9
The Financial Plan: How It Works

Shuffle a pack of playing cards. Now spread them out face down and pick one card. If it is the ace of spades, you win; if it is not, you lose. Your chances of getting the right card are 1 out of 52. These odds are better than the odds of finding independent money for your film. Do not be discouraged, though. Many filmmakers face these odds each year—and win.

Film is probably the worst investment anyone could ever make. It is considered risky and capricious. If risks were measured on a scale of 1 to 10, movies would rate a 15. One might as well go to Las Vegas and throw the dice—in fact, those odds are probably better. Why would anyone invest in films, then? From a purely financial standpoint, it is a gamble for which there is a big payoff. In addition, there are many subjective reasons for investing in films, such as personal ideals, creative participation, and being part of the glitter and glamour. The specific people and firms those are likely to fund films change, but the modus operandi remains the same. Some of the different sources of financing will be relevant for your situation, others will not. Some are dynamic; some are static. As studio executives and production companies go through cycles, so do forms of financing.

By this point, you are well on your way to a finished proposal. You have explained the basic information—your company, your film(s), the industry, the market, and the distribution process. You have your goals and objectives well in hand. Now here is the kicker. Popular agent lore (spread by agents) is that if a script is not interesting after the first 10 pages, it gets thrown onto the “forget it” pile. Something similar can be said of investors and business plans. Investors typically read the Executive Summary first and the Financing section second. If they are still interested, they read all the delicious text between the two. This does not mean that all the in-between material is irrelevant, just that the primary emphasis is on the ins and outs of financing and how the numbers look.

When thinking about investors, most people picture a singularly rich person who swoops in and says, “Here’s an extra $10 million I found in my drawer. Go make a film—no strings attached.” Or they imagine a country suddenly passing a law guaranteeing you 100 percent of your film costs just for showing up. This is the stuff of which movie plots are made. Not impossible scenarios, but improbable ones. You may get lucky early on, but it is more likely that there will be false starts, dashed hopes, and months or years of frustration.

As the saying goes, “If it were easy, everyone would be doing it.” The truth is that finding financing is hard work. If you think otherwise, forget it. There are almost as many ways to finance a movie as there are people reading this book. We will look at specific methods, but note that the full financing of your movie may be a combination of several methods.

With a business plan for a new filmmaker or company, there is an additional struggle. Whether you are asking a money source to invest in one film or several, creating a feeling of confidence is not easy. Any anxiety on the part of the investor about funding one of your films is magnified when committing to finance an entire company. Besides making successful films, you have to be able to run that company. The investor will be looking with great care, therefore, at the production team.

In your Financial Plan section, you will discuss how your films will find financing, but you should do this without restating this entire chapter. Only certain financial strategies will be appropriate for your particular projects or for the type of investor you are going after. Too much irrelevant information will only confuse your reader.

This chapter examines some of the specific sources of money: single investors (rich people), presales, coproduction and below-the-line deals, negative pickups, limited partnerships, and limited liability companies. In addition, it takes a brief look at bank loans. This chapter is meant to give you general knowledge of how film financing works; the intention is to make a complex subject easy to understand and to give you material for your business plan. It is not meant to be the complete and final word on the subject. For your own knowledge, do additional research on the specific financing techniques that you plan to use.

Before you Start

Before writing the financing section of your business plan, there are several guidelines to think about and follow. These concern the following:

• Seeking reality.
• Finding the best fit.
• Being careful what you promise.
• Being careful what they promise.
• Being able to explain it.

Seeking Reality

The way that one person financed a film yesterday may not be relevant to you today. This statement may appear to contradict what was said earlier about learning from other filmmakers, but it does not. We said it was sometimes the same formula, not necessarily the same people. Do not assume that you will find money in the same place. Who you approach, where they are, and what they want to know differs from investor to investor. Learn from the other filmmakers’ experiences in their interviews in Chapter 13, “Other People’s Money.” They may prove useful to you. Keep in mind, however, that you may have totally different results to share in the next edition.

Finding the Best Fit

Filmmakers often believe that all money is equal; it isn’t. Each source sets different requirements or conditions for the delivery of funds. You will be able to live with some of these, but not with others. For example, there may be too many fingers in the pie. Three intermediaries later, you will be paying out large sums to finders. Or prospective investors may have requirements that make getting the money not worthwhile. There may be content, length of time, or rate of return demands you cannot meet.

Worse, at the 11th hour, Ms. Investor may inform you that her husband has to play the lead in the film. Don’t be discouraged. The right source for you is out there somewhere; seek until you find it.

Being Careful What You Promise

Making statements of absolute fact about financial conditions may be dangerous. An investor will hold you to whatever you promise. You might say, for example, “We will seek presales in order to recover at least some of the production financing upfront.” That is not a promise, only a statement of intent. On the other hand, saying to people, “We will obtain presale commitments” is a promise. Unless you have commitments already in hand, you may be making a promise that you cannot keep. And be careful of implied promises. If you want to tell potential investors that Sony Pictures Classics paid less than $1 million for Beasts of the Southern Wild, be sure to say: “It was reported at the Sundance Film Festival that Sony Pictures Classics paid less than $1 million for domestic rights to Beasts of the Southern Wild.”

In the discussion, point out that we don’t always know what the actual deal is in reference to the figures quoted. I have seen investors refuse to approve a distribution deal because they assumed that “normal” purchase prices were twice the negative cost of the film. The typical verbiage that I use is:

Being Careful What They Promise

Always take the stance that you have to see it to believe it. People do not have to be con artists to lead you astray; many just like to hear themselves talk. Even investment bankers are seen bragging at cocktail parties about financing films they didn’t. If a money source (finder or actual) is saying, “The check is in the mail,” your mantra should be, “Do not spend any money until the cash is in the production account.” This warning applies to family and friends as well as bank executives. Check the paperwork. If you are not knowledgeable about financial terms and clauses, find someone who is. Look carefully in the fine print for how much cash this source is keeping. Do they have the resources to meet your needs or are they making a promise on behalf of some other entity that has never heard of you and probably never will?

Recently, a client told me that she wanted to work with a producer who had a certain A-list director and star attached and $50 million in the bank. My first question was: why do they need you? I was not being rude. She had never made a film and no particularly interesting connections. This fellow had $50 million and could go ahead with his director and an actress who had could bring in the audience on her name. While my client was thinking it over, I did an Internet search on Yahoo! I finally found a website for the film. The only people attached were family and friends; however, it said “no director attached” and didn’t mention cast. There also was a statement that they were looking for money for an unspecified budget. It is fair to assume that having that much money you have an assistant who could update the website. Such searches only take a few minutes of your time but can save grief later.

