Film Financing 101 Class Notes Raise money from: - Commercial banks - Hedge funds - Pension funds - Private equity - Wealthy individuals For: - Development - Pre-production - Production - Post-production / finishing funds - P&A (print & ads) To: - Major studios - Independent (production companies, producers)
Why do studios need co-financing? - Six major studios (used to be more), and 4 mini-major. - Most have corporate parents Previous sources of 3rd party financing have mostly dried up - Foreign tax incentive loopholes have closed - Dissipation of german equity funds - Loss of german and UK co-financing structures These trends have made Hollywood more amenable to alternative capital sources, which had previously often avoided the industry. German tax-shelter: Here's how it works: Germany allows investors in German-owned film ventures to take an
immediate tax deduction on their film investments, even if the film they're investing in has not yet gone into production. If a German wants to defer a tax bill to a more convenient time, a good way to do it is by investing in a future movie. The beauty of the German laws as far as Hollywood is concerned is that, unlike the tax laws in other countries, they don't require that films be shot locally or employ local personnel. German law simply requires that the film be produced by a German company that owns its copyright and shares in its future profits. This requisite presents no obstacle for studio lawyers.
The Hollywood studio starts by arranging on paper to sell the film's copyright to a German company. Then, they immediately lease the movie back—with an option to repurchase it later. At this point, a German company appears to own the movie. The Germans then sign a "production service agreement" and a "distribution service agreement" with the studio that limits their responsibility to token—and temporary—ownership.
For the privilege of fake ownership, the Germans pay the studio about 10 percent more than they'll eventually get back in lease and option payments. For the studio, that extra 10 percent is instant profit. It is truly, as one Paramount executive told me, "money for nothing."
UK co-financing: To qualify for Section 48 tax relief in Britain, the movie had to include some scenes filmed in
Britain and employ a couple of British actors.
Go to wall street to look for money Wall Street sees film as very risky, not transparent Single-slate film deals closed, over $10 bn. - Melrose investors I ($230M, 26 films, Paramount) - Kingdom funding ($500M, 39, films, Disney) - Legendary Pictures ($600M, 25 films, Warner bros) - Marvel Studios structured by Relativity. Structures with limited investor/studio alignment Two models: Co-finance full studio slate structure (everything the studio does) a. Fund co-finances 100% of films b. No overhead, no development costs on films not co-financed for fund c. Distribution fee charged on top Development and co-finance structure a. Select a % of films to co-finance b. Fund have to pay development costs which might or might not be recouped. c. Distribution fee charged on top - Legendary (batman, superman, …) Aligned structure: Studio: Fund: Fund select a % (75%, for example) No overhead No development cost on films not co-financed Shows all qualified projects to fund
How are film proceeds distributed? Gross receipts less: Distribution fee less: P&A, Other distribution, Residuals and participation costs = (th., dvd, tv, etc.) (to studio 10-20%) (costs of studio) = Distributable Receipts Split 50/50 studio/fund (depends on co-investment proportion)
Financial structure of funds: Bankrupcy remote co-financing vehicle Senior debt (50-70%) – typical L+2-3% - Can be structured as a revolver Mezzanine/ Sub (0-30%) - Higher interest, 12-20% - Hedge funds, PE o Portion in cash, portion in-kind Equity (10-35%) Fund: Studio: Shows every qualified project Pays pro-rata Share of distributable receipts and film copyright ownership finances its pro-rata share of the DCP of each film selected
Going over budget – every movie have a built-in contingency of 10%. If the movie goes 10-30% over budget, fund have an option: - Provide additional funds 50/50 - Only studio adds money If movie goes 30% or more – studio bear all costs, and also recoups after fund recoups 100%. Studios only present greenlighted movies to fund. That means: - They know director/producer - Have main cast in place - Have location - Have a sense of their marketing strategy, release date, etc. Studios use their own funds first. Fund only delivers funds before movie release! Talent typically get 15% of gross proceeds as backend (which are usually not gross… distribution, 20% of box office, etc.) Split with exhibitors typically 40-50%, (intl. 40-45%) to studios How are proceeds distributed to investors? Payment from studio Administrative & Transaction fees Interest on Senior Co-financing payments Principal of Senior Funding account (until revolver commitment has ended) – sits until revolver period is over Interest on Mezz Principal on Mezz Equity.
Independent film financing Growing, today account for 50% of feature film released in the US. Financing can range from very low budgeted projects to very high (terminator 3 - $160M) How fund selects films? Receive Package I. Evaluation (creative – is this a commercial film that can reach targets?) Prelim Foreign Sales Interest (get int’l feedback) Evaluate soft money (free money available in different states/countries to filmmakers) Evaluate Equity / Co-production (find investors) Create Preliminary “Greenlight” model Pass – if evaluation of project doesn’t look feasible II. III. Negotiate w/producers for exclusive period, etc.(talk to producers, exclusivity…) Evaluate Sales Agents Gather Foreign numbers Evaluate feasibility of other financing components Finalize model and submission pkg. Pass / Approve for commitment. Commitment letter Contracts: Business Affairs Talent deals Co-production deals Soft money / equity deals Domestic / Foreign Distribution deals Pass / Proceed to full documentation
IV. V.
Film financing package o Banks / funds – which monetize foreign pre-sale commitments and tax incentives o Gap loan – based on a % of foreign sales estimated in certain unsold territories o Super gap loan – based on amounts needed above gap loan o Bridge Loans – as needed o 3rd party Equity Capital – to fill a financing hole as needed Typically, first approach a bank. Banks looks at the estimated assets. They will make an evaluation of an extremely conservative scenario. You can also go to Specialty lenders at each level. Gap loan – typically the most secure portion of the loan. Look at primary territories outside of the US, and they take 50% of these estimates. Sometimes the super gap loan are willing to complete all production costs. Other times you go to seek bridge / equity.
What are a film’s assets? Foreign distribution pre-sale value. Comprised of: Script, talent, director, genre + US distribution (minimum guarantee) + Tax incentives / Gov’t subsidies (soft money) + Co-production deals + 3rd party equity (private individuals) = Budget Gov’t incentive programs: Free money Regional tax provisions designed to encourage film investments in that region. Typically need to be monetized or “banked” in order to realize its value before production begins.
International co-production deals: Entities from countries where a film is not being produced contribute a portion of production financing for a share of film profits. May involve ancillary benefits such as subsidies, television quota benefits, tax benefits and certain “in-kind” benefits.
Example: Total foreign estimates (given by foreign parties, based on value of script and attached elements) = $15M - Trigger foreign pre-sales = 5M (get some validation. When 5M are sold we go forward) - Total unsold estimates = 10M o Gap (50% of unsold territories) = 5M L+3% o Super gap = 5M L+10% Soft money = $7M Total budget = $22M What if value of the financing package changes? - Before / during filming - Financing have to be dynamic Original actors become unavailable, and new actors have less foreign value o Several “assets” and options are available to replace lost value Secure a co-production deal Find 3rd party equity Reduce budget