Film finance

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Film finance is a very secretive and little understood aspect of film production. It is a subset of project finance, meaning the film project's generated cash flows are used to repay investors, and generally not from external sources.

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[edit] The main challenge of film finance

It is difficult to predict with any accuracy the revenues that any one film will generate. The main factors determining the commercial success of a film include public taste, artistic merit, competition from other films released at the same time, the quality of the script, the quality of the cast, the quality of the director and other parties, etc. Even if a film looks like it will be a commercial success "on paper", there is still no accurate method of determining the levels of revenue the film will generate.

Due to the uncertain cash flows financiers are faced with a high degree of uncertainty as to whether they will actually have their investment repaid, and if it is repaid, what return they will earn.

Another challenge is securing title. Since the collateral for any film financing arrangement is based on the ownership of intellectual property rights, film finance transaction should commence with a title analysis.[1]

[edit] Typical methods of raising finance

There are four main methods of raising finance for the production of a film: (i) government grants; (ii) tax schemes; (iii) debt finance; and (iv) equity finance.

[edit] Government grants

A number of governments run programs to subsidise the cost of producing films. For instance, in the United Kingdom the British Film Council provides funding to producers provided certain conditions are met. States such as Oklahoma and New Mexico, will provide a subsidy provided all or part of a film is filmed in that state.

Governments are willing to provide these subsidies as they hope it will attract creative individuals to their territory and stimulate employment. Also, a film shot in a particular location can have the benefit of advertising that location to an international audience.

Government subsidies are often pure grants, where the government expects no financial return.

[edit] Tax schemes

A number of counties have introduced legislation that has the effect of generating enhanced tax deductions for producers or owners of films. Schemes are created which effectively sell the enhanced tax deductions to wealthy individuals with large tax liabilities. The individuals pay the producer a fee in order to obtain the tax deductions. The individual will often become the legal owner of the film or certain rights relating to the film, but the producer will in substance continue as the real owner of the economic rights to exploit the film. Governments are beginning to recognise that enhanced tax deductions are an inefficient way of supporting the film industry. Too much of the tax benefit is siphoned of by promoters of the tax scheme. Also, films with little commercial or artistic merit are produced simply to generate tax deductions. In 2007 the United Kingdom government introduced the Producer's Tax Credit which results in a direct cash subsidy from the treasury to the film producer.

[edit] German tax shelters

A relatively new tactic for raising finance is through German tax shelters. The tax law of Germany allows investors to take an instant tax deduction even on non-German productions and even if the film has not yet gone into production. The film producers can sell the copyright to one of these tax shelters for the cost of the film's budget, then have them lease it back for a price around 90 % of the original cost. On a $100 million film, a producer could make $10 million, minus fees to lawyers and middlemen.

This tactic favors big-budget films as the profit on more modestly budgeted films would be consumed by the legal and administrative costs.

That being said, the above schemes are all but gone and are being replaced by more traditional production incentives [1]

[edit] British tax shelters

The same copyright can be sold again to a British company and a further $10 million could be raised, but UK law insists that part of the film is shot in Britain and that the production employs a fair proportion of British actors and crew. This explains why many American films like to shoot at Britain's major film studios like Pinewood and Shepperton and why a film such as Basic Instinct 2 relocated its action from New York to London. These are commonly referred to Sale & Leaseback deals and were discontinued in March 2007 (with Sale & Leasebacks initiated prior to Dec. 31, 2006 grandfathered in.)

[edit] Debt finance

[edit] Pre-sales

Pre-sales is, based on the script and cast, selling the right to distribute a film in different territories before the film is produced. This is the primary means of film financing. Once the deal is made, the distributor will insist the producers deliver on certain elements of content and cast; if a material alteration is made, financing may collapse (as happened on Terry Gilliam's The Man Who Killed Don Quixote when lead actor Jean Rochefort fell ill). In order to gain the “marquee names” essential for drawing in an international audience, distributors will often suggest a casting alteration. Pre-sales contracts with big name actors or directors will often (at the insistence of the buyer) have an "essential element" clause that (as per the example above) allows the buyer to get out of the contract if the star or director falls out of the picture and a marquee equivalent can't be procured.

The reliance on pre-sales explains the film industry's dependence on movie stars, directors and/or certain film genres (such as Horror). It is because of this importance in pre-selling a movie that actors and directors can ask for fees ranging from $10 million to $30 million, plus perks and a percentage of the gross profits.