Being Able to Explain It

If you cannot explain a financing scheme, do not include it. To my constant amazement, I often receive business plans to critique that are based on a complicated financing structure, usually in a foreign country, that the producer does not understand; nor has he ever found someone who has successfully used it. Longtime professionals, not just inexperienced filmmakers, will base entire companies on such schemes. Frankly, not only do many of these require several investment bankers to work through their complexity but also the majority either don’t work or were fictional to begin with.

Be especially wary if an intermediary wants a substantial amount of money in advance. A finder gets paid when you have the money in the bank, not before. Request to see all the documents first. If you have to find an investor to make a deal work, you can bet your bottom dollar that your investor will ask for details about the financing, with examples of films financed. They’ll also want a meeting with a principal (person who actually controls the other funding).

Who are they?

Investors are gamblers no matter what their reasons, and film is one of the biggest gambles you can find. Others have personal reasons for investing in film. Private investors are equity players.

They take a portion of the profits in exchange for their capital. Until you take in partners, you own the whole pie. As partners come in, you start to slice the pie into little pieces, and as the old saying goes, “Them that has the gold makes the rules.” The nature of an entrepreneur is to be filled with passion to accomplish a certain end. The hardest job for you may be your own emotional involvement when attempting to see things dispassionately from the investor’s point of view.

Family and Friends

The first string of the investment team for has often been family and friends. Raising development money and the negative cost of films under $1 million is very difficult. Professional investors do not see enough of a return on such small investments. Mom and Uncle Harry are more likely to be willing to give you a chance. Kevin Smith funded the $26,575 budget for Clerks with credit card advances, the sale of his comic book collection, and a loan from his parents. It is hard to find anyone with the much room on the credit cards since the financial meltdown started in 2008. Filmmakers Alex and Stephen Kendrick raised the $100,000 budget for Facing the Giants as donations from church members, including family and friends. Since the introduction of the original crowdfunding platforms, primarily Kickstarter (launched April 2009) and Indiegogo (launched January 2008), much of this money has been donated through those websites.

I have been at a lot of panels where company executives will tell you that family and friends are the only source of money for low-budget films. This statement is false. Many films have been made with all the money coming from total strangers. When it comes to investment from those close to you, it is wise to have the same written agreements that you would have with total strangers.

Entrepreneurs

Private money comes most often from people in businesses other than entertainment. Entrepreneurial types who have made a killing in almost any industry may feel the lure of film. It takes a high roller at heart to start a firm and prosper with it. You can try the annual Forbes 400 for a listing of billionaires; however, you may have to travel to Hong Kong or Taiwan to speak with them. You don’t have to go that far for what you need.

Investors have all sorts of reasons for taking this risk. Some are after big bucks, some are personal fans, and some want to give back to the community. Despite their reasons, investors are seldom seeking to lose money. I have seen scores of creative people forget their dreams rather than face the reality that, whatever the content, these are business deals as well.

There have always been wealthy people attracted by Hollywood. Many of them invested with studios in the early years. One of the first investors in DreamWorks was Paul Allen, cofounder of Microsoft. Over the past 15 years, however, a growing number of communications, real estate, Internet, sports, finance, and other billionaires have made pacts with experienced producers to start independent production and distribution companies. Phillip Anschutz, chairman of Qwest Communications International, has started several production companies, now combined into Walden Media. He also bought United Artists, Regal Cinemas, and Edwards Cinemas, which currently controls over 6,000 theater screens. Jeff Skoll, a co-founder of eBay, founded Participant Media, which has invested in both studio and independent films. Mark Cuban and Todd Wagner, the founders of http://www.broadcast.com, formed 2,929 Productions and Magnolia Distribution and bought the Landmark Theaters. The partners in Google have co-financed a film; they are also early investors in various areas of high-definition entertainment. Gary Gilbert, co-owner of the NBA’s Cleveland Cavaliers, along with Usher and the Chairman and Vice Chairman of Quicken Loans has financed several movies, among them Garden State. Sidney Kimmel, a founder of Jones Apparel Group, formed Sidney Kimmel Entertainment, which has produced several films and has more in development. The late Adam Yauch of the Beastie Boys formed Oscilloscope Laboratories, which became a film producer and distributor in 2008. Bill Pohlad, the son of self-made billionaire Carl Pohlad (owner of the Minnesota Twins baseball team), formed River Road Entertainment.

In more recent years, Texas businessman Mark Hulme set up Five Star Pictures, which plans to finance and produce one film a year. The company’s first film is Jobs, a biopic of Apple co-founder Steve Jobs. Gigi Prtizker, heiress of the Chicago Pritzger fortune ($1.7B), set up Odd Lot Entertainment. Saul Hudson better known as Slash, the former lead guitarist of Guns N’ Roses followed in the footsteps of fellow rocker Rob Zombie by establishing Slasher Films (horror genre, of course).

The sons and daughters of the rich and maybe famous have brought many of their trust funds to film. Teddy Schwarzman, the son of Blackstone chairman and CEO Stephen Schwarzman, founded Black Bear Pictures. Allison Ellison, daughter of Oracle billionaire Larry Ellison, founded Annapurna Pictures, and Sarah Siegel-Magness and Gary Magness (Sarah Seigel’s parents founded Celestial Seasonings teas, and Magness’ parents founded cable company Tele-Communications Inc.) formed Smokewood Entertainment. Their first film was Precious.

All the people mentioned in the preceding paragraphs came into the business with a commitment to film but had various reasons. Some of them have a commitment to films with a message, others want to develop new technology frontiers, and others just love films. However, none of them intend to be spending their money foolishly. There are many in other countries of the world; and presumably, there are more out there waiting for the right opportunity.

Where are they?

How do you find them? I wish I could tell you. One thing I do know is that these are people who recognize that film operates on a different risk level than the businesses that made them or their relatives rich. Before the current economic conditions, several finders working with real estate investor groups have approached me about film, thinking that they could sell the idea to their syndicates. They couldn’t. As a group, real estate investors are putting their funds into projects with less risk than film. Even then individuals from those syndicates were investing in limited liability companies (LLCs) and limited partnerships on their own. Until the real estate market turns around, film appears to many to be a better bet than that industry. It does not mean that film is any less risky than it has always been; it is a sign of how risky real estate has become.

