BY BOB LABATE
The film production population has fallen in love with the LLC (short for Limited Liability Company), a relatively new and, therefore, sexy business entity. The question is why?
Why do indie producers assume that they must have an LLC? Why do otherwise intelligent people, people who are accomplished in the creative arts or who are at the top of their class, suddenly decide that forming an LLC is of equal importance with attaching a name actor to their project or taking a meeting with a studio executive? Why would people who are short on funds deliberately choose a corporate form that is expensive to create and maintain and offers few advantages until major investors are ready to provide funding? I honestly don’t know.
Creating Your Company
Producing a professional film requires a business organization or corporate structure that allows the producers to accumulate production funds and also protects the producers in case something goes wrong. The simplest protection is the traditional corporation, which is easy to form (visit www.sos.state.il.us to download forms and instructions) and costs relatively little to create. The filing fee is $100, throw in $25 for county recording fees and an extra $35 for a standard incorporation kit (containing form by-laws, pre-organization agreements, shareholder/director consents and stock certificates). Or you could have your attorney take care of it all for $400 to $500, which is a good idea if more than one person will own the company. Your attorney also can prepare shareholder agreements describing what happens if one of the shareholders wants to leave the company. It is not rocket science, but it is simple, effective, and you can be operating in corporate form in a matter of days.
Caution: No matter how well you form your corporation, you may lose your protection if you do not continue to do business in corporate form. That means you should create a corporate bank account with at least a $500 opening balance and you must file annual reports with the state. You may want to buy bookkeeping software, such as QuickBooks, to enable you to keep separate books and records for your company. Do not treat the corporate bank account as your personal piggy bank. And make sure that you pay all applicable federal and state employment taxes because the person responsible for payment of such "trust fund" taxes can be held personally liable if such taxes are not paid.
The LLC Alternative
The biggest problem with using a standard corporation for film/music production is that it is usually governed by the "Golden Rule," that is, the ones who provide the gold can make the rules. In other words, in small companies the amount of control over the corporation generally follows the amount of money invested. A traditional corporation is fine for collecting intellectual property rights and for exploring the viability of your project. But once you need significant production funds you may face the problem of giving up control to investors who will want an ownership interest in your company.
One solution to this problem is the LLC, a structure that enables the producer to raise money from investors/members while the producer, within reasonable limits, retains control of the LLC by acting as manager. In essence, the LLC allows a producer to separate ownership of the company (which rests with the investors/members) from day-to-day control of the company (which, for the most part, rests with the producer/manager). However, using other people’s money to make your film is too good to be true and, as you might expect, there are catches.
The first catch is cost. To begin with, in Illinois the cost of filing a new LLC is four times the cost of filing a traditional corporation ($400 vs. $100), and the annual fee is also four times greater ($100 vs. $25). In addition, the cost of having your attorney create a custom designed operating agreement (the document that governs the operation of the LLC) is significant and often exceeds $3,000.
The reason for such high legal fees is that the operating agreement is a contract between the LLC and its members drafted to suit the circumstances of your project. The following issues are addressed: the rights and duties of the manager, meetings of members and their rights with respect to operation of the LLC, member contributions and allocation of ownership interest in the LLC, the timing and amount of distributions by the LLC to members, limitations on the transfer of member interests and dissolution of the LLC. How you organize and structure your LLC depends greatly on the cost of your project, your proposed return to investors, the number of members you will accept and the extent of the manager’s power with respect to the project. A form downloaded from the Internet or borrowed from a friend’s LLC rarely fits and can create devastating problems later in the project.
The second catch is uncertainty. That is, determining how to treat your members in the operating agreement before you know their demands can be tricky. In some productions, an 80/20 split until 120 (that is, 80 percent of distributable income going to the members and 20 percent going to the manager until members have recouped 120 percent of their investment) is an acceptable arrangement. But, what if you identify a single investor willing to cover your entire budget? Conversely, what if you are unable to identify an adequate number of members who can invest at your suggested a minimum amount of $50,000? What happens if you raise only half the money that you need to produce the film or what happens if you sell your script to another production company and don’t require any funding at all? If you draft your operating agreement before you know the answers to these and other critical questions, you have wasted your money.
The third catch is compliance with securities law, which applies to LLCs as well as to traditional corporations. When funds are provided by a person or entity that does not actively manage the business, an investment in a security occurs, which is governed by state and federal securities laws. What duties you have under such laws depends on a number of factors including: the number of investors, the amount being raised, the investor’s net worth and sophistication, the states in which those investors reside, the investor’s relationship to you and your method of contacting them.
You must discuss these issues with a securities lawyer and, often, you will need to prepare (with your counsel) a private placement memorandum (PPM) which complies with securities laws, including specific anti-fraud provisions. If preparing a PPM sounds complicated and expensive, it is. But failing to prepare a PPM when one is required can expose you to civil and even criminal liability.
While operating in corporate form is a great idea, creating and operating an LLC is tricky and expensive, and you may want to start with a simple and inexpensive corporation.
© 2002 Robert J. Labate. This column is provided as a source of information and is not to be construed as legal advice or opinion. You may contact me through our firm’s Web site (mbc.com), via email at labate@mbc.com or, via mail, to Bob at McBride Baker & Coles, 500 West Madison Street, Suite 4000, Chicago, Illinois, 60661 312/715-5700.