A Primer on Basic Types of Film Finance by David Albert Pierce, Esq.
You went to film school not business school yet all of a sudden you are confronted by a lot of fancy financial terms as you try your best to assemble the budget for your film. Rather than pretending to understand these terms, here’s a quick simply primer to further your knowledge.
Film financing almost always requires a piecemeal approach to fully fund a budget for an independent film. Some of the most common assorted pieces which are utilized to cobble together the entire budget are: Crowdfunding (donor based financing); Development / Bridge Loans; Film Loans (collateralized by territorial pre-sales); Tax Incentives (which may also need to serve as collateral for a loan when cash flow requires the money sooner than the government payout of the incentives); Passive Equity (from investors contributing via a Private Placement Offering); Active Equity (from co-production relationships or in-kind co-production deals such as a post-house providing services in exchange for profit participation); and Traditional Loans (secured by either a letter of credit or other tangible collateral such as a mortgage on the producer’s home—this is the most disfavored source given it risk).
Obtaining the First Little Piece of the Money—Crowdfunding. The most important things to understand about Crowdfunding are: the limits of crowdfunding and the difference between Donor based and Equity Investment Crowdfunding. Equity Investment Crowdfunding, promises any and all comers in the internet world to “point and click” in making a financial investment in a particular picture, with the promise of a proportional share of the profits based on their monetary contribution. Donor Crowdfunding is merely a modern day technological version of “passing the hat” among those who care about either the film or the filmmakers, with these generous donors motivated only by their desire to help see the film get made with no promise of profits from its exploitation.
Equity Investment Crowdfunding should be avoided. Title IV of JOBS Act enacted by the Obama administration is the law that allowed for an equity investment component to exist for Crowdfunding and opened the doors for non- accredited investors (i.e. non-sophisticated and without a high net worth) to invest in projects via crowdfunding where the potential for profits are promised to the crowdfunders. While some have touted Equity Investment Crowdfunding as a system which will work well for independent filmmakers, the reality is the regulations governing Equity Investment Crowdfunding are cumbersome and often cost- prohibitive given the proper amounts of cash the filmmakers will need to expend to fully be in compliance. For example, the law requires certified financial statements of the type that publicly traded stock companies must provide each year and few indie film have money years after production has ended to pay for this type of cost. Also, unlike traditional Equity Private Placement Offerings, the public nature of Equity Investment Crowdfunding does not permit you to properly vet all investors to determine who has a legitimate investment purpose versus those who may be investing only to later bring a class action lawsuit if you have failed to fully comply with the compliance rules for the offering. Therefore, this type of Crowdfunding will usually not work for moviemakers. While we strongly disfavor Equity Investment Crowdfunding, those interested in nonetheless attempting to use it, should contact skilled counsel to avoid traps for the unwary. But consider whether the money raised will be enough to make up for the high costs associated with properly engaging in such a fundraising effort.
Donor Crowdfunding does not have the same dangers as Equity Investment Crowdfunding. Donor Crowdfunding can be effective for the limited purpose of raising a finite sum necessary to “kickstart” a project. Generally, a Donor Crowdfunding will work best when raising a small amount equal to the minimum needed Development Funds required to move a project forward. For example: To raise just enough to finish a script, draft a proper budget, place a key actor on hold for his future services, or cover legal fees to prepare more formal and complex financing documents for presentation to the investors that can actually make a substantial financial contribution. Donor Crowdfunding also serves a separate purpose of early identification of grassroots fans who can generate buzz about a project in development, and whose social media presence can be further monetized when the film is released.
Remember, Donor Crowdfunding is not going to get you a significant amount of your budget (unless you are famous or the property has a large fanboy following). Moviemakers need to understand the limits of Donor Crowdfunding. It is a myth that wealthy philanthropists are “surfing the web” to make random donations to projects with which they have no prior affiliation. Rather, the likely contributors are friends & family of the indie producers, writers, director. Donor Crowdfunding has become a dignified way to basically ask for free donations. Because every dollar counts, this source of money from willing friends & family should not be overlooked particularly when the ask is kept small and designated for a very specific Development purpose.