Your own backyard is the first place to look for financing. Few filmmakers are born in Los Angeles; they migrate there. Nor are all of the investors born in Los Angeles. They are born and live in Ohio, Michigan, Iowa, Oslo, Sydney, Hong Kong, and so on. At least those are areas where many of my clients have found investors. (Don’t call me for a list; it is proprietary—nonpublic, company-owned—information.) You may find untapped markets of entrepreneurs with lots of money from very unglamorous businesses, to whom the lure of the film world may be irresistible. Your best chance is in an area where there is not a lot of competition from other filmmakers—if there still is such a place. The entire financing deal can be conducted without anyone living in Tinsel town.

Giving a party is another strategy that I have seen some producers use to find interested investors. Since I am not an attorney, check the details with yours before proceeding. I have paraphrased some of the rules set out by Morrie Warshawski in his book The Fundraising Houseparty (available at http://www.warshawski.com). Although Morrie is focusing on raising money for nonprofit events, the same principles can be used for film fund-raising:

• Potential investors receive an invitation to come to a private home.
• The invitation makes it clear that this is a meeting to launch a film.
• Participants arrive and are served some sort of refreshments.
• The host or hostess explains why they personally feel it is a worthwhile project.
• Participants sit through a brief presentation—appearances by actors in the films, script reading, and so on.
• A peer (we might say shill) in the audience—someone articulate, respected, and enthusiastic—stands up and explains why she wants to be part of the project.
• Once you have established an individual's interest, you can contact her later with your documents about investing.

What you Get

Equity investors will want at least a 50 percent cut of the producer’s share in the film; some may even want a higher percentage. In recent years, filmmakers have offered the incentive with a return of 110 to 120 percent of the original investment before any split of net profits. No matter how many years you spent writing the scripts or how many hours you spent talking deals, it is their money. Before you start complaining, be glad your investors don’t want 80 percent. Venture capital companies and professional film investors often require that much equity to put in seed money.

Filmmakers have a habit of promising “points” and film credits to people for their work in finding investors, making introductions to potential actors, or other steps involved in getting the project made. Directors and stars who are too expensive for the film’s budget often are given points as a deferment of part of their salary. These points all come out of the filmmaker’s share, unless an agreement is reached with investors. Besides points, filmmakers like to give away credits. Be careful what you promise. If you have one investor for the entire budget, he may want the title of executive producer (and deserves it). Some may want to remain anonymous, so all the other filmmakers wanting money don’t contact them. In addition, be careful about the producer title. When your film is nominated for the Best Picture Oscar (I never said you couldn’t indulge yourself with some fantasy), only three people can be listed according to the 2007 Academy of Motion Picture rules.

Reasonable Risk

Entrepreneurs often want money from investors with no strings attached as a reward for their creative genius. They do not want to be responsible for how the money is spent or for whether investors realize a gain. No doubt, you are a genius. But do not expect to get financing without showing the investor what kind of risk she is taking.

Early in this business, I tried to get financing for an entrepreneur who had a new idea for making films that would have a nontheatrical distribution in malls. One investor thought the idea was “sexy” and that the films could be taken national but that the business plan was so-so. The investor proposed to invest $5 million and then raise additional money from other investors; however, he wanted a revised business plan. My client would have none of this. “After all,” he said, “investors are supposed to take a risk. If these people are not willing to take one, who needs them? I’m not going to waste all this time. Big guys in New York are interested.” You can probably guess what happened. The client never heard from the “big guys,” never got the first film made, and went back to his old job, never to be heard from again.

The moral here is not that people in New York are unreliable. Serious investors, whether they are in New York or Des Moines, will seldom make a final decision based on flash and dash. They want to see substance and detail. Even if someone likes your project, chances are you will hear, “Come back when you have a business plan.”

The Big Payoff

The low-budget, big-return films are the hooks that lure many high rollers into the film business.

Films like Once, Fireproof, and Napoleon Dynamite can be irresistible. Very few other ventures, outside of Las Vegas, offer the potential of a 500 to 1,000 percent return on investment. At a lower percentage rate but nevertheless as alluring are Black Swan, Slumdog Millionaire, and Courageous. As a filmmaker, you must be ready to show prospective investors that the chance of making a killing may outweigh the risk of losing their money. Remember, though, that you can never promise a risk-free investment. And you do not want to tell them, “Ten million dollars is typical of advances and/or buyouts for $1-million films.”

When all is said and done, it is the projected bottom line that builds the investor’s confidence. You need to find similar films and track their dollar returns. Whether you are looking at a single film or a company, you must project your revenues and expenses, box office grosses and rentals, and cash flows over the next three to five years. (You will learn how to do that in the next chapter and through doing the exercises provided in the Financial files on Focal’s companion website for this book.)

Types of Financing

Crowdfunding for Donations

The original crowdfunding (sometimes called crowd sourcing) is a method of raising limited amounts of money without being governed by SEC (Securities and Exchange Commission) regulations. People donate to your film in return for a reward that a nonmentary reward, such as a DVD, T-shirts, or other memorabilia. The donors do not have any ownership in your film. It doesn’t require a PPM or excessive paperwork and should not be confused with the updated traditional investment version of crowdfunding described under the Jump Start Act of 2012, described later in this chapter.

In this method of fund-raising, you create a website on an established platform. The most popular to date have been Kickstarter (kickstarter.com) and Indiegogo (indegogo.com). They are best used for development money, post-production money, or to finance a micro-budget film. You have to research the sites and pick the one that is best for you.

The basic differences between the two mentioned here are that Kickstarter has you set a funding goal and time-frame (usually up to 60 days) that must be met or all monies are returned to the donors. If the funding goal is raised, Kickstarter applies a 5 percent fee to the total amount but only if it is free. Indiegogo also has you set a funding goal, but you don’t have to get to your goal. They charge 4 percent if you meet your funding goal or 9 percent on the money you raise if you do not reach your goal. Both have third party processors that charge at least a 3 percent fee.

The big question is: how do all those potential donors know about you and your project? You have to work the social websites, friends, family, and any forms of communication that you can think of to let them know. There are terrific stories on the Internet from people who have raised money. They have another thing in common, though. It is a lot of work!

