TITLE: ENTERTAINMENT FINANCING - REWARDS AND PITFALLS
I. INTRODUCTION
A. COST OF PRODUCING ENTERTAINMENT
B. WHY FINANCING METHODS ARE NEEDED
C. THESIS - EACH METHOD HAS ITS OWN REWARDS AND PITFALLS:
1. PRESELLING
2. JOINT VENTURE/LIMITED PARTNERSHIP FINANCING
3. CO-PRODUCTION
4. SOLE PRODUCTION
5. SPONSORSHIP
D. PREVIEW OF STRUCTURE
II. MOTION PICTURE AND TELEVISION
A. INTRODUCTION OF MEDIA
B. PRESELLING
C. JOINT VENTURE
D. CO-PRODUCTION
E. SOLE PRODUCTION
F. SPONSORSHIP
III. NON-THEATRICAL MEDIA
A. INTRODUCTION OF MEDIA
B. PRESELLING
C. JOINT VENTURE
D. CO-PRODUCTION
E. SOLE PRODUCTION
F. SPONSORSHIP
IV. CONCLUSION
A. OVERVIEW/WRAP-UP
B. RETHESIS
C. FURTHER INFORMATION
XX. ENDNOTES
No industry in the world epitomizes the free-wheeling entrepreneurial aspect of market capitalism better than the entertainment industry. Although the industry has been around for quite some time (as compared to the burgeoning computer and related technological industries) and has grown into a multi-billion dollar undertaking, most, if not all production are produced and financed by the "seat of the pants".
The reasons for this precarious situation are a result of the inherent characteristics of the industry itself. While any company takes a gamble when a new product is marketed, most tangible products (i.e. soap, razor blades, automobiles) have a set of factual criteria that make them better or worse than others in the same field. The marketing key is simply to point out the product superiority to as many people as possible, or to hide product inferiority from as many people as possible.
The same cannot be said of the entertainment industry. Too often has a movie or TV series been touted as a "sure thing" with "bankable stars" only to flop and become lost in obscurity (and major financial losses). The entertainment industry is ruled by opinions: the opinion of the writer, producer, director, distributor, investors, critics, and, most importantly, the public. This, predicting a movie's success is more a result of sound judgment, keen intuition, and lucky guesses rather than empirical statistical data (although demographics and surveys can help influence a decision).
Since, at heart, investors and financial backers of an undertaking are seeking maximization of return on their investments, risk factor plays an important part in the willingness of investors to finance an entertainment undertaking. As a result, producers of such undertakings must use a variety of financing methods, most of which attach a large premium upon the risks involved. The critical choice for the producer is one of balancing how much control and risk he wants to assume versus how much profit he wants to be assured of.
While major studios are also utilizers of these financial methods, their large asset structures and relative financial security make the issues involved far less relevant for purposes of this discussion. Therefore, this paper will focus primarily upon the independent producer as a user of these methods.
Each method has its own rewards and pitfalls - its own risk versus profit tradeoff. The following methods will be examined:
Most are merely facets of the multi-faceted financing scheme that the independent producer needs to glue together in order to realize his undertaking.
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JOINT VENTURES/LIMITED PARTNERSHIPS
To continue the stockholder analogy, a more reasonable investor in the market develops a portfolio, whereby he acquires interests in a large number of diversified stocks so that a drop in one may be offset by a gain in another. Obviously, his chances of a huge windfall are lessened, but so are his chances of a catastrophic loss. Joint ventures and limited partnerships operate in much the same fashion, serving to dilute the risks involved and, consequently, diluting profits as well.
A joint venture is essentially a co-production. Two independents join forces (both financial and creative) in order to create a synergy of resources. This joint venture might have enough combined clout to gather the sort of talent that neither could gather singularly. Similarly, a joint venture may be able to gain more financing from outside sources than they could individually. Usually, a joint venture is structured as a straight percentage share of costs and profits, with each participant bearing a proportion of the risk that it feels it can absorb.
A limited partnership is one of the most common means of financing a motion picture. Usually, it is combined with a joint venture to provide enough initial financing to start preproduction and develop preproduction promotion. A limited partnership works as follows:
The producer (or co-producers) are deemed the general partners of the limited partnership. As general partners, they accept unlimited liability in the event that liability exceeds the limited partners' interest. Other investors set themselves up as limited partners. A limited partner contributes capital (in this case money) to the partnership in order to secure a certain percentage of the profits. Because he is a limited partner, his liability is limited to the amount he puts into the venture. Thus, if I were to put $10,000 into a limited partnership for the making of Apocalypse Now and the movie runs way over budget, incurring tremendous liabilities, I would never lose more than my initial investment of $10,000.