Development Loans. Development Loans, sometimes called “Bridge Loans” in that the loan “bridges” the financing cash flow gap the producers have as a result of the immediate need of early start-up funds in order to pursue financing for the full production budget. Like Donor Crowdfunding, Development Loans work best when used to raise the essential early funds needed to secure the things necessary to get the film “greenlit” and pursue the full budget of the Picture. Development Loans answer the question as to how you can get your first investors to contribute money when nobody wants to be the very first investor in any project.
Development Loans are attractive to initial investors because they are paid back from the first draw-down upon raising the full financing of the Budget (this usually occurs at the start of pre-production). Conversely, an early investor in the film wouldn’t see payback until revenues from the exploitation of the finished film were received (if at all). Often, the Development Loan lender has the ability to either cash-out entire via a payback of the loan plus interest, or alternatively, re-invest the loan proceeds back into the film as an Equity Participant. If the producers fail to raise the full budget for the film, generally, the Lender for the Development Loan will often insist on a lien on the copyright of the script, so if the film is ever made, the lien must be paid off first (and this lien is recorded with the copyright office as part of the chain of title attached to the script).
Loans backed by Pre-Sales as Collateral. Loans backed by Pre-Sales are yet another form of bridge loan. The Pre-Sales are sale contracts promising to pay a set price upon delivery of the finished picture to a particular “territory” or country throughout the world. Because Pre-Sales payments are contingent upon delivery of the finished film, the Pre-Sales contracts serve as collateral for Lenders specializing in making loans that provide cash for the Budget.
In order to qualify for a Loan backed by Pres-Sales, the film must be of a nature that can generate sufficient interest to obtain bona fide pre-sales via a Sales Agent. Certain films can obtain pre-sales better than others. Certain genres and certain actors perform better than others on a worldwide basis. Reputable sales agents and repeat players in the industry can help you identify what scripts and actors work best to obtain pre-sales. The pre-sales are brokered by Foreign Sales Agents which are generally based in the USA but with relationships to buyers all across the world. The Sales Agent needs to have a good reputation with his/her buyers and the buyers need to have good reputations as well. A Sales Agent that over promises great films and regularly delivers subpar films will not be able to secure top price from top buyers in each territory. Similarly, a Sales Agent that deals with buyers that regularly back out of their deals and fail to pay results in those “pre-sales” not being bankable as collateral.
To obtain a Pre-Sale Loan, you will also need a reputable banking institution acting as lender. Most established bankers and private lenders that specialize in this area are well known within the independent film industry. There are a number of other private lenders that pop up from time to time with promises of funding a film project with elaborate, hard to understand financing schemes, which are in facts scams. A common scam is for these fraudsters to provide some difficult to understand explanation as to why money must be advanced by the Producer to the lender who in turn will give the Producer at a later date a far greater sum in the form of a loan. If the terms don’t make sense to you or your attorney, the terms probably don’t make sense-- especially if the people are promising what no other legitimate recognized film lender can promise.
Finally in order to secure this type of bank loan, you will need to obtain a Completion Bond (and all of your Producers, Directors, Actors, UPMs, Accountants & Attorneys on the project must all be deemed “bondable” by the Bond Company). Remember, the Pre-Sales (the collateral) only have value if the film is finished and delivered. If the film goes over budget and cannot be finished, the Pre-Sales are worthless and the Lender may lose its entire loan repayment. For practical purposes, a completion bond acts as insurance, although technically, the bond is a “guarantee” not an insurance policy. The mechanics of the guarantee essentially work the same as insurance. The Producer pays a premium (2% – 4% of the budget, minimum $1Million budget) to the Bond Company in exchange for guaranteeing that the film will be ultimately finished in the event the film goes over budget. Since Bond Companies do not want to pay out if they can avoid it, their experts carefully go over and verify all line on the budget and watch how money is spent throughout the production.
