Filmmaker’s Guide to Equity-Based Crowdfunding
Learn how you can use equity crowdfunding to finance your film
Written by Evan Crean | Posted by: NewEnglandFilm.com
Donation-based sites like Kickstarter and Indiegogo aren’t the only way to crowdfund a film. You can also leverage equity-based crowdfunding, which is more complex, but allows you to raise much larger sums of money. Here, NewEnglandFilm.com explains how you can use this lesser known method to finance your project.
When you hear about filmmakers crowdfunding their films — you probably think of them leveraging donation-based crowdfunding platforms such as Kickstarter and Indiegogo — but did you know that there are other types of crowdfunding you can use to finance a film? A prime example is equity-based crowdfunding, which can actually help you raise much larger sums of money than donation-based efforts.
Equity-based crowdfunding has been around for about 80 years, but it used to be known by a much less exciting name: private placement memorandum (or PPM). The reason most filmmakers didn’t use PPM though, is because its setup was too complex and its fundraising methods too limited. To employ this method you have to start a company which holds the rights to your project, and then sell equity in said company to raise money. The complicated part is that your company must comply with the procedures and regulations established by the Securities and Exchange Commission (SEC) and the individual states where your investors reside.
A roadblock that prevented filmmakers from using this method in the past was that fundraisers were only allowed to raise money from people they already knew. Thankfully in 2013, the SEC established a new rule that allows for general solicitation of funds. So now filmmakers can take advantage of equity-based crowdfunding by soliciting funds through social media and other online portals.
If you’re a filmmaker interested in financing your film with equity-based crowdfunding, the following guide will walk you through high levels steps you can take to make it happen (with help of course from the proper legal counsel). It will also explore some of the major equity-based crowdfunding sites you can use to help fund your project. For a more detailed look at the process that explores its legal nuances and all of the questions you should be asking yourself, check out the comprehensive guide JB Jefferson at Lawyers Rock has assembled.
NewEnglandFilm.com recommends seeking guidance from legal counsel before performing any of the following steps.
Step 1: Set Up A Company that Will Own Your Film
To run an equity-based crowdfunding campaign you first need to set up a corporation or limited liability company. This company helps reduce your risk by separating your personal assets from business ones. It also provides lower tax rates and the ability for you to deduct business-related expenses from your taxes. The process increases your credibility with investors and provides both of you with protection. If something happens to you, their investment will continue because someone else can run the company, and if you decide to pursue other work, you could transfer ownership of the business to someone else.
Step 2: Prepare Your Offering
To maximize your chances for success you’ll need to have a strong project and a well-formulated offering. This includes elements that generate investor interest like a great screenplay, a unique angle, a reasonable budget, and proper documentation. During this phase you will need to determine how much money you need to raise, how much equity you plan to sell in your company, who will make up your company’s personnel, what your draw will be (i.e. specific talent or executives with a great track record), and which states you plan to target with your fundraising. You should also develop a strong business plan to attract investors.
Step 3: Choose the Right Exemption for Your Fundraising Campaign
This step should generally be done in close consultation with legal counsel, since it involves discussing if the amount of money you’re raising may change. For instance, if your budget is close to one of the dollar limits for a specific exemption, you may want to satisfy qualifications of a higher exemption in case you need more money. You will end up choosing between exemptions from Regulation D, which has six rules (Rules 501-506). The three main exemptions include Rules 504, 505, and 506. You can find a summary of each one below.
Rule 504 covers transactions in which no more than $1,000,000 of securities are sold in a consecutive 12-month period. It doesn’t put a ceiling on the number of investors, it permits the payment of commissions, and doesn’t restrict the method of selling or reselling securities. Generally, Rule 504 lets the laws in each state called “blue sky laws” monitor this fundraising.
Rule 505 applies to transactions in which no more than $5,000,000 of securities are sold in a consecutive 12-month period. It allows you to sell to 35 non-accredited investors and to an unlimited number of accredited investors. Accredited Investors are people or entities who can invest without worrying about paying their bills. This rule does not allow the use of general solicitation or general advertising to sell securities.
