforts of the producer or production team.
The fact that an investor does not receive voting rights or an ownership interest in the production company does not necessarily remove the transaction from the securities laws.
The federal securities laws generally require securities offerings to be registered with the Securities and Exchange Commission (SEC) unless an exemption from registration is available. Private offerings frequently rely on exemptions such as Section 4(a)(2) of the Securities Act or, more commonly for smaller offerings, Regulation D.
“We’re Only Selling To Friends And Family” Is Not A Securities Exemption
One of the most common misconceptions among independent filmmakers is that a private offering does not implicate securities laws because the investors are friends, family members, business associates, or people the producer already knows.
That is not necessarily the case.
Likewise, limiting an offering to a relatively small number of investors does not automatically make the offering exempt from federal securities laws.
For example, Rule 506(b) under Regulation D can provide a valuable safe harbor for private offerings, but it has specific requirements. Among other things, the offering cannot involve general solicitation, and special requirements apply when non-accredited investors participate.
Other exemptions may be available depending on the structure and circumstances of the offering. The important point is that the producer should identify the applicable exemption before accepting investment funds, rather than assuming an exemption exists because the offering is “private.”
Accredited Investors Do Not Eliminate Every Compliance Requirement
Producers sometimes believe that selling exclusively to accredited investors eliminates the need for securities-law compliance.
It does not.
An accredited-investor-only offering may be substantially easier to structure than an offering involving non-accredited investors, but the issuer still needs a valid exemption from registration and must comply with the requirements of that exemption.
For example, a Rule 506(b) offering generally requires the issuer to avoid general solicitation and satisfy the other requirements of the exemption. Regulation D also requires a Form D filing with the SEC.
In addition, securities laws contain important anti-fraud provisions. An exempt offering is not an offering exempt from the obligation to provide investors with truthful and non-misleading information.
State “Blue Sky” Laws Matter Too
Federal compliance is only part of the analysis.
Every state has its own securities laws, commonly referred to as “blue sky laws.” Although federal law substantially limits the ability of states to require registration of certain federally exempt offerings—particularly Rule 506 offerings—states can still impose notice-filing, fee, and other requirements.
This becomes particularly important when a film has investors in multiple states.
For example, a producer might form a production company in California, have its principal office in Los Angeles, and assume that California securities law is the only state-law concern. But if investors reside in Ohio, Michigan, Illinois, North Carolina, Wisconsin, or other states, the securities laws of those jurisdictions may also need to be considered.
A producer conducting a private film offering should therefore maintain a clear record of:
- where the issuer is organized;
- where the offering is being conducted;
- where each investor resides;
- which federal exemption is being relied upon; and
- which state exemptions, notice filings, and fees apply to each investor.
The Offering Documents Matter
A securities exemption is not a substitute for appropriate offering documentation.
Depending on the structure, an independent film offering may involve some combination of:
- a private placement memorandum;
- subscription agreement;
- investor questionnaire;
- risk disclosures;
- operating agreement or limited partnership agreement;
- securities representations;
- accredited-investor representations;
- use-of-proceeds provisions;
- film budget and financing information;
- distribution and revenue assumptions; and
- disclosures concerning the risks associated with film production and distribution.
The appropriate documentation depends on the offering.
Particular care should be taken with projections and statements concerning the film’s anticipated revenues. Film investments inherently involve substantial uncertainty. Statements about expected box-office receipts, streaming revenue, distribution arrangements, tax credits, investor returns, or anticipated profitability should be carefully reviewed before being provided to prospective investors.
What Happens If A Producer Gets It Wrong?
The consequences of a defective securities offering can extend well beyond an administrative filing issue.
Depending on the circumstances, an issuer and its principals may face:
Investor Rescission Claims
A significant concern is the possibility that investors could seek rescission of their investments.
If an offering was not properly exempt from registration, investors may have statutory remedies depending on the applicable federal and state laws. In some circumstances, the issuer may face claims seeking the return of the investor’s money, potentially together with interest and other damages.
Regulatory Enforcement
The SEC and state securities regulators have authority to investigate and pursue violations of securities laws.
An issue that initially appears minor—such as an improperly structured offering or failure to comply with a state filing requirement—can become substantially more serious if a regulator becomes involved.
Personal Exposure For Producers And Principals
The production company is not necessarily the only party exposed.
Depending on the applicable statute and facts, directors, officers, managers, promoters, controlling persons, and others involved in an offering may face personal liability.
This is particularly important for independent filmmakers because the producer and the production entity are often closely intertwined.
Problems With Future Financing
A securities-law problem can also complicate subsequent financing.
A distributor, completion guarantor, lender, equity investor, or institutional financing source conducting diligence on the film may ask for documentation demonstrating that prior capital was raised in compliance with applicable securities laws.
A defect in an earlier financing can therefore become a diligence issue at exactly the time the production needs additional capital or is attempting to close a distribution transaction.
Problems When A Film Becomes Successful
Ironically, a securities issue can become more significant when the film performs well.
If a film generates substantial revenues, investors have a greater economic incentive to scrutinize their investment and the producer’s representations. A financing structure that attracted little attention when the film was struggling may receive substantially more attention after the film becomes profitable.
The “Everyone Does It” Problem
Independent filmmaking is an industry in which producers sometimes hear that other filmmakers raise money informally without extensive securities documentation.
That may be true.
It is not a reliable legal strategy.
The fact that an offering has not resulted in a lawsuit or regulatory inquiry does not establish that the offering complied with federal or state securities laws. A securities-law problem may remain dormant until an investor wants his or her money back, the film becomes profitable, a regulator conducts an investigation, or a future financing requires diligence.
The absence of a problem in a prior film does not establish that the same structure is legally compliant for the next film.
Compliance Does Not Have to Be Complicated
Securities compliance does not necessarily mean conducting a registered public offering with the SEC.
For many independent films, the financing can be structured as a private offering relying on an available federal exemption, together with the appropriate state-law exemptions and notice filings.
The key is to determine the structure before the money is raised.
A securities lawyer can help the producer determine:
- whether the proposed investment constitutes a security;
- which federal exemption is appropriate;
- whether investors must be accredited;
- whether non-accredited investors can participate;
- what offering documents should be provided;
- whether a Form D must be filed;
- which state blue sky laws apply;
- which state notice filings and fees are required;
- what representations investors should make; and
- how the financing should be documented.
The Bottom Line For Independent Film Producers
Raising private capital for a film is not necessarily difficult from a securities-law perspective. But it should be treated as a securities transaction when the facts call for it.
The most effective time to address securities compliance is before the first investor receives the offering materials or wires money—not after the production has already spent the funds.
For independent producers, a relatively modest investment in proper securities structuring and documentation can help avoid substantially more expensive problems later, including investor rescission claims, regulatory scrutiny, personal liability, and complications with distribution or future financing.
Film financing involves enough uncertainty without adding an avoidable securities-law problem to the production.
Producers considering a private financing for an independent film should consult qualified securities counsel before soliciting or accepting investor funds.