Veteran documentary filmmaker Jennifer Fox raised over $150,000 for her latest project My Reincarnation, a portrait of a High Tibetan Buddhist teacher and his Western-born son. She had 518 backers, donating an average of $290 per person. Jennifer Fox told The Hollywood Reporter that it wasn’t easy. You need to have a carefully orchestrated campaign with compelling marketing hooks. Irish filmmaker Alexandra Guinness told screendaily.com that she raised initial money for her film Lotus Easters that premiered at the Tribeca Film Festival in 2011 through a crowdfunding model. “The website and the crowdfunding model got us a small investment at the beginning to keep going, and it raised the profile and let people know we were there.”

Presales

There are two main activities at markets like AFM and Cannes: seeking presales for as-yet-unmade films in order to finance production, and selling finished films. We are concerned here with the former. The seller (you or your U.S. distributor) has a booth or room and entices the buyers from each territory and medium (theatrical, DVD/Blu-ray, VOD, satellite, broadcast, and so on) to buy the ancillary rights (domestic or foreign) to your film in advance. (This is also called a prebuy.) In return, you receive a commitment and guarantee from the prebuyers. The guarantee includes a promise from that company to pay a specific amount upon delivery of the completed film. If deemed credible by one of several specialized entertainment banks that accept such “paper,” the contract can be banked. Then the bank will advance you a sum, minus their discount amount.

In exchange for the presale contract, the United States or foreign buyer obtains the right to keep the revenue (rentals) from that territory and might also seek equity participation. The agreement can be for a certain length of time, a revenue cap, or both. The time period can be anywhere from 5 to 15 years, with 7 being customary. The biggest issue on a presale is to try to have name talent attached. At least talent that has marketability in the territory that the presale is coming from. The presale will not be in the form of a check, but a loan guarantee to take to a bank. Since a presale will not generally cover the entire budget, you may have to have equity for the balance of the budget.

Many filmmakers are under the impression that “in perpetuity” (forever) enters into this negotiation. These terms are not unheard of, but they are more likely to surface if you are transferring the copyright, or ownership, of the film. There is nothing to keep people with money in their hands from demanding as much as they can get. The buyer tries to make the length of time as long as possible, and the seller tries to make it as short as possible. Be careful of the stance you take. Some foreign companies have told me that if the filmmaker balks at 7 years, they will change the term to 10.

The “revenue cap” is a certain amount of money in sales, up to which the buyer gets to keep all the money. When negotiating these terms, buyers try to estimate the highest amount that the movie will make and then try to make that amount the cap. After the revenue cap is reached, the seller may start receiving a percent of the revenue or may renegotiate the deal.

Being the sole source of financing gives people much more power than if they are one of a group of funders. Yet any of these negotiations still depend on the “eye of the beholder.” Any leverage depends on the desire of the buyer for the film.

Advances

In the past, cable, home video, and television syndication companies were major sources of production financing. Through advances, they funded all or part of a film’s production in exchange for an equity participation and the rights to distribute the film in their particular medium. Although advances do not occur as frequently as they did in the early 1990s, particularly in video, they are still a potential form of production financing. As noted earlier, most domestic distributors prefer not to see fractionalized rights.

Always weigh this fact against the benefits of having an ancillary company as your main investor. The advance for a finished film is another matter. It may be a total buyout, have a revenue cap, or combine any number of characteristics common to presales.

Advantages and Disadvantages

The primary advantage of presales is that they offer you the chance to make your film. This source of money continues to be a workable one for new filmmakers. In addition, if you manage to reach your production goal over several territories, it lessens the impact that someone else can have on your film. Presumably, the fewer territories in which you presell or from which you receive advances, the more money you will be able to keep on the back end after distribution.

There are two disadvantages to this source of funding. First, you sacrifice future profits in order to make the film. Selling your film in advance puts you at a negotiating disadvantage. Companies that use presale strategies often give away much of the upside cash flow and profit potential from hit movies. Second, not all paper is bankable. You have to do a lot of research before accepting this kind of contract. Things change quickly, particularly in difficult economic times.

U.S. Film Incentives

Federal Film Incentive

In 2004, Congress passed the American Jobs Creation Act. Section 181 of that act provides for an incentive for film and television productions. Attorney Hal “Corky” Kessler of Deutsch, Levy & Engel has contributed the following explanation of the incentive (and the Jump Start Act). Under Section 181 of The American Jobs Creation Act, 2004, any taxpayer, company, or individual who invests in a qualifying film or television project under the act can deduct 100 percent of the investment as a loss in the year or years the money is spent. Regardless of budget, filmmakers can take advantage of the first $15 million (or $20 million in specific depressed areas). For television, it is either $15 or $20 million per episode for the maximum of 44 episodes. The triggering effect is when the money is spent.

On February 9, 2007, under the IRS temporary rules and regulations, the IRS answered many of the outstanding questions and concerns. It stated that Section 181 deductions may be taken only by the owner of a production, including pass through entities, who received investments from investors. The investors, who had no active participation in the production or were not a part of the production company, could only take their loss under Section 181 as a passive loss and not against ordinary income. The IRS temporary rules and regulations also stated, for the first time, that all contingent compensation, (residual or otherwise), when paid became part of the production budget.

Section 181 said that each qualified film or television project can expense out to the taxpayer investors an amount up to a maximum of $15,000,000 per film or $20,000,000 per film if a significant amount is filmed or paid in a low-income state. In television, the amount allowed to be expensed out to the taxpaying investors is up to a maximum of $15,000,000 or $20,000,000 per episode for up to 44 episodes. The original act was extended twice with the last extension ending in December 2011. The incentive still applies for any films that were qualified through appropriate methods before the Act expired. Any buyer of a certified 181 film project, wherein the copyright and all intellectual property is transferred to the buyer, can now receive new 181 benefits for the amount paid for and any finishing funds.

In May 2012, Congressman David Drier introduced a bill into the House of Representatives (H.R. 5793) “to amend the Internal Revenue Code of 1986 to extend the election to treat the cost of qualified film and television productions as an expense which is not chargeable to capital account. H.R. 5793 would amend the Internal Revenue Code of 1986 to extend the election to treat the cost of qualified film and television productions as an expense which is not chargeable to capital account.” The bill would extend 181 until December 31, 2013. It was referred to the House Ways and Means Committee. With the house bill number, you can track the bill on the Internet. I will post any updates on the book’s companion website.

