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.
Stay tuned for more useful information!
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