July 13, 2020
Document Purpose: Comments Submission for SEC Proposed Rules
File No: S7-05-20
File Title: Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets
In Response to: Section II(F)2. Regulation Crowdfunding and Regulation A Eligibility
We are two individuals in the film industry with additional backgrounds in financial analysis and small businesses. We submit this comment letter to oppose the staffs proposal to limit the type of security that may be offered and sold pursuant to Regulation Crowdfunding. There are a number of businesses and asset classes that do not lend themselves to equity, debt or convertible debt instruments, and in this letter we use film and small businesses as examples to demonstrate this point.
Film
A film is designed to do one thing: generate income. This is the cornerstone of their value from the perspective of an investor.
There are numerous ways for filmmakers and producers to raise early-stage capital to finance the development of a film. The first and typical way is to reach out to friends and family. In this scenario, a filmmaker will write a script or a producer will enlist a friend/colleague who is a writer to pen a script. Theyll take the script and shop it to actors and directors they know, or theyll leverage their network to get it in the hands of actors and directors who may relate to the material, and who have enough credits to entice investors and/or distributors. The bigger the project an actor, director, producer, production designer, writer, etc. has worked on, the more in demand they are and the more money they can command. Additionally, those with more credits on larger, more mainstream projects lower the risk of a movie making money. As a result, they attract larger distributors and more capital. Once a top actor and director are added to the script, its considered a package. The package is then shopped to investors.
Whats critical to understand about this model is that investors in early stages of the film often enter into an investment contract seeking to receive a royalty or profits interest in the film project. Once in the market, a films global box office receipts and digital distribution sales constitute the intrinsic value of the film. It exists as a business endeavor to generate cash flow in perpetuity. Films can be financed at later stages by limited partnerships set up through brokerages to raise capital from individual investors negative pickup deals whereby future funds are contracted once the film is delivered to a studio for distribution pre-sales of distribution rights in various territories, and the standard studio system. However, many early-stage investors in film do not make a conventional equity investment.
The strength of the package informs the potential box office and other distribution revenue the film is expected to generate. Hence, films are financed based on their potential to generate the expected income stream over time. Investors seek a return on their investment in the form of either a portion of gross revenue or net profits. This is not only customary for films, television, music, etc., but is also the standard for any investment in a project or discrete asset designed to generate a stream of income. Investors in film are not financing a company or enterprise. They are investing in the income potential of the project. As a result, raising capital via equity is not always conventional within the entertainment industry overall.
The issues around equity valuation can be complex. Metrics that must be measured include discounted cash flow calculations, discount rates, cap rates, revenue and expense forecasts, depreciation and amortization projections, etc. However, gross revenue and income streams are far easier to calculate and assess. And if an investments value is easy to evaluate and measure, the investor has a far greater level of protection. As such, the potential investor will feel more comfortable executing an investment because they know that its simple, straightforward, and there are very few areas for abuse.
Debt is not typically used due to the high level of risk inherent in an investment in an entertainment project. To compensate the investor for the intrinsic risk associated with a project, or rather, align the risk associated with a film project to interest rates, they would have to charge rates in the 30%-45% range, or higher. There are far less risky assets to utilize debt financing such as real estate, machinery and equipment, inventory and others. However, in the case of film, debt instruments are better suited for production companies, entities or full-fledged studios looking to raise working capital or fund capital expenditures.
Overall, both equity and debt financing are far better suited for companies and enterprises than they are for discrete assets, projects and products such as films, television, music and other artistic projects. As a result, investments based on easily calculated income streams are customary, preferred, more palatable, and offer far more protection for investors.
Small to Medium-Sized Businesses
In 2016, small businesses employed 47.3% of the private workforce. Over 99% percent of Americas 28.7 million firms are SMBs, of which more than 5.7 million have employees. The vast majority (88%) of employer firms have fewer than 20 employees, and nearly 40 percent of all enterprises have under $100k in revenue.
SMBs in these industries alone employ millions of Americans:
Food service—restaurants, bars, caterers, breweries, and food trucks
Mental health, dental, medical practices
Legal practices
Charter schools, pre-schools, daycares
Barber shops, hair salons, nail salons
Cleaners and professional cleaning services
Clubs (comedy, dance, etc)
Pop-up shops -- a fast-growing retail trend
Lesson services -- swimming, music, dance, gymnastics, martial arts, etc
Carpentry, plumbing, home repair, etc
A seminar or limited speaking engagement
Dog-walking, house-cleaning, and other service-oriented sole proprietorships
Most of the businesses listed above are not suitable equity and debt investment opportunities. They typically wont be acquired by private equity firms, as they most times provide a salary to the owner/operator and employees. Moreover, SMBs are not IPO candidates. That distinction is reserved for a few large, scalable corporations that earn vastly more revenue and are almost always national or global in reach.