Section 199

In addition to the tax reduction incentives under Section 181, the income received also has some tax reduction opportunities under Code Section 199 which was also added by the Act. Under the manufacturing sections of the Act, film production businesses are considered “manufacturing businesses.” From 2010, manufacturing businesses can deduct from their qualified production activities income an amount equal to 9 percent of such income. This deduction may also apply to television productions. For example, if $100 is received after 2010, then the taxable income would be $91. A film could qualify under both sections. However, even if a film does not qualify for income tax benefits under Section 181, the film may be a “qualified film production” pursuant to Section 199 if (a) direct labor and overhead costs incurred within the United States account for 20 percent or more of the total costs of the film, and (b) 50 percent or more of the total cost of the film is spent on services performed in the United States. In addition, expenses incurred in Puerto Rico are allowed to take advantage of Section 199.

State Film Incentives

Currently, 37 states and Puerto Rico have incentives for certain qualified films. The incentives vary from rebates, tax credits for the film company, transferable tax credits (for local individuals/ companies enabling them to deduct all or a portion of their investment in the film), and other refunds of expenses. What line items are covered (salaries, below-the-line production spending) and the amount of the incentives (normally expressed as a percentage of the costs covered) differ from states to state. As states have been very competitive in trying to draw films to their communities, similar legislation is being drawn up in many of the remaining states. In addition, some states have assigned all their money for the next two to three years. If you know in which state(s) you want to film, go to their website to check all the details of the incentives. Print off the files and go over them with your line producer/unit production manager (UPM) and your attorney to see if the fit is good for you. If you aren’t familiar with which states have incentives, consult the website of the Association of Film Commissioners International (http://www.afci.org).

A checklist of items to consider:

1. When will the incentive be paid? Most states do an accounting at the end of production before agreeing to a specific dollar amount; therefore, you need to raise your entire budget before you start filming.
2. If bringing crew from another part of the country is necessary, how does that cost mesh with the amount of incentive you hope to receive?
3. What has been the experience of other filmmakers dealing with the state’s incentive regulations?

Jump Start Act of 2012

Crowdfunding

On April 5, 2012, the Jump Start Act, 2012, was signed into law. It consists of two distinct sections. The first is the Crowd funding portion. This is Crowd funding as an equity investment. Under the new laws, any new security created like an LLC is considered a new business; and, as such, if you have a Private Placement Memorandum and Limited Liability Documents and you are trying to raise $1 million or less ($2 million is some cases), you can now for the first time in the history of the SEC publicly solicit, market, and advertise your investment documents and investment opportunities. You can have unaccredited investors and accredited investors. For unaccredited investors, the limit is 35 and no investor can give more than the greater of $10,000 or 10 percent of their annual income, whichever is less. However, the investments must go through as SEC approved portal. The SEC is setting up the rules for same and portals must be first authorized by the SEC. When those rules are available, they will be posted on the book’s companion website.

New Business

Under another section of the act, there is no dollar limit of the capital raise amount if you offer an investment only to accredited investors. You can publicly solicit, market, and advertise your investment documents and investment opportunities if you have Private Placement Memorandum, Limited Liability Documents and only offer the investment opportunities to accredited investors. The SEC will publish guidelines as to the level of due diligence to confirm the accuracy of any such claimed accreditation.

Negative Pickup

In the days when film companies had more cash, there were many negative pickups. The premise is that a studio or independent production company promises to pay the cost of the film negative (production costs) upon delivery of the completed picture. This agreement is taken to the bank, which then provides cash for production at a discount to the total value of the agreement. A discount is a reduction in the stated value of the note.

The Catch-22 here is that the bank has to believe that the studio or distributor will be able to pay off the loan upon delivery of the film (often a year from the date of the agreement). In the past, this was not as difficult to do as it is now. In the late 1980s, banks could count on the Majors, a few of the mini-Majors, and a very small number of distributors to make good on negative pickups. The entire situation has changed in the past several years. The financial problems of many of the large production companies are well known. In addition, the troubles and, in some cases, complete collapse of many financial institutions have created an even more dismal picture. Nothing can be taken for granted. Although there are still companies that will give you negative pickups, this is not a financing strategy that I would count on. As with distribution deals, show the documents for your negative pickup to a bank to see if the deal is acceptable.

Advantages and Disadvantages

One advantage of negative pickups is that the film is made without giving away a share of the company to someone else. In addition, a negative pickup with a major studio or distributor removes the angst of searching for a distributor.

On the other hand, the standard negative pickup agreement contains two loopholes that favor the distributor. First, the agreement has a built-in escape clause that says, in effect, “You must deliver the film we were promised.” Any change in the script, even if it seems minor to you, can cause cancellation of the contract. Second, the contract also states that the finished film has to meet the distributor’s standards of quality. Even if the movie is, shot-for-shot, the same as the script, the distributor can always say that the film’s quality is not up to standards.

Limited Partnerships

Until the mid-1980s, limited partnerships wer e all the rage. Subscribers could deduct losses calculated at many times the amount of their original investment; taxwise, therefore, the losses sometimes were more beneficial than making profits. In 1986, the Tax Reform Act removed most of these benefits, however, and now the investors have to pray for successful films.

A limited partnership has two kinds of partners. The general partner has unlimited liability with respect to the obligations of the partnership and is active in management. The general partner chooses the investments and does not have to ask for the advice or agreement of the other partners. The limited partners, who provide all of the capital, share any profits or losses and are not actively involved in management. In addition, their liability is limited to the amount of their investment. Gains and losses flow through directly to the limited partners.

A public limited partnership must be registered with the SEC, and in the case of a public or private limited partnership, there must be a properly prepared prospectus that includes all the facts about the partnership. The overall package should include a business plan (be still, my heart!) and offering with subscription documents.

DO NOT WRITE YOUR OWN LIMITED PARTNERSHIP. In order not to pay attorneys, film producers are fond of cutting and pasting someone else’s partnership agreement. I think I just emphasized that this is a bad idea. When it comes to fraud, working with unofficial documents is only one aspect. Any misrepresentation about the company’s plans also constitutes fraud. The SEC and the Internal Revenue Service are not known for their sense of humor, and ignorance is not an acceptable defense.

Advantages and Disadvantages

On the plus side, the limited partners have no right to interfere with the creative process. Private placements provide a means to raise funds from multiple investors without having to negotiate different deals with each one. The subscription documents contain all the deal information.

