Wednesday, April 28, 2010

Crowd Film Funding: Losers and Winners

Crowd-funding has a future, but that future will not look anything like the present. The current online crowd-funding models will soon be extinct, but it’s not too late for any of them to do a quick re-vamp of their business models to make them work. Here are my predictions as to the future of the crowd/tribe financing institutions as they currently stand:

* LOSER - Donations/Gifts fundraising is only mildly sustainable in social/issue and hyper-niche filmmaking. Otherwise, it’s business as usual for raising money for a cause, where grant writing is replaced by signing up for a funding site. Is anyone really making $250,000 or even $25,000 online? Outside of Nigeria?
* LOSER – Rewards in the form of gifts won’t work. It’s a passing fad and the novelty will wear off. People will tire of swag, the exception being for fan-boy films that already have a cult following and for which an exclusive reward of some value can be earned (e.g. graphic novel based films), or an animated film where one could earn actual cells from the movie (assuming it’s animated old school.)
* LOSER – Pre-selling DVDs as fundraising won’t last either. First, this, too, is a novelty. Second, people aren’t interested in owning DVDs any more. DVDs as a sell-through are down 40%, whereas DVD rentals are up 7%. But VOD is the fastest growing segment in home entertainment. I own a Blu-Ray player and I think Blu-Rays look amazing (especially “Coraline”), but I don’t buy them, I only Netflix them. The ONE except to this is family films/animation: kids love to pop in the same video and watch it over and over again. That’s why their video takes are 100% higher than other genres. But again, I use Netflix’s Watch Instantly feature for unlimited viewings of “Dora” and “The Wiggles.” Pre-selling a video download won’t cut it either — it’s valueless.
* LOSER – Building an audience as a way to appeal to investors/financiers might sound like a great idea, but having a bunch of YouTube hits does not translate into dollars and means almost nothing to the buyers or financiers. Filmmakers need to remember that their job is to market to buyers and distributors, not to audiences. It’s the distributors’ job to market to their audiences. It’s easy to lose sight of this during the publicity phase leading up to your film’s release, because distributors use filmmakers to market to their audiences. But you have to remember who is pulling the PR strings: the distributor.

If crowd-funding is going to have sustainable legs, it needs to appeal to the most basic of investor emotions: greed and self-interest.

In order to get disinterested investors to support a project, you’ve got to give them something back for their money – and it better be more than a sense of satisfaction. Think about it, what would you want in return?

I’ve been thumbing through the securities blogs for the past couple days (compelling reading) and the fundamental roadblock that crowds hit is the prohibition of “general solicitation and advertising” (unless it’s to accredited investors.) This clearly pulls the rug out from under the crowd concept. But where I do see a ray of hope is within the “intrastate exemption.” Following is an excerpt from a blog called Cutting Edge Capital Raising:

Intrastate exemption – this exemption is based on the premise that an offering that stays within a single state does not require federal regulation (it will be regulated by the relevant state). The business must be incorporated and do a significant portion of its business in the same state where the offering takes place (for example, if you are incorporated in Delaware but located in California, you cannot use this exemption). You must also take stringent measures to make sure all investors reside in your home state and do not sell their stock to anyone living outside that state. Because the statute is somewhat vague about how to qualify for this exemption, the SEC created a “safe harbor” for compliance. A safe harbor is a set of conditions that, if you comply with them, you can be assured that you will meet the requirements of an exemption. However, it is not necessary to comply with the safe harbor conditions to comply with the exemption. The conditions required to meet the safe harbor are as follows:

a. 80% of the company’s assets are located in the state in which the offering is made;

b. 80% of the company’s revenue comes from the state in which the offering is made; and

c. 80% of the proceeds from the offering will be used within the state in which the offering is made.

In short, if your film’s LLC is registered in the state where the film is going to shoot, then that is where you restrict your fundraising. While this isn’t as appealing as casting a net across the globe, it is perhaps more realistic for home grown filmmakers wanting to stay local.

Section A, above, is pretty straight forward if the film stays within the state.

Section C works if the film shoots in the state, while still leaving room to “post” elsewhere if your state does not have facilities.

Section B is a bit trickier, but not impossible… Deriving 80% of your film’s revenues from within California or New York is certainly plausible, since most of the entertainment companies that you could sell to would be intrastate, but you would have to restrict yourself to a buyout arrangement for all non-California revenues, like foreign sales and domestic exploitations outside California.

Basically, the buyout works to shield the LLC from foreign and out of state revenues.

If you’re outside a major media center, then perhaps arranging a non-recourse “buy-out” situation with an intrastate entity (like a broker of some sort) might be the way to go.

I’m not going to presume that this buyout will be the model that sustains crowd-funding, but this is how filmmakers and crowd-site business models need to think about their financing.

People don’t want kitsch — they want cash. And you should always give the people what they want.

POSSIBLE WINNER? – I’ll leave the details for the crowd sites to iron out; with the buyout. But this is one of my suggested possible frameworks I see most likely to succeed.

POSSIBLE WINNER? – The Biracy Project uses rewards as a deferred compensation model to motivate people to do actual work on behalf of the production. Like any other low budget film, these deferrals would be paid out of the film’s profits (if any). This may not let you “ride the upside” like an equity investment would, but at least they’re appealing to the right human motivation: self-interest.

POSSIBLE WINNER? - Another would be if local crowds could create local intrastate investment clubs that raise enough capital so that the club entity itself becomes accredited. This to me is a smart entrepreneurial move for the motivated business player.

POSSIBLE WINNER? - Offshore based crowd-funding business (like in the British Virgin Islands or Costa Rica), where income isn’t generally reported. Many large production companies keep their projects’ intellectual property rights there.

POSSIBLE WINNER? - Crowd-funding for post production: finishing funds, visual effects, editing, sound track, etc. has merit. Vlad Vukicevic of mentioned this and I kind of like it.

This is crowd-investing, so the wisdom of the crowd will need to weigh in.

One of these crowd funding sites will get it right, but who it will be, I don’t know. The winner is the one I am waiting to work with as a future partner in alternative financing for indie films.

Note: I am not an attorney or a securities expert, so please don’t construe this blog post as legal or investment advice. But I do welcome all attorneys and securities experts to join the discussion.
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