This being said, these businesses are critical to our economy and generate cash flows. Therefore, the value in these SMBs to an investor lies in the revenue or excess earnings they generate, not in a future exit, appreciation or the repayment of debt.
This is an instance where the power of the Jumpstart Our Business Startups Act to drive economic growth and create jobs hasnt been fully realized. No one seems to be asking: What investment types other than equity or debt would spark job creation for SMBs, while at the same time, providing maximum value and safety to investors? In other words, what are the investment vehicles for various asset classes and business types that are the most optimal, fair, lucrative and offer the most protection for investors?
In Closing
Overall, raising capital isnt just about starting a company or purchasing an asset or producing a product. Its about creating and taking advantage of money-generating opportunities that require capital to pursue. A business may have a product to design and require capital to bring it to market. They may need to purchase an asset that will generate cash flow over time. A company may have a prototype built, supply chain identified, purchase order in hand, yet only need capital for fulfillment. One may require a modernization of a warehouse in order to exploit new revenue opportunities. Or someone may require funds to produce a product or event. Or they may have already produced a product, but only require funds for distribution. The list goes on and on, and not every scenario lends itself to equity, debt or convertible debt from the perspective of the people that require funds and those seeking to invest, or rather, provide those funds.
Furthermore, there are many discrete assets, products and projects that investors are familiar with and require financing. However, equity and debt instruments do not provide the necessary level of simplicity or protection for investors compared to expected returns generated from easy-to-understand and ascertain income streams.
Foreclosing on the plausible use of Reg CF for SMBs before they can begin to leverage the JOBS Act will have an adverse effect on the number of projects, products, companies and individuals that can raise funds in a manner that is most financially beneficial and safer for investors. And as a result, the number of additional jobs created by the JOBS Act will be stifled.
We hope you will hold off on harmonizing the limitations on the types of eligible securities issuable under Reg CF with Reg A until more diversity in the types of investments and types of entities, individuals and collection of individuals can be studied and explored, and more statistically significant data has been collected and analyzed.
Best Regards,
Marshall Uzzle
Ron Matana
Reviewed and edited by:
Mark Hiraide
Partner, Mitchell, Silberberg Knupp, LLP
Ron Matana
Ive spent the last ten years building streaming media platforms for both major entertainment companies including Fox Corporation, Time Inc., and World Wrestling Entertainment, as well as for startups. My specialty is in launching new products and initiatives—because life in the entertainment business is a never-ending series of projects. We dont sell products or services so much as conceive of and launch projects—e.g. a new website, a mobile game, a Youtube channel, a podcast, a tabletop game, etc. Like many of my colleagues, Ive launched similar projects in my personal life with the intent of growing them into profitable businesses.
Though I like to say the longest job I ever had was working for my fathers small business from my childhood through college. He was a local jewelry distributor. Hed travel to remote regions of Mexico or Thailand to source quality jewelry (no Internet or fax machines in the 80s). Then hed travel around the New England area, where we lived, and sell to local shops. Hed employ 1 or 2 people at any given time to fulfill orders or help with sales.
Marshall Uzzle
Relative to entertainment, I have been a screenwriter and director for more than 15 years. Ive written numerous screenplays and television pilots, directed, financed and produced a feature film starring the late Karen Black and Geoffrey Lewis, and directed a number of commercials for Reebok, Transamerica Insurance—and more. Ive optioned several scripts and sold one. Ive also developed a television show with Juvee Productions run by Viola Davis and signed an if/come deal with Warner Horizon to pitch an hour drama tv show to networks. Ive also developed and written a Marvel comic book based on a Bandai/Namco video game IP and am represented by Bauman Management as a television writer.
With regard to my expertise relating to small-to-midsize companies, I served as a Sr. Financial Valuation Analyst for 10 years, and have completed valuations for the purposes of estate tax planning, mergers acquisitions, ESOPs, partnership disputes, blockage discounts, litigation support, eminent domain and private placements. I have valued controlling and minority interests in privately held companies, limited partnerships, undivided interests in real estate and machinery and equipment, sale leaseback transactions—and more. I have analyzed more than 2,000 companies—from small mom and pop convenience stores and multi-billion dollar conglomerates to undivided interests in small industrial buildings to office towers, regional malls and real estate holding companies. Major cases Ive been involved with include MMAR v Dow Jones Company libel suit, and I led the valuation of Koch Industries in concert with the Anna Nicole Smith bankruptcy proceedings. Additionally, I analyzed and valued Castle Rock Productions in association with an investment transaction.