FILMMAKERS, IT’S 2013. DO YOU KNOW WHERE YOUR JOBS ACT IS? Part 2 of 2
Written by Michael R. Barnard
Michael R. Barnard is a writer and filmmaker who has been researching the American JOBS Act since it was first proposed. Barnard is currently working on creating an independent feature film, A FATHER AND SON. He lives in Brooklyn, New York, and is the author of the historical novel NATE AND KELLY. Find him on Twitter at @mrbarnard1, Facebook at michael.barnard and LinkedIn at michaelrbarnard.
This article is an overview and observation, not legal advice.
SUMMARY: The independent film industry in America is not enjoying the growth that would be expected from the surge in the quantity of indie movies being made. The American JOBS Act, passed in April 2012, offers hope to reinvigorate the independent film industry.
In Part 1, we discussed the reasons behind the difficulty raising equity investment.
According to prolific indie producer Ted Hope, with more than five dozen prominent indie films across the history of the current independent film culture to his credit, “The real issue right now is the artists and the people that support them are not benefiting from their work, and it just can’t be done. I’ve watched six years of my own personal earnings keep going down each year. I’m not making a living producing the movies. And the system as it’s set up right now does not benefit artists or those that support them.”
Almost to prove his point, Hope has stepped away from producing and is now the Executive Director of the San Francisco Film Society in California.
“I produced close to 70 films, and I know in my heart that movies like The Ice Storm, 21 Grams, American Splendor, Happiness, or In The Bedroom would not get made today,” says Hope.
THIS IS EQUITY
New filmmakers are often surprised to find out (usually from friends, but sometimes more harshly from Federal authorities) that it is illegal to randomly offer securities to the public to raise money to make their movies. Their first reaction is to try to find a way around the term “securities,” only to learn that a security is pretty much any offer of a potential return in the future for any cash investment made now. Click for the definition of “security.”
Young filmmakers often argue that the SEC could not possibly be interested in pursuing and prosecuting their own small, insignificant movie project.
Correct. Sort of.
Your worry is not the SEC; your worry is your investor. While the SEC may never notice your movie project, the people who invest in your movie are paying a lot of attention to it, and America is full of investors who become disillusioned and disgruntled about the difference between what they feel they were promised, and what they feel they really ended up with. Those are the people who will sue you, and they win by relying on the rules and regulations of the SEC that you ignored.
Offering securities for your film is tightly restricted and regulated. Even under what are known as “Reg. D exemptions,” there are still many expensive regulations to keep you from investors’ money.
Those problems often boil down to enthusiastic, over-confident filmmakers overstating the potential of their movies. You need to be confident to get a movie made, but when you pitch investors, you must include the realities of the risks. Not only is that the ethical course to take, it is also the course that will help you protect yourself.
Offering securities for your film is tightly restricted and regulated by the SEC. For every rule of the SEC that you ignore, your disgruntled investor’s attorneys will accuse you of fraud and deception and other wrongdoing. They will win, and collect good sums of money for their clients.
“If somebody loses their money in a film investment,” says Steele, “Nine out of ten times, they’re going to sue the producer. That’s how the world works. The difference between being sued by ma and pa investors or Accredited Investors is that Accredited Investors have better lawyers.” Click for the definition of “Accredited Investors.”
In simple terms–explanations that are more complex require attorneys–the process to raise money for your movie by legally offering securities is referred to generally as a “Private Placement Memorandum,” which usually costs about $15,000 or more in time and fees.
When you have your expensive PPM, what can you do with it?
Under Rule 506 of Regulation D, you can only show your expensive PPM to, simply put, millionaires. This audience, legally known as “Accredited Investors,” is allowed because of the presumption that people with lots of money can’t get destroyed by a single bad investment, and are smart enough to properly evaluate the realistic potential for any investment.
According to attorney Dan DeWolf, attorney with the New York law firm Mintz Levin Cohn Ferris Glovsky and Popeo, “As a matter of public policy, the courts really do not want to get involved in investments with someone where, if it was disclosed it was a risky investment, and they are wealthy, and they can afford good counsel. If they have a million dollars net worth and they’re making these types of investments, they can afford to pay counsel or their accountant to look this up. The courts really don’t want to interfere in this type of capital formation.”