There are disadvantages as well. Because of the complicated nature of all SEC regulations and the differences between public and private offerings, participating in one of these formats requires research and expert advice from an attorney. The law is complex, and ignoring any filing regulation (each state has its own requirements) may bring an order for you to cease and desist in your sale of the offering. Another disadvantage is that the producer or the purchase representative must have a previous relationship with the investor before approaching her with a specific offering.

Limited Liability Companies

In the past few years, a new financial structure, the LLC has become widely used. LLCs are a hybrid combination of the partnership and corporate structures. They are an attractive alternative to partnerships and corporations because the LLC provides limited personal liability to the investors, who are referred to as “members.” They have a share in the profits as outlined in the offering document. The LLC also provides a single level of tax. In the standard limited partnership, general partners (read “filmmakers” here) have personal liability for partnership debts, whereas limited partners in an LLC have no personal liability. Theoretically, the worst thing that happens is that they lose their investment. In addition, the limited partners cannot participate in management without jeopardizing their limited liability status.

In addition, an LLC member can participate in the entity’s management without risking loss of limited liability. For federal tax purposes, the LLC generally is classified as a partnership. The same is true in most states—the operative word here being “most.” I have clients who have formed an LLC in Michigan, for example, but not in Florida, where the LLC is taxed as a corporation. As there is no uniformity in the LLC statutes across states, creating an LLC with members in more than one state may be complicated.

The same rule that I stated for limited partnerships exists here: DO NOT WRITE YOUR OWN. Can I say that too often? From what I have seen, the answer is a resounding “No!” When you hire an attorney, however, be sure that he is someone with experience with both film and the particular form of Investor Offering that you are using. You do not want to pay for an attorney’s learning experience.

When pass-through of revenue is of primary concern, strict conformance to IRS and state revenue accounting criteria should be considered before the LLC is chosen over other organizational structures. With new tax credit schemes (both state and federal) appearing on a regular basis, you also may need to consult with a CPA familiar with IRS statements.

Austin- and Los Angeles-based attorney Michael Norman Saleman prefers the limited partnership structure to limited liability companies (see later in this chapter). As he explains:

The LLC has become one of the most favored business structures for independent film investment. Producers frequently set up their own production companies separately as closely held corporations in which investors do not participate. LLCs are a hybrid combination of the partnership and corporate structures. The LLC is an attractive alternative to partnerships and corporations because the LLC provides limited personal liability to the investors who are referred to as “members.” The LLC owns all distribution rights to the film, and investors have a share in the profits as outlined in the offering document. The LLC also provides a single level of tax like a partnership, however, unlike a formal partnership the filmmakers as managers of the LLC have no personal liability for business debts. The worst case for investors is the loss of their investment but there is no liability for any business debts. Limited partner investors cannot participate in management without jeopardizing their limited liability status, but if an investor becomes a manager, the member can participate in the entity’s management without loss of limited liability. For federal tax purposes, the LLC may elect at the time of its formation to be treated as either a corporation or a partnership. Most states afford the same tax treatment to an LLC as its federal status. The operative word here is “most.” As there is no uniformity in LLC statutes across states, creating an LLC with members in more than one state may be complicated.

The same rule that I stated for limited partnerships is applicable to the formation of an LLC. DO NOT CREATE YOUR OWN. The Operating Agreement for an LLC, which governs its business operations, is a complex document far more complicated than simply filing basic Articles of Organization and must be drafted with the assistance of legal counsel and often accounting advice.

Being Fair to Your Investors

When people invest in an LLC or a limited partnership, there is a payback schedule that is agreed to by both the filmmaker and investors. The investment agreements that are included in the financing package include the budget that you have prepared. Production Attorney and Producer William L. Whitacre of Orlando, whose clients include Haxan Films (The Blair Witch Project) Company, says:

Bank Loans

Bank loans are not associated with business plans per se. However, this discussion focuses on what you will tell potential investors, and bank financing may be relevant to your situation.

Banks are in the business of renting money for a fee. They have no interest in the brilliance of your potential films; they do not care that you are a nice person and have a sparkling reputation. By law, commercial banks (the ones that give you checking accounts) can only lend money based on measurable risk, and the only credit they can take is the collateral, or the assets being offered to secure the loan. The contracts that have already been discussed—negative pickups, distribution agreements, and presales—are such collateral (assets offered to offset the bank’s risk). The bank does not have to worry about when you deliver the film or how the box office performs; it is the distributor who has that worry.

The cost of the loan is tied to the prime rate, which is the rate of interest that banks pay to borrow from the Federal Reserve. It is a floating number that may fluctuate significantly. Home lending rates, also based on the prime rate, are a good example. When the prime rate falls, everyone rushes to refinance their mortgages. In most commercial lending, loans to “low-risk” firms (e.g., major studios) can be 0.5 to 1 percent above the prime rate. On the other hand, a small production company, which represents a higher risk, would pay up to 3 percent above prime. Let’s say that the bank is going to charge 2 percent points above prime and that prime is 9 percent. The total would be 11 percent. On a $1-million loan, therefore, the bank removes $110,000 ($1 million multiplied by 0.11). To hedge their risk, the bank also retains another 1 or 2 percent in case the prime rate goes up. If the bank charges 1 percent, another $10,000 is added to their retained amount. Now you are down to $880,000 for the film. The bank is not through with you yet, however. It also charges you for its attorneys’ fees, which can range from $15,000 for a simple contract to six figures if several companies are involved. Of course, you will still have to pay your own legal fees.

Once again we come back to the subject of attorneys. The one who represents you must know the ins and outs of all these contracts, so you should hire an experienced entertainment attorney. Costs go up drastically if your attorney is charging you an hourly rate to learn how the entertainment industry works. General corporate attorneys may mean well, but they can be an expensive choice.

Advantages and Disadvantages

The first advantage of bank loans is that the producer is not personally liable for the loan; the bank can’t take your house. A company is established for the production of the film, which is its only asset. In addition, many producers prefer to pay back a loan rather than give up equity. On the down side, the process to obtain a loan is expensive, and several parties and miles of paperwork are involved. Also, if the distributor defaults on the loan, the bank takes possession of the film.