Limited partnerships are so common because of their limited liability feature. Many investors in the entertainment industry (especially for independent productions) are not, themselves, entertainment people. They are real estate persons or corporations or even private individuals who 1) want to invest to diversify their holdings, 2) want to generate passive activity losses for tax purposes, 3) are willing to trade substantial risk for the allure of tremendous potential return on investment, or 4) want to be involved in the excitement of the entertainment industry. These investors usually do not know enough about the industry to even form an opinion regarding the profitability of a film. Therefore, they desire limited liability to cover their lack of knowledge.
Usually, a limited partnership (and a joint venture) are formed for a single undertaking. Often, the name of the partnership will be the name of the movie itself. For example, the upcoming feature film The Pushover by Avton Films International, Inc. is being funded by a limited partnership named "Pushovers Limited".
The down side of joint venturing and limited partnerships is obvious. The limited partners are all entitled to a share of the profits. This can be a substantial share if an undertaking is funded by a large number of of partners each claiming a small percentage individually. However, most limited partners are willing to accept a very low percentage share in return for their limited liability.
BANK FINANCING
Once again we can return to the stockholder analogy. Often, a stockholder will purchase stock on margin, whereby he pays only x% of the stock price and is loaned the rest of the money by a broker. When the margin becomes due, the stockholder hopes that stock prices have risen so that he can pay back the amount borrowed and make a profit. Bank financing is similar to buying on margin in the sense that the bank is not an investor per se. It doesn't expect or want a share of the profits. Rather, it loans money with the sole purpose of earning interest on the loan. Since motion pictures are so risky, the bank can usually get a rather high interest rate (at least 3% above the prime). Other institutions besides banks also offer interim financing to producers. These companies will be likely to accept even grater risk at an even greater interest rate.
Most banks have an entertainment division that is devoted entirely to the financing of entertainment undertakings. Even so, most banks are not experts on the entertainment field and cannot form a reasonable opinion regarding the solvency of an undertaking. Therefore, most lending institutions require a secondary source of income or potential remuneration should the picture not come into completion. If the producer has sufficient personal assets or ancillary income sources, he could pledge those as collateral. However, the most common way to satisfy this contingency is via bonds and/or insurance.
Completion bonds and/or insurance insure the holder against non-completion via unforeseen circumstances or going over-budget. The bonding agency will either pay for any amount over the agreed upon budget, or will pay an agreed upon amount if the film "dies" before completion. Premiums for this type of coverage varies with the nature of the market, the material in question, and the producer's reputation, but they can be quite high. However, since most investors prefer or require a completion policy of some sort, the high premiums often must be paid.
PRESELLING
Preselling, for the independent producer, pushes to the limit the extent of one's contacts, clout, reputation, and resources. However, if successful, the benefits can be well worth the effort. In the past, most entertainment undertakings targeted the primary, first-run markets as their profit-makers. In recent years, however, this has changed. The foreign film market has grown considerably in the past few years, especially with regard to the demand for U.S> films with "name" stars. Similarly, the advent of the home video market has opened up new territory not only at home, but abroad as well.
Preselling can target both domestic and foreign markets. However, the foreign markets are the faster growing and often more accessible to an independent with good contacts since many foreign users of entertainment media are looking for low budget features with an American gimmick and some name recognition.
Preselling essentially involves a licensing agreement for a film that is consummated before the film is produced. The licensee usually secures exclusive rights to distribute/exhibit the film in a certain territory, thereby locking out competitors. In this manner, the foreign distributor/exhibitor can, if he believes that a film will have legs, secure his rights before anyone else can, eliminating bidding wars. Also, since the producer is often desperate for funding prior to completion of a film, he will offer a better deal to the foreign distributor/exhibitor.
The producer gains much from preselling his undertaking. First, he usually receives a sizable cash advance (which will be deducted from his profit participation later on) which he can use to help fund the picture he just presold. Second, he has guaranteed revenue upon completion. This can be sizable if he can sell to a lot of small territories at once. Third, he can gear the film towards these audiences if he needs to. If a producer knows that much of his profit will be coming from Japan, he can cater his film (within limits) to a Japanese audience. Finally, since presale money is guaranteed and in hand, it reduces the uncertainty of a film's completion, which makes the film attractive to other investors. This can have a snowballing effect if, once more investors put up money, more foreign distributors want to engage in presell and so on.
Preselling can involve more than the film itself. It has become increasingly common to presell rights for a variety of undertakings related to the original entertainment undertaking. Producers can presell soundtracks, singles, characters for use with toys, names of characters and the title and logo of the film for use on consumer products, etc. The cartoon series Robotech (distributed and then produced by Harmony Gold) had the rights to its vehicles and characters presold to Kenner, who required in the contract that a certain amount of new vehicles were shown each show. This allowed Kenner to have a constantly expanding line of toys. Unfortunately, the show went under.
DISTRIBUTORS
There is one key rule when dealing with distributors: have as much of the product finished as is possible before you present it to them. Distributors will always charge excessively (in the form of higher percentages from the picture) for less completed films. This is one reason why the other forms of financing are important, for presales and bank financing can get a picture to negative and allow a producer to keep more of his profits.