Typically, upon signing a pre-sale contract, the buyer will pay a 20% deposit to the film's collection account (or bank), with the balance (80%) due upon the film's delivery to the foreign sales agent (along with all the necessary deliverable requirements.)

Usually a producer pre-sells foreign territories (in whole or part) and/or North American windows/rights (i.e. theatrical, home video/DVD, pay TV, free TV, etc.) so that the producer can use the value of those contracts as collateral for the production loan that a bank (senior lender) is providing to finance the production.

[edit] Television pre-sales

Although it is more usual for a producer to sell the TV rights of his film after it has been made, it is sometimes possible to sell the rights in advance and use the money to pay for the production. In some cases the television station will be a subsidiary of the movie studio's parent company.

[edit] Negative pickup deal

A negative pickup deal is a contract entered into by an independent producer and a movie studio wherein the studio agrees to purchase the movie from the producer at a given date and for a fixed sum. Until then, the financing is up to the producer, who must pay any additional costs if the film goes over-budget. Superman and Never Say Never Again are examples of negative pickups.

Generally, a producer will have a bank/lender lend against the value of the negative pickup contract as a way to shore-up their financing package of the film. This is commonly referred to as "factoring paper". Most major North American studio and network contracts (incl. basic cable) are collateralized/factored by the bank at 100% of the contract value and the lender just takes a basic origination/setup fee. This is not the case with foreign contracts, which the bank will usually only lend 80%, 50%, or 0% of the value of the contract, depending on the bank's history with the buyer, country/territory, and/or seller.

[edit] Gap/SuperGap Financing

In motion pictures, Gap/Supergap financing is a form of mezzanine debt financing where the producer wishes to complete their film finance package by procuring a loan that is secured against the film's unsold territories and rights. Most gap financiers will only lend against the value of unsold foreign (non North American) rights, as domestic (North American: USA & Canadian) rights are seen as a "performance" risk, as opposed to more quantifiable risk that is the foreign market. In short, this means that the foreign value of a film can be ascertained by a Foreign Sales Company/Agent by evaluating the blended value of the quality of the script, its genre, cast, director, producer, as well as whether it has theatrical distribution in the US from a major film studio; all of this is taken into consideration and applied against the historical and current market tastes, trends, and needs of each foreign territory of country. Surprisingly, this is fairly predictable to a certain degree of certainty. Domestic distribution, on the other hand, is very unpredictable and far from ever a sure thing (e.g. just because a film has a big budget and a commercial genre and cast, it could still be unwatchable and thus never receive a theatrical or television release in the US, thus being relegated to being a big budget, direct-to-video film.) So, in as much as there can ever be any certainty in the entertainment business, lending against foreign value estimates is almost always going to be a much better bet than banking on domestic success (comedies and urban films being two notable exceptions: they're referred to a "domestic pieces" or "domestic plays".)

True to its mezzanine nature, in the pecking order of recoupment of investment, generally, gap (or supergap) loans are subordinate to (recoup after) the senior/bank production loan, but in turn, the gap/supergap loan will be senior to (recoup before) equity financiers.

A gap loan becomes a supergap loan when it extends beyond 10-15% of 100% of the production loan required to shoot the film (or in other words, when the percentage of the gap required to complete the film's financing package becomes greater than a bank is willing to bear, which is traditionally 10-15%, but can sometime be a flat dollar threshold like USD$1,000,000.)

Gap/Supergap lending is a very risky form of capital investment and accordingly the fees and interest charged reflect that level of risk. But at the same time it's not unlike buying a house: nobody pays 100% of the purchase price with cash; they pay about 20% in cash and borrow the rest. Supergap financing works by the same principal: put down 20-30% cash/equity and borrow the rest.

Over the years, because of the high risk nature, many supergap companies have come and gone, but a few established players have survived the ups and downs of the markets with Relativity Media, Screen Capital International, Endgame Entertainment, Blue Rider, Newmarket Capital, Aramid Entertainment, Limelight and 120dB all active in the debt financing space in March 2008.

[edit] See also

[edit] References

  1. ^ Thomas Glen Leo & Gregory Siewitt, Chain of Title Review is Major Hurdle for Film Investors Los Angeles Daily Journal, July 20, 2006. Retrieved August 17, 2007.

[edit] External links