Completion Guarantors

Misunderstood by neophyte filmmakers is the role of the completion guarantor. This is not the person you go to for the rest of your production money; the guarantor’s role is to provide an assurance that the film will be completed and delivered to the distributor. The contract with the producer or distributor allows the guarantor to take over the film to complete it, if need be. For the bond itself, the guarantor charges a fee based on the film’s budget. The charges have been flexible over the past few years, depending on the state of the completion business. The bond is not issued until after funding is in place, however, and this fact is often difficult to explain to investors. To make matters worse, small films have trouble getting bonded anyway. The risk is too great for most guarantors to bond low-budget films. In the past few years, several of the biggest bond companies lost their financing from insurance companies when high-budget films failed. The active companies had their hands full with major productions, leaving them little time or inclination to consider your $1-million film. New companies have come into the market, making the completion bond more accessible for some smaller films. However, their staying power depends on the insurance companies that back them.

In many business plans for low-budget films, I no longer mention a bond, as I know they have no chance of getting one. Bonders seem to be constantly going in and out of the market and changing their requirements. Check the market before deciding what to say in your business plan. One suggestion is that you say you will “seek” a bond. If you say that you “intend” to get a bond, it implies a promise to the investor. Never promise what you don’t already have, whether it is a financial document, an actor, or a director.

A completion bond is always desirable to protect both you and your investors financially. Accidents and bad weather can happen, but investors have the right to decide what exposure they want to have. As always, honesty is the best policy with your investors and yourself.

International Investors

We hear a lot about European and Japanese investments in the American film community. In the early to mid-1990s, most of the foreign money went to studios or the formation of large production companies with experienced studio executives; $100 million was a favorite start-up amount. From the late 1990s to 2002, German investment funds grew like crazy. Investors looking for prestige, profits, and extraordinary tax breaks began funding as much big-budget output as they could. Some funds existed to fund studio films; others financed independent companies, such as the UK firm Intermedia (Iris, K-19: The Widowmaker, The Quiet American). As some high-budget films failed and the economy started to collapse worldwide, many of these funds closed. However, new ones came along to take their place. Any detail presented here would be out of date before you bought the book.

Generally, this money doesn’t go to novice filmmakers. In tracking foreign money, you often run into finders who claim to have a special relationship with foreign money. Some do, many do not. Remember to check these people out. A finder should be paid a percentage of the money you receive from the investor, and only after the cash is in your bank account, as in any interaction with an intermediary. And, at the beginning of this journey, ask how many people there are between the finder and the money. If that person is going through two other people to obtain the money, have them agree to split one fee. For example, if your finder’s fee is 5 percent, then all three split that money; otherwise, you are paying 15 percent in finders’ fees. Naturally, this is always your choice. But don’t get backed into a corner to pay out three times what you intended simply because you didn’t get the facts straight upfront. And I can’t stress enough, do not give them any money in advance.

International Coproductions

International coproduction deals are the result of treaty agreements between countries. Qualifying films are permitted to benefit from various government incentives provided by the country in which production will take place. However, coproduction agreements are not a charity event. A number of requirements may be imposed on the film by government treaty, including the following:

• The producer must be a resident of the host country.
• A certain percentage of above-the-line talent must come from the host country.
• A certain percentage of the technical crew must be residents of that country.
• Distribution must be done by a company located in the host country.
• A percentage of the revenues from the film must remain in that country.

Advantages and Disadvantages

The first advantage of coproduction is that the total budget may be smaller because of the advantages of filming in a cheaper locale. Second, because of the readjusted budget, you will have to find a smaller amount of hard cash. The right deal will cover most, if not all, of your below-the-line costs. Many films would still be only a gleam in the producer’s eye if part of the actual cash burden had not been removed by a coproduction deal. In terms of disadvantages, you will still need to have hard cash for the above-the-line payroll—that is, the cast, director, writer, and production office staff. No film is made without these people, and they will not take IOUs, although some take deferred salaries. Another disadvantage is that finding enough skilled personnel in a host country could be a problem. If you end up having to fly key technical people from the United States to another country, you may end up with a budget burden that offsets the advantages of the coproduction deal.

European Financing

This separate section is courtesy of Thierry Baujard, Peacefulfish, a consultancy for financing the content industry in Berlin, Germany.

In Europe, coproduction is the most used option to finance projects within a country or with other countries. The term can be misleading as coproduction can simply be a collaboration between two companies or a collaboration that follows very strict rules that are indicated in an official contract between two or more countries.

This chapter is trying to give some background information and issues on how to develop coproduction financing in Europe for independent producers. Peacefulfish, a consultancy based in Berlin, Germany, can help you better understand the process, identify the right partners to raise the money, and develop the right business and finance plans that will make the most of the coproduction opportunities in Europe.

Coproductions

One way to finance your film is to look for a coproducer. Coproduction means sharing production costs, rights, and profits with another production company either from the same country or from a foreign country. In the case of a foreign country, there are two possible reasons: either the coproducer can access additional funding in the form of public subsidies such as grants, interest-free loans, or tax incentives, or the coproducer offers very low production costs.

If the main goal is to access public funding in the foreign territory, then there needs to be a coproduction agreement or a treaty between your country and the foreign one. Regarding Europe, there are two types of agreements to keep in mind: the European convention and bilateral treaties.

European Convention on Cinematographic Production

Note that the Council of Europe (COE) is not the European Union (EU)/European Commission; these are two completely different organizational entities.)

The European Convention aims to support European co-production by enabling a film production to benefit from all national supports available through the participating producers. There have to be at least three established producers from different countries. Only these countries are relevant, which have ratified the Convention. If a producer from a nonmember country is involved, her contribution must not be more than 30 percent of the total budget.

Public Subsidies

In Europe, subsidies are playing a key role in film production. There are state-funded grants on three levels: the European level (provided by the EU and the COE), national level, and regional level. Subsidies have to be applied for and are granted if a project is approved by a board or commission depending on business and creative criteria.

European Level

At the European level, there are two relevant schemes: the MEDIA 2007 program (EU, duration 2007 to 2013) and EURIMAGES (Council of Europe). The EU is a community of currently European member states that collaborate to a level where some national sovereignty is handed over to EU bodies in order to make democratic decisions on specific matters of joint interest. The COE is an organization of currently European states that aims at increasing the awareness of a European identity and providing control and monitoring for human rights and democratic processes. The COE has no legislative powers.