Tax Rebates and Tax Credits. Tax Rebates are cash refunds paid directly for every “qualified spend” dollar spent in the state during a film production. Tax credits, on the other hand, are like an “IOU” processed through tax returns and work as a dollar-for-dollar reduction on your company’s income tax liability. Since most producers are out-of-state production companies that do not pay tax in that state or nation in which filming occurs, the tax credit or IOU from the taxing authority will only be valuable if they are “fungible” meaning they can be sold (at a discount) to those taxpayers in the state that would like to acquire the tax credit for that specific state.
When dealing with tax incentives, remember that you won’t see this money until after the production is wrapped, so if you are using it to help fund the production, you will need a bridge loan with the tax incentives acting as collateral to cover the gap that exists between when you need the money and the time you receive the tax incentive money. You will also need to strictly comply with government regulations in order to fully take advantage of these programs. One mistake that producers make is failing to understand the rules of each state’s tax incentive program before filming begin. It is also important to remember that if you are selling the tax credit to wealthy tax payers in the state that you filmed in, the sales price will need to be less than the actual tax incentive amount, otherwise it would make no sense for people to want to pay the tax credit.
Equity. Equity money remains an essential major component of independent film financing at all levels. Equity investment deals can be identified by many different names: co-production agreements and collaboration agreements are often the names for Active Equity partnerships. Financing agreements and private placement offerings are often the names for Passive Equity investment deals. Equity investment deals generally involve the creation of a Single Purpose Entity, which can be a partnership, joint venture, corporation, LLC, or other commonly used types of entities.
Passive equity investments are the type that require use of a Private Placement Memorandum and the individuals that invest have no say in how the film is made. Rather, they are told simply to invest, show up at the premiere, and if there is a profit, they will get their share. These investors must meet certain qualification rules before they can lawfully invest and the producers must convey certain material information about the investment prior to accepting their money. By contrast, active equity investors are production partners that have a real say in how the film is made and work to some extent side by side with the other producers. Unlike passive investors, active investors, are bona fide participants in the filmmaking process. Whether passive or active, to avoid potential disputes, it is prudent for the equity participant to be fully informed as to not only the risks associated with film investments, but also where precisely on the Revenue Waterfall the equity participant exists in relation to all of the other financing components that need to recoup and/or participate from that Revenue Waterfall. And when dealing with passive investors its not just prudent, its essential. An Interparty agreement are a type of contract that serve as a master contract identifying all of the assorted financing and where each sit in relation to one another and is a great way of allowing all financial and inkind contributors to understand where they sit in relation to other financiers.
Active in-kind production deals is a form of active equity wherein the participants actually contribute significantly to the production. For example, a number of post-houses are willing to enter such co-production deals wherein their post services are provided in exchange for profit participation and usually some form of production credit.
Traditional Bank Loans secured by Letter of Credit: Sometimes despite using all of the above modes of financing, a producer still comes up short. In such cases, a Traditional Bank Loan is necessary. This should be used only as a last resort to complete the final piece of the financing puzzle and only where other options have been exhausted. To utilize a traditional bank loan you will need some type of collateral. A Letter of Credit can be given to act as collateral when given by a credit worthy individual. In such situations, the hope is that the traditional loan will be paid back from the (hopeful) revenue stream of the Picture from Domestic sales or other deals that were not subject to pre-sales already serving as collateral for a Loan Collateralized by Pre-Sales. In order for a Letter of Credit to be deemed “bankable” the letter (or pledge) must be tied to a source that is liquid and can be used to immediately pay off the loan plus interest if the loan is not paid off through revenue generated by the film. The risk associated with this financing mechanism is that the issuer of the Letter of Credit may be on the hook for the full amount of a traditional bank loan in the event the Picture is not a success.
Film financing is often described as a juggling act and like juggling it is its own artform. Each of these different types of financing mechanisms are used to cobble together the overall budget of the Picture. Each presents their own unique set of challenges and traps for the unwary. Therefore, it is always best to fully investigate everything associated with each form of financing and work in conjunction with qualified film financing counsel to ensure that someone knows what you otherwise don’t know.