Rule 506 has stringent requirements, but has no limit on the funds that can be raised. It permits sales to no more than 35 non-accredited investors and an unlimited number of accredited investors. It used to prohibit the use of general solicitation or general advertising to sell securities, until the introduction of Rule 506(c). This rule is what allows you to advertise your project online, on television, through social media, or other online methods.
STEP 4: Create Your Private Placement Memorandum
A Private Placement Memorandum is a document that summarizes the securities you’ll be selling. It outlines the terms, conditions, and risks that a prospective investor should know about before buying equity in your company. This document should be informational rather than promotional, so you’ll have to consider who should write it, whether it be yourself or legal counsel. Your Private Placement Memorandum should a number of things, including how you’ll use your funds, a description of your project, a description of your business and its management team (with past accomplishments), marketing strategies, milestones, target market and audience analyses, assessment of competitors and risks, financial statements and projections, and an exit strategy.
Step 5: Safeguard Your Private Placement Offering
The start date of your offering is generally the date that you documents are ready to be sent to potential investors. If you’re using an online portal it’s likely the date that you uploaded your PPM. All printed PPMs should be numbered so you can keep a record of who received them and account for each one that’s sent, which is important if you’re contacting investors in different states. Different state laws will dictate when you need to file your PPM and handle any fees with regard to selling equity in your company. Be sure to track sales, incoming checks, and other documents in a system or a spreadsheet.
You should also take steps to ensure potential investors are serious by sending out executive summaries and questionnaires prior to sending full offering documents to gauge interest and ensure the person is qualified to invest. This is where using an online portal will work to your advantage since my equity-based crowdfunding sites vet their members.
Once you receive payment, make sure all of your paperwork is in order and you have all the necessary information about your investors. Then you will file Form D and other appropriate state paperwork.
The last thing you’ll want to consider if whether to set up an escrow account to hold your investment funds. Depending on the amount that you’re raising you might need one anyway, but an escrow account can be used to hold funds until fundraising terms specified in your PPM have been met. This may help put investors at ease, since once terms have been met, the funds are transferred to you and If they’re not, the funds are returned to investors.
Step 6: Close Your Private Placement Offering
The way your private placement offering ends depends on the type you are using. A fixed or defined termination date is needed for an “all or none” offering, while your sales could go on indefinitely until they’re all sold with a “best efforts” offering. Once your fundraising is complete, your private placement offering will end and you’ll need to perform a series of steps to wind down.
You will need to meet with an escrow agent to discuss your closing date. Then you will need to prepare closing documents and circulate them for review. At closing, you should assemble documentation of executed subscription agreements, investor correspondence, and the stock certificates representing the securities purchased. This documentation will be mailed to investors. At closing, your escrow agent will follow escrow instructions and disburse your funds. After that you will sign closing documents and file all final blue sky and federal documents with the appropriate agencies. Finally, you should develop a plan for ongoing document management that lets you update investors on a regular basis and keep up with tax filing requirements.
Time to Get Started
You’ve learned all the steps you need to start a company for your film and to sell equity in that company to raise money. You also understand the process and you know some places that can help you raise the money, so now is the time to get started with the process (with the proper legal advice of course). Still have questions or want to think more about this equity-based crowdfunding before trying it yourself? Check out the comprehensive guide on it by JB Jefferson at Lawyers Rock. And see a description of various equity-based crowdfunding sites for films on NewEnglandFilm.com.
Evan Crean is a film critic in Boston and a founding member of the Boston Online Film Critics Association (BOFCA). He is co-author of the book Your ‘80s Movie Guide to Better Living and co-hosts the weekly movie podcast Spoilerpiece Theatre. He is also the marketing director for Boston Reel, a site dedicated to Boston’s independent film culture. You can learn more about his work at www.reelrecon.com.