The definition of “Accredited Investor” is very specific, and was updated in 2011 to exclude the value of one’s home because of the destructive volatility of the mortgage crisis. It includes those with a net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of their primary residence, or those with income exceeding $200,000, or $300,000 with the spouse, in each of the past two years and the reasonable expectation of the same income level in the current year.
“What the courts don’t want, and the SEC doesn’t want,” continues DeWolf, “is people preying on widows, orphans, and others where these types of high-risk investments are totally inappropriate. That is why they limit it to only Accredited Investors, because they can bear the risk.”
It’s a closed community. Only after you find an Accredited Investor can you then pitch your expensive PPM. Generally speaking, you cannot legally let anyone other than Accredited Investors have access to your project for evaluation (there is an allowance for those with prior relationships, but that is not in the scope of Title II of the JOBS Act), nor can you allow anyone other than accredited investors to invest in your project.
These facts commonly frustrate new filmmakers.
Of course, the spirit of artistry and story-telling still burned under the collapse caused by the Great Recession. Filmmaking never died. Even in the worst times of the Great Recession, when distributors, hedge funds, foreign presales, and bank credit started to disappear, filmmaking found support. Even with the tremendous downward pressure on budgets for production and distribution, filmmakers continued to strive to make movies.
At the same time, audiences clamored to help the arts of filmmaking. The spark of creativity was nurtured by a new process of perks-based donor crowdfunding to fund filmmaking.
The process is like an egalitarian version of the ages-old concept of “patron of the arts,” when wealthy benefactors provided money to support their favorite artists for the sake of the art.
With today’s perks-based donor crowdfunding, filmmakers, instead of seeking equity investment in their movie project from a few people in exchange for profit participation, simply ask everyone for outright contributions, usually offering perquisites as a return gift. There is no equity participation; this means that none of the donors will receive any ownership in the movie project. Supporters give money to filmmakers solely for the sake of helping get the movie made. They cannot receive any possible profit. They usually cannot even receive a tax deduction, since perks-based donor crowdfunding is rarely set up for qualified donations to registered non-profit organizations, such as 501c3 entities.
“Any resource that allows artist and audience to link directly and strategically is a great thing,” said Sean McManus about crowdfunding. McManus is co-president of Film Independent, the largest organization serving independent filmmakers in America. He added, “They crowdfund pre-production, production, post-production, and even festival runs and distribution.”
“Crowdfunding also enables filmmakers to develop direct contact with potential viewers once the film is available,” added Josh Welsh, also co-president of Film Independent.
Perks-based donor crowdfunding is probably just as hit-or-miss as seeking equity investment. Many projects launched on crowdfunding sites fail to reach their goals. However, Kickstarter, the biggest player in the field of crowdfunding sites, rightfully brags about some fascinating and exciting results on their blog. Kickstarter alone has brought together nearly 900,000 people who supported independent filmmakers, pledging more than $100 million to features, documentaries, shorts, web-series, and other film and video projects over the past three years. Rentrak, which tracks such things, reports that almost one hundred Kickstarter-funded films were in more than 1,500 North American theaters, and another dozen or more have theatrical premieres slated for 2013.
The term “crowdfunding” refers to a subset of the term “crowdsourcing,” a recent term to describe the use of social media, primarily, to obtain information and maybe even consensus from the crowd of people accessible by one’s online and offline social circles. Click for the definition of “crowdsourcing.” “Crowdfunding” is the process of using crowdsourcing for the specific purpose of raising funds.
Curiously, the most popular crowdfunding site, Kickstarter, does not use the term “crowdfunding.” It calls itself, simply, an online funding platform. Considering the U.S. Government’s definition in Title III of the JOBS Act of “CROWDFUND” as an acronym of the contorted “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure,” it’s easy to side with Kickstarter’s dislike of the term.
Some investment professionals are only aware of the term in the context of the forthcoming Equity Crowdfunding, which is not yet legal, as well as some closed-to-the-public investing sites that now exist, and they might express confusion or concern when people talk about “crowdfunding” as it is popularly used today.
This confusion is likely to grow when perks-based donor crowdfunding and Equity Crowdfunding both become fundraising tools for filmmakers and other entrepreneurs.