Distributors often offer a type of financing called negative financing, wherein the distributor agrees, up front, to purchase the finished negatives from the film. Negative financing allows for some added security for other investors, since the film only need be completed in negative form. Once this happens, a buyer is guaranteed. This reduced the risk involved in producing the film and makes the undertaking more attractive to investors.
Domestic distributors will also often pay for presale rights of a film. This operates exactly like foreign distribution presales, although the domestic market is not as conducive to independent producers. Of course, distributors, by nullifying the risks of marketing and by negative financing, also draw heavily from a film's profits.
TAX SHELTERS/GOVERNMENT SUBSIDIES
Not so much a means of financing as a means of inducement, this category is included because many independents rely on these to provide needed funds or investors. Tax shelters allow limited partners and certain other investors to write off passive activity gains. Certain nations and/or municipalities offer tax breaks specifically designed to induce shooting in their area. These can include sales tax breaks and special credits like the investment tax credit.
Subsidies are more significant to the financing effort. Most are designed to encourage or promote film shooting in an area and to induce the churning of money within that area. For example, the Canadian Film Board will subsidize films if they meet certain rather rigid criteria. Most of these criteria are designed to keep the money spent on the film in Canada for the benefit of Canadian citizens. The film must have a Canadian director, certain Canadian staff members, and expenditures must be made primarily in Canada.
England, Germany, and many other countries have similar subsidies, for a film shoot brings with it a large amount of money, and, as any economist will tell you, a dollar injected into an economy will generate several dollars through transfer and credit. Thus, a film shoot for $2,500,000 could being a locale and its citizens for $5,000,000 in economic inflows. Thus, both the producer and the locale benefit from the subsidy. However, the producer must accept the limits upon his decision making powers that are required by the locale's subsidy rules. As illustrated for Canada, these can be very strict.
SPONSORSHIP
Sponsorship is another means of financing. It involves a company, usually unrelated to the entertainment industry, that is willing to provide funding for the undertaking not for profit participation, but because the film itself stands to increase its own industry-related profits. For example, Kelloggs might sponsor a Saturday morning cartoon show in exchange for public recognition for its sponsorship (usually via advertising). Such sponsorships are good for public relations and allow a vehicle for the sponsor's advertisements. This is particularly true now that many children's shows are based upon lines of toys and games. The shows themselves become 30 minute to hour long advertisements that tie in directly with the companies' normal commercials.
Producers must pay a price for sponsorship, however, Although sponsors may supply a great deal of the production cost and demand a relatively small amount of the profits (if any), they usually demand final say on the content and marketing of the product, since it will be intimately tied to their product. Proctor and Gamble are not going to sponsor a program that offends housewives! Thus, as with subsidies, the producer is relinquishing his control of the product in order to finance it.
Another less important means of financing involves use of advertising within the product itself. Often, a company will pay to have its name shown prominently in a film. Whether or not the company will pay depends on the reputation of the filmmaker. Steve Spielberg has a reputation for popularizing brand names in his films (esp. E.T.), Therefore, he could probably induce a company to pay for a certain amount of recognition. However, many times just the opposite occurs. The company in question charges the filmmaker an amount to use its name. Obviously, which situation takes place depends upon the relative bargaining strength or clout of the two parties. Most independent producers would have to pay for the use of brand names and usually resort to changing them on screen.
The ides of being an independent producer is an alluring one. The thought of having complete and total control over a production and raking in millions of dollars from it cannot fail to entire most persons. However, the independent producer has a variety of sources that impede both his profit participation and his creative license. Most of these involve financing and have been illustrated in this paper. However, the producer also gains from these sources by taking some of the substantial financial risk of productions off of his shoulders. In many cases, the production could not be done at all without these outside sources of financing. A knowledgeable producer will weigh his own financial capacity with the risk involved in the undertaking. With this in mind he will seek some or all of the sources of financing indicated above. His decision will be based upon the benefit gained by diluting risk and gaining funding versus the consequences of sharing profits and compromising creative license. He must also keep in mind that each source of financing is interrelated to the other sources, and that they can be played off against each other to gain the snowball effect previously described. The knowledgeable producer will use one source to secure another, always protecting his profits and as much of his creative integrity as possible. This will allow him to keep placing better and better products on the screen or on the air.
For further information regarding entertainment financing, please refer to the end notes included with this paper.
Sources Used:
1. The Movie Business, David Lees & Stan Berkowitz, Vintage Books, NY 1978
2. The Movie Business Book, Edited by Jason E. Squire, Prentice Hall, NJ 1983
3. The Movie Business; American Film Industry Practice, William Blum & Jason E. Squire, Hastings House, NY 1972
4. Interview with Brad Zukovic, President low budget division of Avton Films International, Inc.