Filmmaker Mistakes: distribution & foreign rights

Mistake Filmmakers Maker:   Not Pre-Selling the Foreign Rights
by Bianca Bezdek 
Formerly an Associate at Magic Circle international law firm Linklaters, Bezdek as been the managing partner of Bezdek Law since 2003 and has advised on tax-incentivized financing of tent-pole blockbuster films for Paramount Pictures, Universal Studios and NewLine Cinema.  Ms. Bezdek specialized in independent feature film financing and related entertainment law issues, and is an adjunctprofessor of New York University and University of California Los Angeles, teaching about deconstructing independent feature film financing models and their related legal underpinnings. Ms. Bezdek consults filmmakers seeking financing and creates and implementsinnovative and cost-effective financing and distribution strategies for media.

 
THE MISTAKE

Don’t make the mistake of failing to pre-sell just the right amount of foreign rights. Time after time, I see independent filmmakers and producers show a conviction for raising 100% of their film budgets through private equity. But, rarely do I see those filmmakers succeed within the time frame they have to do so.  Raising millions of dollars is a Herculean effort that takes time.  Often, the window of opportunity and time available to lock in the talent and complete their films is less than the time they need to raise the necessary funds.  Thisis why ‘alternative forms of funding’ are integral to raise a complete budget. 

These ‘alternative forms of funding’ include:

-Monetized international and domestic (whether federal, state or municipal) tax incentives (or credits, rebates, subsidies, etc…)-Debt financing such as senior debt (“gap”)-Mezzanine financing (“super gap”)-Bridge loansHere we will focus on debt financing, which is predicated on international estimates, pre-sales, and sales. ‘Estimates’ are projections from international sales agents of values they expect international media buyers to pay for the distribution rights of a filmmaker’s picture in specific territories.  Based on these estimates (and actual executed pre-sales), banks determine their comfort levels for debt financing to independent films seeking funding. There are a number of factors banks consider when evaluating estimates and pre-sales against which to lend money to filmmakers.  Be aware of those factors!First, debt financers look to the credibility of the sales agent selling your film; basing that credibility on the agent’s past performance in selling films similar to yours in genre, budget, language and casting.  Second, timing is a key factor in determining the caliber of a sales agent; specifically in how long it takes a sales agent to sell key territories, who they sell them to and for what price at the different film festivals.  Accordingly, debt financiers also look to the credit worthiness and credibility of the sales agent’s buyers in various territories.  Finally, debt financiers can only conclude their assessment of credit-worthiness based on actual performance of a sales agent andwill request that a certain number of territories be pre-sold to the highest level of media buyer.  This confirms that the marketplace has an appetite for your film and that your sales agent understands how to tap into that appetite. For debt financiers to feel comfortable enough to make their loans, they will customarily request for approximately 20% of a film’sbudget to be pre-sold by your chosen sales agent.  Assuming the individual media buyers, who purchases these rights are deemed credible and sufficient, the debt financier will then cash flow these pre-sales contracts by collateralizing them and lending against them.  The bank will take certain fees and interest for this service.  And, assuming that you authorize your sales agent to pre-sell an amount of foreign territories (less financingfees and interest) equivalent to 20% of your film’s budget and the bank does cash flow them, you are only 80% of the way toward raising your total budget. After this initial step, you must look again to the estimates and determine the value of the territories remaining unsold subsequent to your initial pre-sales.  Let us assume that your budget is $10M and you have had cash-flowed $2M in pre-sales.  Based on your sales agent’s international estimates totaling $12M for the distribution rights of your film in every media and every territory worldwide, your film has a value totaling $10M in unsold territories.  Let us further assume that these unsold territories break down into $2M for U.S. domestic distribution rights and $8M for foreign distribution rights.  Debt financiers will evaluate these “open” (unsold) territories, based on the quality of the buyers to whom your capable sales agent has already “pre-sold”, thus illustrating the ability of your sales agent to sell more territories for amounts corresponding to their estimates. The debt financier will then be willing to lend up to half of the value of those open territories.   Therefore, based on our previous scenario, a debt financier will be willing to lend the filmmaker up to $4M (less financing fees and interest) against all of the unsold territories. Please note that of this amount, no more than 20% of your total budget (or $2M) will be treated as “senior debt.” The distinction between “senior” debt and “mezzanine” debt is the interest rate and related financing fees charged to the production. Senior debt is less expensive, as it sits in first position for recoupment and therefore is less risky.  Mezzanine debt is in a position subordinate to senior debt.  It assumes a higher risk of getting repaid to the lender.  That noted, in the previous scenario, the filmmaker can raise circa $2M by executing pre-salesand having them cash-flowed by a production loan and raise an additional $4M (less financing fees) via debt financing based on the stability of the pre-sales and related estimates.  This leaves a shortfall of $4M remaining, which can be raised by a combination of tax credits and private equity. Then consider if your film is shot in a lucrative U.S. tax incentive state, such as Connecticut, and is subsequently cash-flowed by a tax credit broker at a competitive rate, this should yield an additional 15% of the film’s total budget (or $1.5M).  You are left with a final equity piece to be raised at$2.5M, which is an amount that can certainly be raised faster than the original $10M total budget.While it can take a producer years to raise a full budget, it typically takes a sales agent only 2-3 months to pre-sell enough territories to provide a debt financer with the comfort to agree to a production loan, gap and super gap (if applicable).  Certainly, territories with a festival will sell faster. The amount of time a producer should budget for the negotiation and completion of the production loan and gap/super gap financing is between two and three months.  This process can only begin once the pre-sales contracts are executed.  Moreover, the legal fees attributable to the debt financiers will be expected to be paid for by the production and can be as high as $200K, not including the filmmaker’s legal fees.Another noted difference between raising a budget entirely out of equity as opposed to a combination of alternative financing sources in tandem with an equity piece is ownership. When a debt financier provides a loan applicable toward the budget of an independent feature film, there is no expectation by the debt financier of back end participation or any other form of ownership in the film.Therefore, if a filmmaker is raising 100% of a film’s budget out of equity, the market dictates that he should expect to sell to the investor(s) approximately 50% of the ownership in the film after the investor’s 115% to 125% return on its investment. Conversely, when a filmmaker raises a shortfall of $2,500,000 from private equity, or a quarter of the amount in the prior scenario, then the filmmaker should expect to retain approximately 12.5% of the ownership in the film after the investor’s preferred return on it’s investment. The disparity between the two ownership prospects forfilmmakers as illustrated here, (namely, 50% versus 87.5%) is profound. Depending on the success of the film itself, it can mean the difference between breakeven and retirement for the filmmaker.One additional aspect of estimates and pre-sales we should discuss that is related to private equity and a filmmaker’s ownership in the film, is the ability of the filmmaker to buy back more of his back end which was originally sold to the private equity investor. Let us assume that the estimates for a $10M are $14M as opposed to the $12M estimate I projected earlier in the chapter.  Based on such a higher projection, with $2M in cash-flowed pre-sales, debt financing of up to $6M can be successfully raised, leaving a shortfall of $500K to be raised out of private equity assuming a tax credit of approximately 15% of a $10M budget, or $1.5M. Therefore, assuming a filmmaker raised circa 20% of the budget, or $2M as a first step In the financing process from which to make talent offers, that filmmaker can use the monetized tax credits or a portion of the debt raised to pay out the private equity investors and essentially buy back his back end prior to distribution, thus retaining virtually full ownership of the copyright and corresponding distribution royalties, should investors be so amenable (and often they are). Finally, we must discuss the pre-sales and sales strategy for the domestic and foreign marketplace, as the financing alternatives discussed in this chapter are predicated on successful pre-sales and subsequent sales. There are a few primary postulates every filmmaker should know, and along with them a few codicils.Firstly, use your foreign territories to raise financing for your film and use your domestic distribution deal as your profit center.Secondly, do not unnecessarily pre-sell more territories than youneed (or more specifically, only pre-sell the territories the debtfinancier requires as a condition precedent to its loan terms) asthe earlier in the process you pre-sell territories without having any materials to convey to the buyers the quality of the finished film, the greater the discount will be at which you will have to pre-sell those foreign territories.Of course, when you have a completed film to showcase a media buyer, the less risk that buyer has in terms of what it is getting, and in exchange for you providing the buyer a means by which to mitigated risk, the buyer will pay you more as a licensing fee.  