Perks-based donor crowdfunding has been legal and immensely popular. Public use of “Equity Crowdfunding” under the JOBS Act has not yet been implemented and is still illegal. Existing closed-to-the-public equity investing sites are limited to only Accredited Investors.
DOWNWARD PRESSURE ON BUDGETS
The perks-based donor crowdfunding efforts that are successful commonly provide only a bare minimum amount of funding for making a movie. In an industry where ‘flying by the seat of your pants’ and being ingenious in cheap ways to create movie magic has always been the lifeblood of making movies, there is now a new lower threshold as many crowdfunded projects raise barely enough money to pay for extremely reduced expenses.
Although it’s now the assumed reality for our new generation of filmmakers, this new lower threshold often results in shorter production schedules, lower or non-existent wages, fewer cast and crew, no rental of equipment to increase production value, avoidance of location fees and even insurance, presuming ‘word-of-mouth’ instead of crafting a marketing budget, and other critically minimized expenses. The Great Recession’s downward pressure on budgets that had already been small has hindered the infrastructure of the independent film industry in America, making competitive production value, consistency, opportunity and livelihood difficult. This is particularly unusual, given the tremendous growth in the quantity of independent movies being made. For instance, more than 2,000 feature films made in America were submitted to the Sundance Film Festival 2013.
“There is now a strata of filmmaking where they get their fifty grand and do whatever they can possibly do with it,” says Abramowitz .
In the modern independent film industry in America, Ted Hope of the San Francisco Film Society considers three levels of independent feature film budgets: about $20 to $25 million, which might be considered as Oscar-worthy films; about $3 million for independent films that attract a lead actor who had a significant role in prior feature films grossing in the range of $100 million; or, otherwise, budgets of about $500,000 or less.
“That breakdown is a simplification made for the sake of clarity,” says Hope.
Several industry experts agree that a filmmaker can now craft a feature-length movie for a production budget under $1 million that is competitive in theatrical production values.
“Absolutely,” says Abramowitz.
“1,000 percent agree,” says Hope, and adds, “It’s been a long time since we had a ‘Napoleon Dynamite.’ On the other hand, Oscar-nominated ‘Beasts of the Southern Wild’ is only marginally above that $1 million figure and is nothing short on the theatrical production value, and well-positioned in the marketing, too.”
Regarding the downward pressure on production budgets, Steele adds, “I would say a $15 million film from a few years ago is now the $3 to $5 million film. The crunch brought the budgets down to where they should be.”
Stacey Parks of Film Specific, which works with filmmakers to properly package their film projects, frequently advises her clients to reduce their original budgets. “If you have started with a $5 million budget,” says Parks, “You’re really only going to make your film for probably no more than $2.5 million.”
There are new opportunities because of the ‘correction’ in filmmaking budgets. More can be done with less. The trick will be to rise out of poverty and rebuild the infrastructure of the independent film industry.
The new generation of filmmakers, and those filmmakers who can quickly adapt, face exciting opportunities for funding their movies.
THE MONEY IS OUT THERE
Yes, there is cash available for investing. Lots of cash.
Cash is being hoarded by the very wealthy and by your friends and family. The notorious mindset of “stuff the money in the mattress” eight decades ago, borne from the fears of the Great Depression and the fear of banks collapsing, returned again in the Great Recession.
Individual Americans have missed almost $200 billion of stock gains by hoarding cash rather than investing it (see Bloomberg’s “Americans Miss $200 Billion Abandoning Stocks”).
Corporations and institutions have done the same; trillions of dollars have been sitting idle instead of creating jobs and building business infrastructure (see NPR’s “Companies Sit On Cash; Reluctant To Invest, Hire,” Forbes’ “Super Rich Hide $21 Trillion Offshore, Study Says,” and PolitiFacts.com’s “Obama says companies have nearly $2 trillion sitting on their balance sheets.”
The FINANCIAL TIMES reports that equity funds have seen the strongest inflows in more than five years because of boosted investor confidence. Net inflows into equity funds monitored by EPFR, the data provider, hit $22.2 billion in the week of January 9, 2013 – the highest since September 2007 and the second highest since comparable data began in 1996.
“Access to capital is essential for success,” says Salute .
