The New New Thing...
By Jonathan Gardner | 03-Nov-2011
What's the NEW new thing in independent film? That's the question the forward looking early adapters in Hollywood ask every day. In a hyper-competitive town, everyone wants to be on the leading edge. As a lawyer, our job is often to try and realize the aspirations of our innovative clients while conforming to federal and state law. It isn't easy.
One of the most interesting topics faced by entertainment lawyers today is crowdsourcing. The term was coined by Jeff Howe in 2006 to describe the process of large groups of networked people solving problems more quickly than individual contractors. It was only a matter of time before this concept found its way to the movie business.
One of the movies I am seriously looking forward to in 2012 is called IRON SKY. I confess I'm a comic-book loving, WWII-addicted, STARSHIP TROOPERS berzerker so the plot of Nazis who have been hiding on the dark side of the moon since 1945 returning to invade the earth in 2018 held automatic appeal. Visionary Finnish director Timo Vuorensola, his producing partner Tero Kaukomaa and world-class f/x studio Energia have already completed photography and released an awesome series of teasers and trailers featuring a Nazi space armada and the slogan "We come in Peace!" Yeah right. With space zeppelins and tanks. Check out the terrific trailers at www.ironsky.net.
But it's not just the uber-cool visual stylism and campy story that have me so interested in this project. It's also the producers' highly imaginative business plan of using crowdsourcing and crowdfunding to produce and finance his picture. In the elitist world of filmmaking, the producers of IRON SKY have planted a flag for the so-called 99%, both in actually making their project, and in financing it. Whether the business plan actually can be successful as a case study for US productions was something I wanted to investigate.
First let's look at what the IRON SKY producers set out to do. Most indie film finance experts will tell you that projects come together using a combination of three sources: debt (usually a loan against bankable pre-sales), private equity, and soft money national or regional subsidies or bankable tax credits. IRON SKY was sold extensively at the 2010 Cannes, and the film was a cross-border co-production taking advantage of several soft money options. What Vuorensola and his team have done that is really new is to attempt to replace the private equity portion of the financing process, which is often the most unstable leg of the chair, with crowdfunding.
The producers raised 600,000 euro of a 7.5 million euro budget by tapping a community of socially networked fans to provide cash donations, directly invest in the project, or purchase branded merchandise (tee shirts, comic books, key chains, etc). In a conversation with lead producer Kaukomaa, who was the architect of this strategy, I asked whether there were any concerns from distributors at Cannes that the crowdfunding approach would leave the project under-financed. "The reaction was only positive," he said, "and it has worked so well." As extra protection, Kaukomaa engaged a Finnish bank to backstop the crowdfunding through a gap finance facility. "From the bank's point of view, if we don't reach our [crowdfunding] target they will recoup from the film sales as is usual for such a loan."
The Producers used three different approaches to achieve this goal: 1. solicitation of investment through their website; 2. sale of transmedia merchandise and perks; 3. "race" between nine international crowdsourcing sites (e.g. flattr, indiegogo, interactor) to raise capital. (In the end, the producers did not use kickstarter, the best known of US crowdsourcing sites, due to the requirement of a US bank account.) Of the three crowdfunding approaches, #1 and #2 were successful, whereas #3, the race, did not succeed.
What went wrong with the race? The producers identified a number of errors: the first was a dilution of their message by using multiple platforms, i.e. the concept of the race itself. Instead they recommend using a single aggregator of capital. The producers also felt that raising post-production funds was less interesting to micro-investors than startup money. In other words, people wanted to feel like a part of "making the movie" not merely polishing a film that had already been shot. Finally, the producers acknowledged their goal and short timeframe had been unrealistic. The financing process required a larger time window.
While the "race to finance" goal was unsuccessful, the producers did raise almost a half million euro through their crowdfunding efforts. Many US pre-sales are occurring around this level (i.e. $750,000), so it is natural to ask whether such an approach might be successful here in the US? After all, most producers would prefer to hold onto the US territory instead of repaying the upfront investment and splitting the territorial overages.
Let's look at the primary way the IRON SKY producers raised funds, which was through small unit investment through the public forum of their website. The major obstacles in the United States to this kind of crowdfunding are the federal securities laws, specifically The Securities Act of 1933 and the Securities Exchange Act of 1934. These laws require that financial instruments (notes, stocks, bonds, "investment contracts") that do not fall under a legal exception must be registered with the SEC. In fact, the SEC has sued numerous film financiers over sales of unregistered securities. (SEC v. Heritage Film Group, et al 2002). It's not unreasonable to have these protections; the movie business and scam artists have a long history together. The problem is that the legal cost of compliance with the securities laws is incompatible with the budgets of most indie productions.
So is the small unit raise used by IRON SKY impossible for US indie producers? For now probably yes; but on April 6, 2011, the SEC wrote a letter to Rep. Darrell Issa, Chairman of the Committee on Oversight and Government Reform, in which the SEC pledged to study rule exemptions for crowdfunding as a means of raising capital for small businesses, which might include filmmaking.
There are two basic paradigms under securities law in which small raises can occur: rules 504 and 506, but each is problematic in its own way. Rule 504 permits raises without registration of up to a $1 million, but prohibits general solicitations and advertising, both essential to the crowdfunding approach. Rule 506 places no limit on the amount which may be raised, but limits the offering to "accredited investors." Accredited investors are basically sophisticated, high net worth individuals who require a lower threshold of protection by the SEC. This isn't much help to producers considering crowdfunding, since they would be trying to tap into the 99%, not the 1%.
One loophole worth mentioning is Regulation CE, an exemption specifically designed to assist small businesses in California, which permits sales of securities of up to $5 million to "qualified purchasers." While a "qualified purchaser" is a somewhat lower standard to meet than the exalted "accredited investor," there are still net worth tests and a fairly robust disclosure requirement. On the upside, Regulation CE does permit a wide announcement of the offering which would be suitable for a crowdfunding platform so this exception deserves further study by California-based film producers interested in this financing approach.
No changes to SEC regulations have been enacted to date, but the tone of Chairman Mary Schapiro's letter suggests the SEC is open to relaxing restrictions on this sort of community based financing. In a footnote, she states that pursuant to 413(b) of the Dodd-Frank Act, the Comptroller General will issue a study in July of 2013 of the "appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds." This was in response to a recent petition by the Sustainable Economies Law Center to create a crowdfunding exemption to the Securities Act.
At the end of the day, I am uncertain whether the model of IRON SKY can be replicated in the US. Currently SEC requirements make this type of funding impractical, although Regulation CE deserves another look. But looking forward, it is possible that the IRON SKY producers will have made a profound and lasting contribution to the way motion pictures are developed, financed and produced. At least by 2018 - when the Nazis return to invade the earth from their hideout on the dark side of the moon.