Feature Film Equity Finance John Cones Three Key Rules

We hear a lot these days about ‘Feature Film Equity Finance’ or what I like to refer to as investor financing (a more concrete term according to my eighth grade English teacher). In any case, let’s first look at some of the ways this equity financing can be useful for filmmakers:

Uses of Feature Film Equity Finance

1. Production Costs

The entire production budget of a feature of documentary film may be raised from investors. This typically works best for the low and ultra-low budget films. The higher the budget, the less likely that the entire production budget can be raised in this manner.

2. Development Costs

For films with larger budgets, equity or investor financing may be used just to cover the costs of the film’s development phase (i.e., acquisition of underlying rights, if any, developing the script, preparation of the production budget and securing firm commitments (attachments) from a director and lead actor(s).

3. Mixed Financing

In some instances, filmmakers may want to consider combining the equity financing with other forms of film finance (e.g., foreign pre-sales, product placements, state tax incentives, etc.) however, combining several forms of film finance creates a very complex series of transactions typically requiring the expertise of several different advisors each of whom may be pulling the filmmaker in a different direction.

4. Distribution Expenses

Raising money from investors to cover the so-called P&A expenses (prints and ads), otherwise known more broadly as distribution expenses.

Whichever approach or combination is chosen by the filmmaker still involves some level of equity financing, so let’s delve into that part in a bit more detail. As a general rule, if your investors are not regularly involved in helping make the important decisions related to the project, or they do not have a sufficient level of knowledge and expertise in the film industry in order for them to participate in such decision-making in a meaningful way, they are considered to
be passive investors.

Of course, even if your investors qualify as active investors (which is rare), you may not want to deal with the practical problems of having someone who puts a lot of money into your project and who may also want to tell you how to produce your film.

Further, if you make a mistake and wrongfully classify an investor as active when they do not actually qualify as
such, that investor may be able to come back later and claim that you sold him or her a security without making any attempt to comply with the securities laws, thus obligating you the filmmaker to refund the investor’s money, among other possible negative consequences. Any offering (i.e., attempt to raise money) to passive investors involves the sale of a security and in order to make the offering legitimate (e.g., to avoid the possible felony of securities fraud), it is important to comply with all of the conditions and limitations imposed by the applicable Federal and state securities laws.

Rarely do independent, low-budget filmmakers choose to conduct so-called public (registered) offerings since they are too time-consuming, complex and expensive. Besides only three public offerings for indie films have been conducted in the US in the past 25 years, so far as I know, and they all failed to raise the money sought (i.e., they were not successful offerings).

In the alternative, most indie filmmakers rely on so-called exemptions from the securities registration requirements and these offerings are typically called exempt offerings or private placements.

The three most commonly used sets of rules for these exempt offerings are:

1. The SEC’s Regulation D, Rule 506(b);
2. The SEC’s Regulation D, Rule 506 (c); and
3. The SEC’s Regulation Crowdfunding (the federal equity crowdfunding law).

Feature Film Equity Finance – The hidden complexities explained

It is difficult if not impossible to comply with these securities laws if you are not aware of which specific exemption is being relied upon.

All three of these Federal exemptions from the securities registration requirement preempt the application of state law to the offering except for notice filing purposes. In other words, the states still are able to require that the issuer of the securities (i.e., the company selling the securities – seeking to raise the money) complete and file a form with the appropriate state agency notifying the state that securities are being sold in their state. The SEC also requires certain notice filings with these offerings.

Firstly, the traditional Reg. D, Rule 506(b) offering allows the filmmaker/issuer to raise an unlimited amount of money from up to 35 non-accredited investors and an unlimited number of accredited investors (i.e., wealthy investors with a net worth of $1 million exclusive of the value of their primary residence, or annual income of $200,000, $300,000 with spouse – see the SEC’s Regulation D for more detailed definitions of accredited investors). But, this rule does not allow advertising or a so-called general solicitation, thus as a practical matter, the filmmaker and associates must have a pre-existing relationship with all of the prospective investors for this type
offering. There are ways to expand that pool or prospective investors with whom the filmmaker has a pre-existing relationship, but those techniques are beyond the scope of this article. A notice filing on the SEC’s Form D is required for these offerings and similar notice filings are required for each state in which the securities are sold.