The Internet enlarged the playing field for securities offerings, whether valid or not, and for potential investors, whether knowledgeable or not.
How do you legally and ethically access that hoarded cash and encourage its investment in your well-developed movie project so you can hire people and make your movie?
Easier access to that cash is the promise of the JOBS Act, which was the biggest bi-partisan effort of the past several years of hyper-partisanship. Support for the JOBS Act spanned both parties.
America needs good jobs, and some of those jobs need to come from the independent film industry. Joblessness and low-wage jobs have crippled the survival and prosperity of millions of Americans, and are a drag on our entire economy.
For you, the significance of the JOBS Act is not only the production of your movie, but also its potential to rebuild the infrastructure of the American independent film industry by structuring movie projects to show business as well as artistic realities.
The ability to reach out to investors means you will have to analyze the strengths and weaknesses of your movie project, plan its production and distribution, and calculate reasonable possible returns. Your stronger, compelling plans and successful investor strategy will allow you to pay better wages, attract superior cast and crew, rent and purchase proper equipment, engage legal counsel and insurance, and make stronger efforts to engage audiences and deliver your movie to them. By opening access to that hoarded cash and other cash from investors, the JOBS Act can provide filmmakers with increased production quality and increased likelihood of a return on investment, which can increase the stability of the independent film industry in America. The process can increase the potential to deliver higher-quality movies to larger audiences.
There are two parts of the JOBS Act specifically attractive to independent filmmakers. They are Title II—ACCESS TO CAPITAL FOR JOB CREATORS, commonly referred to as “the General Solicitation Rule,” and Title III—CROWDFUND. These offer the promise to improve filmmakers’ ability to raise money for development, production, marketing, and distribution of their movies.
Some filmmakers are lucky enough to raise money for their movies through family and friends, angel investors, venture capitalists, or other ways of private funding. Most filmmakers are not so fortunate.
Many filmmakers turn to crowdfunding, whether perks-based donor crowdfunding or the forthcoming Equity Crowdfunding. That’s a good path for filmmakers whose social circle is pretty normal, and you will benefit from Title III—CROWDFUND of the JOBS Act.
Are you fortunate enough to have millionaires in your social circle? The change to the fundraising process, opening it up for general solicitation, will be the benefit for you from TITLE II—ACCESS TO CAPITAL FOR JOB CREATORS of the JOBS Act.
TITLE II—ACCESS TO CAPITAL FOR JOB CREATORS
TITLE II is popularly referred to as the “General Solicitation” rule. It will change some of the exemptions from the most strenuous rules; these exemptions, which are still very strict, are commonly referred to by investment professionals as “Sec. 506, Reg. D”. The rules that allow exemptions from some of the harshest regulations still include prohibitions against you, or any person acting on your behalf, offering or selling securities through any form of “general solicitation or general advertising.”
Most of those posts long ago on Friendster and MySpace and those ads printed in magazines and newspapers by filmmakers telling people to invest in their films and promising the investors profits have always been illegal. Examples of general solicitation include advertisements published in newspapers and magazines, communications broadcast over television and radio, and seminars whose attendees have been invited by general solicitation, as well as other uses of publicly available media, such as unrestricted websites and social media.
The big news is that TITLE II is going to let you promote your movie project to everybody you can reach. The only restrictions will be, simply, that you can only sell your securities to Accredited Investors – but you can now find those Accredited Investors by publicly announcing your movie project.
The JOBS Act instructs the SEC to make rules to stop the prohibition against general solicitation and to give you reasonable steps to verify that those who invest in your movie are truly Accredited Investors as defined by law.
You will not be able accept investment money from anyone who can’t prove they are Accredited Investors. The Act says you will not be subject to requirements to be a registered broker or dealer because of maintaining and advertising online or on other platforms your offer, sale, or negotiation of an investment in your movie. Under the general solicitation rules for your Sec. 506 of Reg. D offering, there might be no other reporting requirements other than, probably, the basic Form D now required by such offerings. It is likely the SEC will modify the Form D only to acknowledge that your offering is being made under TITLE II of the JOBS Act.
