Film Financing 101: An Analogy

I love film. A great film moves you, makes you laugh or makes you cry. Makes you think about life. Or escape it for a while. Makes you learn new things and remember old ones. A great film is the ultimate art form. It has great writing, acting, music, photography and even fashion. There is no other type of entertainment that includes all these, with the possible exception of video games (yes, another art form). 

But to make a great film, something else is absolutely necessary: good business management. Which is why I have huge admiration for indie film producers - the hidden stars behind a great film, away from the spotlights which usually shine on the cast and director instead. A successful producer needs not only to raise funds for his film, but also the ability to move people from all types of cultures and background, inspire them and coordinate them under a single vision, which is extremely difficult in any situation - including in filmmaking. 

“A writer needs a pen, an artist needs a brush, but a filmmaker needs an army.” – Orson Welles

Producing a film usually involves a combination of “sweat, tears, passion and perseverance”. Explaining why is not an easy feat, given the number of variables involved. So there is an analogy which I heard a few years ago and have been using since then: the real estate industry.

To finance your film you will need to involve tax and production funds, banks, equity investors, sales agents, distributors, completion guarantors, sale & leaseback facilitators, public bodies and, now, crowdfunding. Who are all these people? What do they do? And why do they need to be involved?

The first thing to understand is that, at anything above “microbudget” levels, you are unlikely to find a single investor to fund your project. Most investors like to share their risk with others. This means you will be dealing with more than one financing entity right from the start.

This wouldn’t be a problem if all entities financing your film were the same. Let's say you needed $10m for you film. If you had ten identical $1m financiers, you could just offer each one the same deal, splitting the pie ten ways and giving each one a tenth of what a single $10m financier would get.

Unfortunately, that doesn’t happen either.

In the film financing world, each financier tends to approach the project from a different angle, looking for a different type of deal and a different reward. In fact, it is often impossible to have more than one of any specific “type" of financier on board at the same time. So the problem facing you, the Producer, is how to make all these pieces of a huge and complex puzzle fit into a big happy family. How to make them feel they are getting the deal they want, even if it’s completely different from everyone else.

That’s where the Real Estate analogy comes in.

“To make a film is easy. To make a good film is war. To make a very good film is a miracle.” – Alejandro Gonzalez Inarritu

The Players

Imagine you want to construct a large, fifteen floor, apartment building, containing condos or flats, a top-floor penthouse, and costing $10m.  Someone owns the land. You, as the Construction Company, buy the land in order to erect the building on it, based upon a plan created by an Architect. At some point, you will engage with a Real Estate Agent (or Realtor) to sell off the various apartments, in order to bring revenue.

The land-owner is analogous to the owner of a film’s underlying rights (the script, book or other property that is going to be used as the basis for creating a film). You, as the Construction Company, are equivalent to the film’s Producer – the person who puts the project together, engages the team, gets funding, and ultimately intends to own and earn money from the finished product. The Architect is the film’s Director, under whose guidance the creative vision is materialized. The Estate Agent can be compared to the film’s Sales Agent, whose job is to sell the film to international Distributors.

The analogy does not hold entirely when analyzed in more detail, but it is a useful tool to help understand the basic “Who’s Who” in filmmaking and film financing.

Let’s explore a little further.

Soft Money

So, once you (the Construction Company) have all your plans and designs finalised, and have obtained the necessary planning consents (which may be conditional upon certain things taking place) and identified the main department heads within your construction team, you will be in a position to go out looking for the finance required to pay for the construction of the Building.

The first place you may go in order to obtain some of the finance needed could be your local government. You may be eligible for a grant or other incentive specifically available to those who create residential housing in your local area. We could, for the purposes of this example, assume that you are able to get a $1.5m contribution towards your $10m project in this way. This is the equivalent of what is called “soft money” in the film industry because, although the money probably comes with restrictions as to how, where and on whom it may be spent, it is unlikely that you will be obliged to repay it in full.

Pre-selling

You may also, at this stage, try to pre-sell some of the apartments (or entire floors of apartments) in order to obtain further money to put towards the cost of construction. To do this, you will enlist the services of an Estate Agent (Realtor). The prospective owners of these apartments would have to commit certain funds having only seen plans of the proposed Building, and would therefore probably obtain their apartments at a lower price than if they had waited to see the finished apartments before committing to buy them.

We could, for this example, assume you sell three of the fifteen floors at $1m each, thereby providing another $3m towards the construction costs. This is the equivalent of “pre-selling” a film to foreign distributors, whose “territories” could be considered the equivalent to the different floors (the penthouse being North America, and the other floors being equivalent to the UK, France, Germany, Japan, Scandinavia, Latin America, etc).

Although they are committed to buy, the purchasers are unlikely to part with their money until the apartments are actually finished and available, so you will have to go to a bank to borrow the money in the meantime, using the sales contracts as collateral. In film, this is known as “discounting” the pre-sales.

“I’d rather direct than produce. Any day. And twice on Sunday.” – Steven Spielberg

Deferments

It may be that you and the Architect both believe in the future commercial success of the project so much that you are willing to defer some of your own fees. Although, between the two of you, you may have (say) $1m of fees technically included as part of the budget for the construction, you may choose to defer half of these ($0.5m), and agree for them to be paid out of future income (obtained from selling off the remaining floors of apartments) rather than from funds raised from elsewhere to finance the Building.

This will therefore reduce the amount that you have to find from elsewhere by $0.5m. Effectively, you and the Architect are yourselves financing the construction to the tune of $0.5m. The analogy here would be the deferment by the Producer and/or Director or, for that matter, cast and crew, of part of their fees; a common (if often reluctant) sacrifice made particularly by above-the-line personnel when “passionate” about their independent film project.

