OC T O B E R 2 0 1 1 venture-capital, “angel” and other seed capital seeking high returns against high risk, most equity investors in the independent environment fail to see returns on their money. On the bright side, most equity investors in the independent environment don’t expect their money back — they’re the everdependable investors mentioned above, frequently the family and friends of the filmmaker. When they do see returns, of course, they are sometimes spectacular, as was the case with investors in The Blair Witch Project — made for about $60,000, the film went on to gross $249 million worldwide. But films like The Blair Witch Project are the exception, not the rule. Most people who invest professionally in film financing don’t do equity investing and even studios have to own a film outright if they’re going to make an equity investment in it. Next is senior debt, which accounts for a significant portion of the film’s total financing. Traditional providers of senior debt (banks like JPMorgan Chase) require a security interest in the film and all revenue streams associated with it in priority to equity. So, before a film is completed, a producer might sell the distribution rights (including theatrical, home video/DVD, pay-TV, free TV and other rights) for various countries. The producer can then use the value of these contracts as collateral against a production loan from a bank. Another form of financing, which became an important part of the funding for independent films around 2002, is ‘soft dollars’ or tax credits for shooting your film in a certain state or country. One fund manager recounted his own experience with a tax credit deal in Connecticut for “a fairly mediocre” film. In that state, a portion of the film’s budget qualifies for a tax credit provided the filmmakers meet certain criteria in terms of filming and spending in the state. The film had a budget of about $60 million with a tax-credit qualifying portion of about $20 million. To get the credit, however, the director couldn’t simply promise to spend in the state — he actually had to do it, then claim the credit later. The director thought a better deal might be to swap the right to the tax credit for ready cash he could use to finish the film. To sweeten the deal, he’d offer to sell the credit at a discount ($16 million). However, for this sort of deal to work, credits must be transferable — no financier will be interested if the rights can’t be assigned directly to him. The Connecticut tax break could only be used by a corporate taxpayer with a tax obligation to the state, so a financier purchasing the tax credit needs to use it himself or sell it to a Connecticut corporate taxpayer who can use it. The Pennsylvania tax credit, on the other hand, gives you an actual rebate, so when the film is done, you submit the expenditure documentation and they cut a check. Since 2005, according to Business Week, states have granted $3.5 billion in incentives to makers of films, TV shows and commercials, but many of these programs are currently under assault, as states struggle to balance budgets. pretty steeply against this. A large-scale, independent studio making 12 films a year will probably get eight losses, two break-evens, one pretty good film and one hit. Smaller-scale institutions with the wherewithal to make only four films could find themselves with four losers and end up closing shop. As a business proposition, it’s better to spread the risk over a larger number of films. That’s an ability the studios have always had — they can release 20 films over a season and are virtually guaranteed, if they did their math and everything else right, to make a profit because they would distribute risk and return expectations in such a way as to have a normal statistical distribution. A slate of films, as it’s called, probably won’t bring great wealth but will prevent the investors from losing They will step in to protect investor money when necessary — and it can be necessary, because the movie-making business is a constant battle between creative and commercial forces. Give money to creative types and they’ll spend it. But not to put it in their pockets, but to create something all that much more spectacular. Sometimes, allowing the creative team to spend millions pays off, but more often, it’s money — investor money — down the drain. Some studios are basically looking to share the risk (and, along with it, the higher returns) inherent in filmmaking with hedge funds or private equity firms. In return, the studios get distribution fees, which give them steady returns, which can be shown to analysts who might give the thumbs up to the studio’s stock, pleasing shareholders. Other studios are more opportunistic about third-party financing, seeing it as a chance to off-load an ugly slate of films. These are the sort of deals that can go south — the final scenes played out by lawyers. Still other studios are so expert at managing their cash flows that they play this distribution fee/tax game perfectly well, to where the amount received by the provider of capital is effectively the same as something better than an investment grade bond. This article was originally published on February 27, 2011 by FINAlternatives, an online investment industry newsletter. Still another component of film financing is print and advertising (P&A) financing — prints need to be made for theatrical distribution, but the main part of the tab is advertising. The typical P&A budget today is equal to the film budget, if not higher. For example, a $16 million film with a $20 million P&A budget, financiers offer to provide $8 million senior debt at 20 percent, which is a very common interest rate range for P&A financing. What’s distinct about P&A is that it has no security. The rights to the film itself are not the security, but it is senior by virtue of the order of payment, which is effectively like being senior secured in that the revenue from the film — after the distributor is paid — pays P&A first. Last in, first out. Producers can also earn money from product placement. And then, there is slate financing. Whatever the structure of the filmfinancing deal, those involved hope for a Hollywood ending, i.e., the film is a smash hit and everyone involved gets fabulously wealthy. The odds, however, are stacked their shirts, and that’s often the goal in film production financing — not to hit the ball out of the park but not to lose everything. Because it is one of the most volatile industries that there is. Borrowing a page from the studios’ book, hedge funds and other investors entering the film-financing world decided to create their own slates. Slate financing is a “term of art” for a financing arrangement in which an investment group provides capital to a major studio-distributor or its subsidiary. Every deal is different, but in an article on the subject, Los Angeles entertainment lawyer Jeffrey C. Foy wrote that generally, the investment is in the multi-millions and the studio receives a distribution fee between 10 percent and 15 percent and is allowed to recoup its marketing costs before splitting the profits with the slate investment group. Slate financing funds can offer senior, mezzanine or equity packages, depending on investor risk appetite. Slate financing agreements put financiers into relationships with major studios and large independents. Most studios have a real culture of partnership. (Continued from Page 50) Film Financing Models “This is my silent partner” Film financing is a complex business that requires good information, strong experience and a balanced approach that avoids emotion about being in the business. It is not for the faint of heart. V I D E O • A G E 52
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