The JOBS Act established a deadline of Wednesday, July 4, 2012, for the SEC to promulgate rules and regulations for the implementation of TITLE II—ACCESS TO CAPITAL FOR JOB CREATORS. The SEC missed that deadline. The agency did publish proposed rules for TITLE II on August 29, 2012, but has not implemented them. Although the SEC has missed the deadline required by the Act, and used a process a little bit out of the ordinary regarding its usual schedule of receiving public comments and publishing proposals, the SEC believes they are working prudently within the complex requirements of implementing the JOBS Act. There is not yet an anticipated date for finalizing the rules for Title II of the JOBS Act. It continues to accept public comments regarding TITLE II.
Title III—CROWDFUND of the JOBS Act, twisted into an acronym of that tortured construct, “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure,” relieves filmmakers of many of the burdens of raising equity investment for movie projects. The goals of the Act appear to allow a filmmaker (or any entrepreneur) to offer securities to any American for up to a maximum of $1 million in any 12-month period for all of the entities controlled by the filmmaker using the process similar to perks-based donor crowdfunding
It appears the filmmaker’s offering of securities must be made only through a registered securities broker or through a newly-described “Funding Portal” registered with the SEC. Funding Portals are intermediaries that might be similar to the existing crowdfunding sites, and will be responsible for educating the public about investing, protecting the public from fraud, vetting the people offering the securities, distributing to the SEC and potential investors any information about the securities, and holding in escrow all proceeds prior to reaching the offering amount. Funding Portals will also protect the privacy of investors and cannot purchase from any finders or brokers any personal information about potential investors. Filmmakers will not be allowed to be officers, partners, or directors in the Funding Portal servicing their projects.
In order to offer equity shares in their project, it appears filmmakers will need to provide some form of a Business Plan and Financial Projection, which was common before the collapse of the independent film industry, that includes the purpose for the offering and the target offering amount and its deadline, as well as the description of the ownership and capital structure of the issuer. The Business Plan and Financial Projection will likely include the name, legal status, physical address, and website address of the issuer; the names of the directors and officers and anyone with more than 20 percent of the shares of the issuer. A description of the financial condition of the issuer including all other offerings of the issuer within the preceding 12-month period is also required. The filmmaker will need to make regular updates about progress meeting the target offering amount. There will be rules about describing the price, value, terms and class of the securities offered. Annual reports will be required.
WHO CAN INVEST, AND HOW MUCH?
Once the new SEC regulations are in place, you likely will be allowed to approach anyone via any method of communication, describing your well-developed movie project, as long as you only send them to the Funding Portal or broker handling your movie project. If you pay someone to bring people to your project at your broker or Funding Portal, you will be required to declare publicly that you pay the person to do so.
It appears there will be no limit to the Americans you can approach, but their participation will have limits. Expect that those potential investors whose annual income or net worth is less than $100,000 will be allowed to invest up to 5 percent of their annual income or net worth, capped at a maximum of $2,000. Anyone with an annual income or net worth of more than $100,000 will be allowed to invest up to 10 percent of their annual income or net worth, capped at a maximum of $100,000. These maximums will apply to all of the investments made by the individual to all issuers – not just you – in any 12-month period.
It is attractive to filmmakers to be able to raise up to $1 million per year in equity investment. This fits into a common timetable for making movies; the first year’s fundraising could support development, production, and post-production, and the second year’s fundraising could support marketing and distribution, effectively allowing filmmakers to raise up to $2 million for your movie.
The investment securities in your movie will be barely, if at all, liquid. Your investors will likely not be allowed to resell their securities for a period of 12 months except to people such as accredited investors and family members, or through a complex registered public offering in the unlikely case that you were to develop one.
The issue of Funding Portals has become very complex. It originally appeared that the JOBS Act would allow a proliferation of new businesses to serve as Funding Portals. However, complex and contradictory parts of the Act now appear to make it illegal for Funding Portals to earn a profit unless they are functions of registered Broker-Dealers. The possibility of non-profit organizations setting up Funding Portals has not yet been addressed by the SEC. The process of becoming a registered Broker-Dealer could take probably more than six months and cost probably more than $25,000. The SEC publishes information online about the process.
“You’re dealing with other people’s money, there is an obligation of financial and fiduciary duty to the investors,” says Bob Thibodeau of Crowdfund Capital Markets, a service company providing backend and clearinghouse functions for equity crowdfunding operations.