Equity

An Equity Investor may also believe in the long-term profitability of the apartment block. Despite realizing that s/he is unlikely to see any money out of the three pre-sold floors for some time (the amounts paid for those apartments went straight into the construction of the building), s/he is comfortable that the remaining 12 floors of apartments can be sold off at prices high enough to cover the remaining cost of construction, and make a profit on top. In return for providing equity cash, the investor will require a share of any profit you ultimately make. Likewise in film; an equity investor will share in any profit made from selling off the unsold territories (ie. those not pre-sold). If, in our example, the equity investor puts up another $3m, you are still left with a shortfall of $2m (the total budget was $10m, right?), having sold off three floors for $3m, received $1.5m soft money, and deferred $0.5m in fees.

The Bank

Reluctantly, this is when you probably have to go to the Bank for a loan. You still have 12 floors of apartments to sell (including the penthouse), and you only need a further $2m to complete the financing for your block. The Estate Agent (whose sale price projections the Bank trusts) confirms to the Bank that it thinks it can sell the remaining floors for a figure far in excess of this amount, even without selling the penthouse. The penthouse, of course, is equivalent to the territory of North America – notoriously and inherently difficult to sell but, if sold, likely to bring in the most money).

So, ignoring any possible income from selling the penthouse, if the Bank can be convinced that the potential receipts from selling the remaining floors outweigh - by a huge margin - the amount it is being asked to lend, it will consider lending you the remaining $2m. This will probably be on condition that:

a)    the Bank gets its money repaid with interest (and an additional fee!)

b)   it is the first in the pecking order (or recoupement… more on that later) to be paid from any receipts generated by selling off the remaining floors (so your deferments may have to wait),

c)    it takes a security (in the form of charge or mortgage) over the building until such time as it is repaid in full, and

d)   it has the right to do the discounting for the pre-sales (see above).

In the film industry, this type of plugging the hole in the finance is known as “gap” financing, and depends on the Bank’s faith in the Sales Agent to sell the territories on behalf of the Producer at sufficiently high prices.

“If no producer, no movie.” – Dino De Laurentis

Crowdfunding: the new kid on the block

Crowdfunding is an alternative to the established arenas of film financing, facilitated by platforms like Kickstarter and Indiegogo. Any producer can set up a project page, upload a pitch video, offer some rewards, and reach out directly to the audience (the project backers). The icing on the cake is that crowdfunding builds your funds and your audience.

Indie films have raised hundreds of millions of dollars through crowdfunding. For example, Film & TV is the top category on Kickstarter in terms of number of projects launched, with $350M pledged to date.

Since a producer does not need to share his future profits with the project backers (apart from goodies usually offered to different levels of backers), crowdfunding can be considered another form of soft money. 

The advent of crowdfunding also brought a new player to the financing arena: gap funding. This is a source of funding that filmmakers can tap to successfully achieve their crowdfunding goals, in case the crowdfunding campaign did not achieve the desire amount. 

Completion Bonds

Another important thing I still need to mention is the concept of a completion bond, which (to my knowledge) does not exist in the real estate world but is very common in filmmaking. A completion bond is an insurance taken out by the producer guaranteeing that the film will be completed without running over budget or over schedule. If a film does go over budget or over schedule, the insurance company will be required to either (i) repay the banks and any other financiers listed as beneficiaries the entire amount of their investment or (ii) pay for the cost of completing production of the film. Such insurance policies are generally required for films with budgets of over $1 million that use Debt financing.

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And so you have it. The Construction Company has managed to obtain the whole $10m needed to construct its building. And in a similar vein, the independent film Producer is likely to need to approach a significant number and range of financiers in order to obtain the $10m needed to produce his/her film.

The next outstanding issue to be addressed is how, and in what order, each of the financiers gets paid back its contribution. That is, of course, down to the various financiers (and their respective lawyers) to agree, usually before one penny of construction (or, in our case, production) finance is actually spent. This is known as the Recoupment Waterfall, and is a full subject of discussion in its own right!

Independents vs Hollywood

One last thing…

It is important to emphasize that most of what has been described above applies to indie filmmaking. The major studios run a different model, in which everything is (usually) done internally:

Studio	Independent
100% financed	Patchwork Finance
Guaranteed Completion	Completion Bond
Guaranteed Distribution	Patchwork Distribution

There is this kind of myth in the film industry about how indie filmmakers offload risk by foregoing margins, while studios take all the risk but also keep the margins. I would dispute this studios-take-all-the-risk myth by mentioning a very important characteristic of Studio film financing mentioned in the above table: guaranteed distribution. Particularly when it comes to TV distribution.

Studios have this great thing called “output deals” meaning that a TV licensee in most countries is required to license the entire film slate in a given year, regardless of how well or not a film made in box office. Also, let’s take into account the following:

• virtually all expenses required to distribute a film on TV (or on-demand platform) including tapes, digital encoding, subtitling, voice-over and advertising, are borne by the licensee, and
• TV licensing is the biggest revenue generator for Hollywood studios in most markets (when compared to theatrical and home entertainment revenues).

Great business, right? TV distribution is an incredibly profitable business for Hollywood studios with 90%+ margins – taking away most of the risk in producing a movie. Something indies could never get, even in their wildest dreams.

So next time you come across an obscure indie film, spare a thought for the producer. He probably went to hell and back just to make it possible for you to watch his work.

Isn't filmmaking amazing?

“I couldn’t sleep one night.  I was sitting in my office and I realized that I was an independent filmmaker.” – Darren Aronofsky