The anti-child trafficking thriller “Sound of Freedom” just opened in theatres on July 4th.  Based on a true story, it stars Jim Caviezal as former Homeland Security special agent Tim Ballard who quits his job with the agency and embarks on a mission to rescue children from traffickers in Latin America.  Another true story relating to the film is that the cost of marketing it has been funded through an equity crowdfunding campaign under Regulation CF.  What makes it even more interesting is that the investment instrument issued in this crowdfunding offering was not your typical stock, convertible note or SAFE, but rather something called a revenue participation right.

Angel Studios, which acquired the distribution rights to “Sound of Freedom”, is a non-traditional film distribution studio, even on indie standards.  The films it distributes get selected through a crowdsourcing process in which filmmakers pitch projects to a community of thousands of Angel Studio platform users from all over the world who share Angel Studios’ mission to create meaningful films that the big studios won’t promote.  “Stories that amplify light” is the studio’s tag line.  Angel Studios then launches equity crowdfunding campaigns on its affiliated crowdfunding portal Angel Funding to fund the cost of marketing the crowdsourced films.

Angel Studios raised the money to fund the distribution costs of “Sound of Freedom” through a crowdfunding offering under Regulation CF, which allows issuers to raise up to $5 million in any 12-month period from anyone, not just accredited investors, online without a full SEC registration.  Most Reg CF offerings don’t even come close to raising the $5 million maximum amount.  Angel Studios successfully raised the maximum $5 million in this offering from approximately 7,000 investors. 

As is required by Reg CF, all sales and communications were made through one crowdfunding portal.  In this case, that funding portal was Angel Funding, a sister company of Angel Studios.  Angel Funding does Reg CF crowdfunding raises primarily for the same film production companies whose films are distributed by Angel Studios after the films have been produced.

Angel Studios conducted this offering in order to fund the “prints and advertising” expenses associated with the theatrical distribution of “Sound of Freedom”.  “Print and advertising” or “P&A” generally refers to the money spent to release and market a completed feature film.  Funding P&A is attractive to investors because it’s less risky.  The money is only raised after the film is already made and investors are investing in a finished product they could actually evaluate.

As was the case with the manner of funding, the investment instrument used in this offering was also unconventional.  Instead of issuing stock, convertible notes or SAFEs, Angel Studios issued “revenue participation rights” under a revenue participation agreement each investor was required to sign with the studio. 

Under the revenue participation agreement, Angel Studios is required to pay the investors on a first priority basis all of the gross receipts from the theatrical release of “Sound of Freedom” until the investors have received a maximum return of 120% of the amount they invested. If gross receipts from the film don’t exceed the total amount invested in the offering plus 20%, the investors will be paid 100% of the film’s gross receipts on a pro-rata basis.

“Gross receipts” are defined as all revenues received and earned by Angel Studios from the theatrical release of “Sound of Freedom”.  Investors won’t be entitled to receive payments from any other sources of revenue that may be generated by the film (presumably, such as proceeds from streaming service downloads). Unlike stock, investors don’t share in any upside beyond a return of up to 20%. The revenue participation rights are not common equity, are not entitled to any distributions or voting rights and are not secured by a security interest in any assets of Angel Studios.

The revenue participation rights issued here look like a variation on a traditional revenue participation financing where an agreed-upon percentage of general revenues are paid to the investors until they’ve achieved a designated percentage return. In both cases, investors don’t become equityholders in the issuer.  Nor do they become creditors in the traditional sense inasmuch as there’s no promise by the issuer to repay the investors except to the extent the issuer generates gross revenues sufficient to fund the revenue participation commitment.

The difference in the “Sound of Freedom” revenue participation is that the revenues supporting the participation rights are limited to one discreet project, the “Sound of Freedom”, and not the general revenues of Angel Studios.  Also, while a typical revenue participation arrangement provides for an agreed upon portion of revenues to go to the investors until they’ve achieved the agreed-upon return, the investors here have the right to receive 100% of the film’s revenues until the designated return is achieved.

Revenue participation arrangements have features that benefit both issuers and investors.  The deal structure is easy to explain and there’s no need to argue over valuation, a common stumbling block in investment negotiations.  Issuers appreciate the absence of equity participation and the lack of pressure to produce an exit event.  Investors on the other hand are attracted to the first call on revenues and the multiple rate return.  But the arrangement of course only makes sense when the issuer’s business model calls for reasonably predictable and adequate gross revenues.