“Orderly, transparent, liquid markets are good for everybody,” continues Thibodeau. “The processes, the technology, the understanding of regulatory environments is much more conducive to orderly markets than everybody learning something all at once, which is chaos, which is where crowdfunding is right now.”
The SEC is working with The Financial Industry Regulatory Authority (FINRA), the largest independent regulator for all securities firms doing business in the United States, on rules for funding portals, and FINRA has a voluntary Interim Form for prospective Funding Portals. Once the SEC and FINRA have adopted funding portal rules, they then need to promulgate the rules that will apply to those who need to use Equity Crowdfunding to fund their businesses.
“Investors soon can expect to be inundated with crowdfunding pitches, legitimate or otherwise,” said Heath Abshure, President of North American Securities Administrators Association (NASAA), the oldest international organization devoted to investor protection
An analysis of Internet domain names found nearly 8,800 domains with “crowdfunding” in their name at the end of the year, up from less than 900 at the beginning of the year.
Fraud concerns run high in certain circles of the professional investment community. However, the openness and transparency of the Internet, according to crowdfunding experts, serves to thwart fraud.
Slava Rubin of popular perks-based donor crowdfunding site Indiegogo, and very active in the process of crafting the Equity Crowdfunding part of the JOBS ACT, says “Indiegogo’s 5,000 campaigns are proven case studies to predict that there is no significant worry about fraud. The fraud rate in our case studies has been about 1 percent.” He notes that when e-commerce was new on the Internet, people also predicted huge increases in fraud. However, eBay and Amazon proved that online fraud risk is no greater than every other risk we face every day.
According to the report “How the Crowd Detects Fraud,” “This is the new crowdsourced diligence paradigm.” The crowd itself effectively polices against fraud.
PERKS-BASED DONOR CROWDFUNDING AND EQUITY CROWDFUNDING WILL CO-EXIST
Perks-based donor crowdfunding and Equity Crowdfunding each has its own process and participants. It is likely perks-based donor crowdfunding will be more focused on funding for personal, artistic movies, while Equity Crowdfunding will be focused on movies with commercial appeal.
Kickstarter is not going to get involved in Equity Crowdfunding because its mission was never profit-oriented over artist-oriented. It launched in 2009 after an original idea in 2001 to fund creative projects that would probably not be profitable, but that were good ideas that people want to see come to life.
For instance, last year Charlie Kaufman, Dan Harmon, Ira Sachs, David Fincher, Bret Easton Ellis and Paul Schrader all turned to Kickstarter to invite fans to participate in their personal creations.
Equity Crowdfunding will be a different experience, and for different backers, than perks-based donor crowdfunding.
The JOBS Act established a deadline of Monday, December 31, 2012 for the SEC to promulgate rules and regulations for the implementation of TITLE III—CROWDFUND. The SEC missed the deadline, and has no anticipated date for the rulemaking to implement TITLE III. The SEC has not published any proposed rules for TITLE III and continues to accept public comments regarding TITLE III.
When the SEC is engaged in rulemaking, they typically want to hear from the public and will say very little beyond what is proposed.
Part of the reason for delays in rulemaking may be the change in leadership at the SEC. On December 14, 2012, Chairman Mary Schapiro left the agency, and President Obama appointed Elisse Walter as her successor.
Although the SEC has made few announcements about the JOBS Act and its rulemaking, former Chairman Schapiro spoke about it in her opening remarks at the SEC Open Meeting on August 29,2012 and current Chairman Walter gave her “Opening Remarks Regarding the Proposal of Rules Eliminating the Prohibition against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings” at that same meeting.
When it wends its way through the SEC rulemaking processes, the JOBS Act will be a powerful tool that will give filmmakers something they have desired for decades: easier access to investors for their movies.
You face the opportunity to have a significant impact on the future of America’s independent film industry.
You can immediately participate in the process to make sure the JOBS Act supports the needs of America’s independent film industry. The SEC wants to hear from you.
As a filmmaker, you can tell the SEC that it’s important to you to be able to have access to investment capital in order to make your movies and to rebuild the independent film industry.
© 2013 Michael R. Barnard All Rights Reserved