Secondly,  the more recently passed Reg. D, Rule 506(c) offering allows the filmmaker/issuer to raise an
unlimited amount of money from accredited investors only, and advertising or a general solicitation is allowed, so the pre-existing relationship requirement of 506(b) does not apply – meaning money can be raised from strangers and through the Internet. This is where online intermediaries like Slated come into play, although there is not much evidence to suggest that such services have been all that successful in actually helping to raise money for the highly risky, low budget feature films from wealthy investors who are not known to the filmmakers. An additional requirement for Rule 506(c) is that the issuer take steps to confirm the accredited investor status of each investor. The SEC sets out the various ways that can be done. My own preference is the so-called third party confirmation for which I have created a specific form to be used.

The third available Federal exemption from the securities registration requirement is the recently created Regulation Crowdfunding or Federal equity crowdfunding law. Note that this form of crowdfunding is different from the donation crowdfunding used by the likes of Kickstarter and IndieGoGo. Those do not involve investments. The SEC’s Regulation Crowdfunding does involve investments from passive investors, thus the securities laws do apply. Regulation Crowdfunding allows issuers to raise up to $1 million from small investors who are limited in the amount of money each can invest (see the SEC release on Regulation Crowdfunding for details on such limitations). Regulation Crowdfunding also requires numerous different filings which makes its use even more burdensome than either of the Reg. D exemptions. All sales relying on this Federal equity crowdfunding law must also be processed through a registered online portal, so you’ll have to select a portal, review their requirements and meet those in addition to SEC requirements.

In each of the above cases, a properly drafted securities disclosure document must be presented to each prospective investor before they invest. There are some differences in the levels of disclosure (i.e., the information about the offering that is put in writing and presented to each prospective investor before they invest) although in my practice, I tend to provide full disclosure in each instance. In any event, keep in mind that the SEC’s anti-fraud rule applies to all securities offerings (including all three of the above) and the anti-fraud rule provides a minimal level (and general standard) of disclosure for all offerings. The anti-fraud rule requires (1) the disclosure of all material information relating to the offering (i.e., everything that an ordinary investor would want to know about such an offering in order to be able to make a reasonably informed decision as to whether or not to invest), (2) that no important information be omitted from the offering materials and (3) that everything stated in the disclosure document, be stated in a manner that is not misleading. In other words, a material omission of fact or a misleading statement of fact in a securities offering to investors could be grounds for a charge of securities fraud. Compliance with the anti-fraud rule typically requires some experience and judgment relating to this specific area of disclosure (i.e., feature film offerings), thus it can be a trap for the unwary.

For a cautionary tale about what can happen to filmmakers who fail to comply with the securities laws concerning feature film equity finance, research online the names of Rand Chortkoff, Sam Braslau and Stuart Rawitt. They were raising money for films based out of Van Nuys, California. Two are now in prison. The third was convicted but died before being incarcerated.

We no longer favoUr the Reg. D, Rule 505 or 504 exemptions, since Rule 505 requires compliance with the specific state exemptions and most states do not recognize Rule 504 offerings as compatible with a Federal exemption. For additional related information see the articles posted at my website. If you have questions or want to discuss festure film equity finance, feel free to post at my online discussion forum, send me a direct email with your question or call the number below.

John Cones, Attorney, Author, Lecturer

Books by John Cones



John Cones is a securities/entertainment attorney who practiced in Los Angeles for 23 years advising independent feature film producers and others on matters relating to investor financing of feature film and other entertainment projects. He is now based in Austin. He has prepared or participated in the preparation of investor documents for more than 250 such offerings. Mr. Cones has lectured on film finance topics more than 350 times for a variety of film industry organizations. In addition to numerous articles, he has authored 16 books on related topics. He also hosts a Q&A Internet site about investor financing of entertainment projects at FilmFinanceAttorney.com.