FINANCING OF INDEPENDENT FILMS: THE SOLE PROPRIETORSHIP
FINANCING OF INDEPENDENT FILMS: THE SOLE PROPRIETORSHIP AS THE BUSINESS FORM FOR THE PRODUCTION COMPANY
Hi everyone, my name is Justin Sterling. I am an Attorney and the Founder of The Sterling Firm. We are discussing the advantages and disadvantages of operating an independent film production company as a Sole Proprietorship.
I. SOLE PROPRIETORSHIP
A Sole Proprietorship is an unincorporated business owned and managed by only one person in order to make a profit.DEFAULT BUSINESS FORM
The Sole Proprietorship is the default business structure for the filmmaker because no legal formalities are required – no government filings. There are no formal requirements as there are in forming a Corporation, such as annual shareholder meetings, regular meetings of the board of directors, maintaining the minutes of such meetings or approval of board resolutions. However, the filmmaker may still need to comply with tax registration, permits, and licenses to operate as a Sole Proprietorship.FICTITIOUS BUSINESS NAME STATEMENT
To conduct business under a different name than the individual filmmaker/owner, a Fictitious Business Name Statement will need to be filed with the State or the office of the Registrar-Recorder/County Clerk in which the individual owner resides. This is the same as a “DBA” or “doing business as” form. The notice of DBA must also be published in a newspaper within the county.
MINIMAL FINANCING CAPABILITIES OF SOLE PROPRIETORSHIP
Because the Sole Proprietorship does not offer any equity, or ownership interest, it is difficult to attract investment and to raise funding. An equity investor will only see a return on the investment if the business makes profit. Equity is attractive to an investor because they are only liable up to the amount of the investment and because any risk of losing the invested funds may be spread out amongst a number of investors, thereby making it less likely any individual investor will suffer significant financial loss.SECURITY LAWS ISSUES
Generally, the Sole Proprietorship is a self-funded business and all expenses are paid by the individual owner, the filmmaker. However, the Sole Proprietorship may receive gifts, grants, and loans. The Sole Proprietorship may also raise additional development and production funding by serving as a general partner in a Limited Partnership or a manager in a manager-managed Limited Liability Company. However, the investors in these business entity forms are considered passive, thereby triggering compliance with the State and Federal security laws when offering an equity ownership share in the business. In addition, it is also possible that funding for the Sole Proprietorship business entity itself may come from an investor pursuant to an agreement. This is a purely contractual relationship and it is not an equity ownership in the Sole Proprietorship; but, nonetheless, if the investor is considered passive the requirements of State and Federal security law compliance are triggered. In order to avoid securities laws implications, it is important to make clear in any investment agreement that the investor is taking on some sort of active participation in the management of the project. For this reason, it is important to have such agreements and business relationships drafted by an Attorney.PERSONAL CREDIT
Sole Proprietorships mostly rely on debt financing, such as loans which carry an obligation to repay a fixed amount by a specific time and with a fixed rate of return known as “interest.” The individual filmmaker who is operating business as a Sole Proprietorship may need to resort to his or her own personal credit history. The Sole Proprietorship is the most simple business form, therefore allowing for the individual to utilize personal credit and assets, though this is the most expensive form of debt financing. The Sole Proprietorship can be financed on the individual’s personal credit cards, unfortunately with very high interest rates. If the income and expenses of the film project are very small, a Sole Proprietorship may be a suitable business form. However, especially if the filmmaker intends to create multiple film projects, the Sole Proprietorship is most likely not the right business form if the budget is not relatively small as funding will need to be raised.FINANCING AGREEMENT
An agreement for a party to provide financing to a project can be a source to raise funds, in exchange for some kind of consideration such as screen credit or a participation share. A financing contract can be presented to a potential financier with a business plan of the film project or the production company itself. However, in order to avoid security laws issues, the financier must be active in the management and operation of the business. The financier must be involved in a substantial manner that is regular and continuous. The financier’s involvement must be properly documented in order to withstand an investigation of a securities regulator, no matter how unlikely such an investigation may seem. The filmmaker must be able to demonstrate the financier’s active relationship within the business. It is often that such financing agreements are referred to by different names such as a Development and Acquisition Financing Agreement and may be limited to funding of certain aspects of the project. The key issue is whether the financier is active in order to withstand security laws issues.
In short, the Sole Proprietorship offers maximum control but it does not offer good capabilities to raise funds because equity ownership is not available. Rather, the ability to raise money from others is by contract in consideration for rights to the film’s revenues or some other arrangement. The contract must also be carefully drafted so as to not transform the Sole Proprietorship into a General Partnership, which could make the filmmaker liable for any acts of the third-party financier. It is important to have a knowledgeable Attorney.SOLE PROPRIETORSHIP TAX TREATMENT
For Federal Internal Revenue Service (IRS) purposes, the individual filmmaker who owns and manages the business, who is also known as the “Sole Proprietor,” and the business itself are considered to be one tax entity. The tax burden is reported on the individual owner’s personal tax return. As a Sole Proprietor the owner is considered to be self-employed and quarterly estimated tax returns must be filed with the IRS and the State. There is no taxation at the business level, only at the individual level for the filmmaker. Simply put, the income of the Sole Proprietorship is taxed as personal income of the filmmaker at the individual tax rate, rather than the higher corporate business tax rate. This is an advantage of the Sole Proprietorship – it is taxed at a lower tax rate.
Furthermore, the business expenses of the Sole Proprietorship may be tax deductible. The individual filmmaker must use a Schedule C on the 1040 annual tax form to report the itemized business expenses and income. Moreover, the individual filmmaker must show that the business is legitimate, as opposed to a mere hobby. The individual filmmaker must show positive income in three of every five years or the IRS may treat the costs as non-deductible.
The tax identification number for the Sole Proprietor is the owner’s social security number and income and expenses are reported on a Schedule C tax form. However, if the Sole Proprietor would like to hire employees, then the owner must file an SS-4 form with the IRS to obtain an employer identification tax number (EIN). Sole Proprietorships obtain EINs to prevent identity theft and to be able to open a bank account.
MAJOR DISADVANTAGE OF SOLE PROPRIETORSHIP – PERSONAL LIABILITY RISK
By operating as a Sole Proprietorship, the filmmaker is subject to personal liability. There is no corporate shield to protect the filmmaker, as there is in other business entities such as Corporations, Limited Partnerships, and Limited Liability Companies. The Sole Proprietor must personally pay the debts and obligations of the business. If the business is found liable in a lawsuit, the prevailing party can look at all the filmmaker’s assets, both business and personal, in order to recover. This makes the Sole Proprietorship a very risky business form.
Now that we have covered the advantages and disadvantages of operating an independent film production company as a Sole Proprietorship, you can be more aware of the circumstances of when it is appropriate to be a Sole Proprietor and when it is not.
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