Decision Whether to Invest
Everyone wants to be in the movies, and that includes investors. However, any potential investor interested in putting their hard-earned money behind an independent film production should be careful before making the decision whether to invest. There are a number of things which a potential investor should look out for before agreeing to invest in an independent film production.
Form a Limited Liability Company (LLC)
The most common approach for structuring a film production is to form a Limited Liability Company, or LLC, for the purpose of producing one film. A LLC is a form of business entity which provides the legal protections of a corporation without the formalities required of corporations. Like a general partnership, the members of the LLC (or "investors") can participate in management of the LLC, or most management decisions can be delegated to one manager (or "producer"). The LLC is a pass-through entity for tax purposes so if the film does produce revenues, each individual member pays their income taxes individually.
The Three Necessary Documents
In order to create an LLC for a film production, the managers/producers need to produce three documents, which include an LLC Operating Agreement, a Private Placement Memorandum (PPM), and a Purchase Offer or Purchase Agreement. These are very complex documents requiring a great amount of detail and should be produced by an attorney with experience forming LLCs.
LLC Operating Agreement
The LLC should have a thorough Operating Agreement which dictates the structure, members, voting procedures, and other details concerning operation of the LLC. The Operating Agreement will spell out in detail the role of Members and the Manager(s), explain how profits and losses are handled, dictate the number of Members that may join and how much they must contribute to join, list existing members at formation, and generally spell out the purpose of the LLC.
What to Look Out For in the Operating Agreement
Investors should review the Operating Agreement carefully. One issue of concern is how expenses will be handled, given that in most circumstances there are one or two manager/producers who will be producing the film, while potentially dozens of passive investors will not be involved in day-to-day decision-making. The danger is that the manager/producer could run up the gross costs, thereby reducing the net profits for the film. For example, the producer could spend thousands of dollars traveling around to film festivals promoting the film and staying at 4-star hotels and eating at 4-star restaurants. All of these costs will reduce the amount of net profits after deducting for expenses. On the other hand, the investors (the "Members") may want the producer to go around to numerous film festivals so that they can network and sell the film at a bigger profit than they could have gotten by staying close to home.
How to Sell, Transfer or Assign Interests
Finally, the Operating Agreement should explain the circumstances under which an investor can sell, transfer or assign their interest in the production, explain termination and dissolution of the LLC, and when and how the investors can amend the Operating Agreement.
Private Placement Memorandum (PPM)
The PPM is a document that explains all the pro's and con's of investing in this particular film project, with a heavy emphasis on the con's. This document is intended to outline the risks of investing. It is designed to make sure the investor is fully informed about the risks that they may lose their investment, and to protect the producers from being sued later by investors who never got paid back their investment, which frequently happens in film production. The PPM should include disclosures about what the project is, an explanation of how the production will operate, how the investment funds will be spent, what kinds of investors should invest, risk factors, limitations on selling their shares, estimated production budget summary, etc. In short, the PPM provides an extra layer of comprehensive disclosures which makes sure the investment is as transparent as possible.
Limited Time Period
The PPM offering is usually held open for a limited period of time, often under a year. The PPM is designed to comply with state and federal securities laws which can be very difficult to satisfy, so be sure to work with an attorney to make the required filings with the SEC and register in jurisdictions outside of California if necessary.
The Purchase Offer is the contract for the actual purchase of a share or shares of the film production. The Purchase Offer also often provides investors and producers with the option for whether the funds invested will be immediately available, or only available after all funds are raised. Typically, the investor's funds go into an escrow account which only become available to the producer after all funds for the film have been raised. The Purchase Offer is generally a much shorter document which summarizes a number of the disclosures which are provided in greater detail in the PPM.
The above may sound simple and straightforward, but it's important to understand that forming the legal entity for an independent film production is fraught with pitfalls and risks. This is one area where no producer should cut corners. If putting together an independent film was easy, a lot more people would leave their jobs and give it a shot. The best bet is to consult an attorney for detailed advice to make sure the production is well constructed and the film is given its best chance at becoming a hit.