Finally, hold back your domestic distribution deal to when you do  not need to use any of your domestic distribution advance toward  closing your budget. The reasoning behind this piece of advise is  simple.The more you need the studio’s money to finish your film,  the less leverage you have in negotiating your deal, and the more risk the domestic distributor must take to ensure the film will be  completed. The more production risk the domestic studio distributor  must take on, the more you will end up having to pay for that increase risked by a less lucrative distribution deal. Having said that, while you do not want to be premature in executing  your domestic distribution deal, a clever filmmaker should also  realize that their film’s domestic studio distributor must have some  “skin in the game.”This can be achieved by a competitive P&A (prints and advertising) commitment paid up front by the domestic studio distributor ensuring that the film will be aggressively publicized. While the domestic studio distributor need not take on  any production risk, they will still be directly and intricately invested in the success of the film as they are effectively fronting the costs of distributing it. Otherwise, the domestic studio distributor can simply license your film domestically and open it up against one of their own (which they fully financed) without marketing it to prevent it from being serious competition in the marketplace. Why I chose to analyze the topic of timing your domestic sale strategically in a section dedicated to foreign sales is because a filmmaker’s foreign pre-sales and sales will immediately spike upward and increase in value by 10%, 20%, perhaps even 30% the moment a sales agent can confirm that the film has in place a domestic studio distribution deal, because the film’s expensive branding and marketing will then have been undertaken by thedomestic studio rather than having to be shouldered by the foreign buyers. From the perspective of all foreign buyers, a domestic studio distribution commitment is a seal of approval and an additional risk mitigator for them. From your perspective, timing these sales correctly is the difference between a franchise and a failure.

 

SOLUTION

A well-conceived financing plan comprised of both private equity and alternative forms of financing driven by strong estimates, selective pre-sales, and a well-timed domestic studio distribution deal subsequent to and autonomous of the film’s production financing represents a reliable means for filmmakers to both retain creative control of their independent films, as well as retaining meaningful ownership and entitlement to their film’s royalty streams.Dreamscape Studios2638 6th StSanta Monica, CA 90405 Usa

 

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One response to “Filmmaker Mistakes: distribution & foreign rights

  • Ben Gelera

    Hello,

    My name is Ben and I am one of the producers for a Sci-Fi feature. We currently have an investor who is putting up 90% of the budget. All that he requires is that we have a Distributor LOI and fund the remaining 10%. I want to raise the last 10% through foreign presales. I would like to speak to someone who can help in in that process. Thank you.

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