The MEDIA 2007 program supports the audiovisual industry in Europe in the areas of training, development, distribution, promotion, and cinematographic festivals. For aspiring filmmakers, the areas of interest are mainly support for development. To be eligible for support, the applying company has to be registered in a country that participates in the MEDIA program. Currently, the MEDIA 2007 program has 32 members. The scheme could therefore also work for non-European companies in case they enter into coproduction with an eligible company. Apart from geographical eligibility, there are also requirements regarding the existence of the applying company (registered for at least 12 months) and proof of previous experience. However, there are no specific requirements of a company’s turnover or profit. The amount of support granted can be up to 50 percent or even 60 percent of a part of the budget, depending on the kind of support and the respective threshold. For application forms as well as more information and deadlines, visit the EU’s MEDIA website at http://ec.europa.eu/.

EURIMAGES is a funding program initiated by the Council of Europe aiming to support coproduction, distribution, and exhibition of European cinematographic works. Support is divided between coproduction, distribution, and exhibition for feature films, documentaries, and animation projects of at least 70 minutes in length. To be eligible for coproduction support, the project needs at least two producers from different EURIMAGES member states and has to have a European origin. Financially that means that at least 51 percent of the funding has to derive from EURIMAGES member states and no more than 30 percent of the funding can originate from non-European sources or one non-EURIMAGES country. For filmmakers outside EURIMAGES member countries, this means that the program becomes only of interest in the case of minority a coproduction. For more information, visit http://www.coe.int/Eurimages.

National Level and Regional Levels

Throughout Europe, most countries and many regions within the countries provide state support for the audiovisual industry. Foreign filmmakers can benefit from these support schemes through being part of a coproduction with one or more of these countries. If the participating countries have agreements with one another, national subsidies are accessible for international coproductions as well. In the following, different schemes are outlined based on their support budget, eligibility and selection criteria, funding aspects, and recoupment strategies. As with the U.S. state incentives, these change too frequently to detail in the book. You can use the Internet for up-to-date information. However, I would suggest working with a consultant like Peacefulfish to understand the complexities in each deal.

Banking

Only the five big European countries have developed film banking markets: France, Germany, United Kingdom, Spain, and Italy. The main film banking services that are provided are Interim Finance, Tax-Incentive Financing, Gap Financing, Working Capital/Corporate Finance, and Bank Guarantee. On a European level, there is a development, which sees the European Investment Bank getting involved in film financing. So far, it is active in France, but support for specialized banks in other European countries is possible.

What you need to know

Before looking at an example with some numbers, here is a list of questions you may like to consider when looking at coproductions:

1. Where is the main production company located? If you are located in the United States, consider coproducing with Canada, since Canada has a range of agreements with European countries.
2. Is your country part of a bilateral agreement of a European country or member of the European Convention on Cinematographic Production?
3. Is your country part of the EU?
4. Has your country signed the EURIMAGES agreement?
5. Are there national subsidies in your country?
6. Are there regional subsidies in your country?
7. Are there tax incentives in your country?
8. Are there broadcasters involved in presales or coproduction in your country?
9. Are there banks specialized in film financing in your country?
10. Which countries are most promising in entering into a coproduction with (choose your candidates and go through the previous questions for each of them)?

Case Study of a Fictional Film

Our fictional film project involves four production companies from France, Germany, Canada, and the United States. The budget is EUR 4 million. As in every coproduction, be it national or international, involved companies have to decide on their individual share of rights, territories, profits, recoupment positions, revenue corridors, etc. In a traditional coproduction, the coproducer from a certain country normally received the rights for that particular country and neighbor countries using the same language. The coproducer can also look for distribution (theatrical and TV) in the country.

France and Germany both have a bilateral agreement with Canada and are members of the European Convention on Cinematographic Production. The bilateral agreements and the convention secure the same option: to benefit from the coproducing countries’ national supports. But if the convention is applied, the share of the total budget (and thus shares of rights, profits, etc.) for the United States and Canada can only be up to 30 percent (EUR 1.2 million). Through the coproduction treaty, you will be able to access funding from the other country.

That might not be enough considering the efforts such a multi-international production causes. However, even under the bilateral agreements with European countries, the obligation is that the majority needs to be held by European producers.

France and Germany are both part of the EU as well as members of EURIMAGES and are thus eligible for European subsidies. Both have national and regional subsidies. France has a tax shelter and two tax credits. Germany has the German Federal Film Fund. Both countries have cultural tests linked with their subsidies. The German-French broadcaster “arte” could be involved in presales or coproductions. France and to a lesser degree Germany have banks involved in film financing.

This is only a very rough idea of the complexity of international coproductions. There are extensive rules and obligations for each country referring to each financing tool. Due to local spend, majority requirements and cultural relevance finance might not be as easy to get as it seems at first glance. Many funds on a national level are selective aids; however, this can also be an advantage for producing in Europe since funding is not primarily aimed at commercial projects.

In addition, there are excellent production facilities and professional staff capacities available in Central Europe for a fraction of the price of the ones in established countries. If you are going to produce in or with Europe, it will be wise to get some professional help in dealing with the business plan, the financing strategy, and the legal aspects involved, as well as to benefit from an already established network of contacts in the European film industry.

For more information, please log on to http://www.pecefulfish.com or contact thierry@peacefulfish.com.

What Do you Tell Investors?

A section on financing assumptions is required as part of your business plan package. Give investors only relevant information, not everything in this chapter. Based on the assumption that your readers are not film sophisticates, you should explain what constitutes a presale agreement, a negative pickup, or whatever form of financing you will pursue. Be prepared to answer investors’ questions.

They may ask you about the forms of financing that you have not included. You should be conversant enough with the pros and cons of various strategies to explain your choices intelligently. As mentioned earlier, it is unproductive to include financing methods that you do not plan to use. If you plan to use a limited partnership, for example, the business plan will be part of the offering; otherwise, there is no reason to discuss this form of financing. To do so would be to create a red herring for investors, confusing them with a nonexistent choice.

Along the same lines, you should be careful about considering options that may no longer exist. What Canada or Australia is doing in 2006 may not be relevant in 2008 or later. Financing patterns, like everything else in our culture, can be in or out of vogue from year to year. It is important to keep current with the business climate through the trades and other sources while writing your plan.

In Chapter 13, we discuss more about investors, who they are and what they want. As stated above, filmmakers share their investor experiences with you; however, let me share with you the words of one of them, Jay Spain, now. Do your homework!