Film Financing: Equity and Debt Financing

Jon M. Garon
Published on : 2009-08-05

This is part of a series of book excerpts from The Independent Filmmaker’s Law and Business Guide: Financing, Shooting, and Distributing Independent and Digital Films
designed to introduce filmmakers and others interested in creating content on the legal issues involved in the filmmaking process.

Survey of Film Financing Tools

There are a number of distinct sources of money for film financing, and every film uses some combination of these sources to finance the project. First, equity investment may come from outsiders funding the film company or in exchange for financial participation in the particular film. Second, the filmmaker may raise production funds by selling the right to distribute and exhibit the film prior to the film’s creation. Third, the filmmaker may use loans to make cash available for the production. This third category is known as debt financing. Funding is first distinguished between debt financing in the form of loans or credit, and equity financing in the form of sales of property.

In debt financing, a lender such as a bank, gives the borrower money in exchange for a promise to repay that loan on time. The bank makes profit by charging interest on the loan. Loans place the risk of failure on the borrower because the lender expects to be repaid whether the film is a success or failure. On the other hand, although the borrower must pay back the principle and interest regardless of the outcome of the film, the lender does not participate in any profits above the interest. As a result, the borrower stands to make significantly more profit if a successful film is debt-financed rather than equity financed.

Equity financing requires the filmmaker to sell interests in either the film or film company in exchange for the funding. This serves to distribute the risk of the project because the investor only receives his money back if the film shows a return. If a filmmaker sells 50% of the corporate interest to an investor, for example, then the investor will lose his entire investment if the film is a complete failure. If the film is a tremendous success, the investor will receive 50% of every dollar of profit – far more than the lender.

The most beneficial situation for the filmmaker would be to receive 100% of the film costs from an equity sale in exchange for substantially less than 100% of the income – in the range of 25-50%. In this way, the filmmaker shares in a portion of the profits but undertakes no cash risk of loss. Nonetheless, many independent filmmakers – including successful directors such as Spike Lee and Francis Coppolla – have used their personal funds to finance all or part of their films. There are no legal limits or restrictions on this practice. Despite the adage that a filmmaker should only spend other people’s money, personal funds are invariably part of the film financing mix.

Financing Based on Distribution Deals & Pre-Sale Arrangements

Unlike other industries, there are two discrete types of equity sales in the motion picture industry. The first is sale of securities in the film company. By selling stock in a corporation or membership interests in the LLC, the company raises funds by increasing the amount of equity owned by people other than the filmmaker. This is the typical model of equity financing.

The second form of equity financing involves selling the film’s distribution rights. In this form of equity financing, the company sells its assets in exchange for a present or guaranteed payment. For example, if the film company sells its rights to Canadian distribution in exchange for $50,000, then the future revenue will exclude Canada whether the Canadian markets generate $5,000, $50,000, or $500,000. In terms of the leverage discussion above, this form of pre-sale agreement serves to reduce the potential for future income, but also serves to reduce the risk of loss.

Unfortunately the business realities for pre-sell agreements often require that the completed film be delivered prior to any payment. This, in turn, requires the filmmaker borrower from a lender, using the pre-sell agreement as collateral for the loan. Under this structure, the interest costs are not avoided, and the filmmaker may still shoulder the residual risk of the pre-sale fees not materializing. Nonetheless, since pre-sell agreements allow the filmmaker to finance a project without personal funds at stake, they remain very attractive to the filmmaker. The pre-sell and distribution deals vary significantly. Some of the more common structures are described briefly.

In each of the various funding scenarios other than an outright sale to a motion picture studio, the film producer must still bear the burden of both controlling the costs and paying the bills as they accrue. Although the filmmaker may have sold the right to distribute the film (or the copyright) in the completed film, these are future transactions that do not translate into production funds. Instead, the filmmaker must apply to a lender to provide the cash to make the movie.

Although rare, there are some commercial banks who provide this form of independent film lending. Two of the more successful are the Lewis Horowitz Organization (a division of Southern Pacific Bank) and Comerica Entertainment Industries (a part of Comerica Bank). The experience and knowledge of these banks allows them to assess the credit risk of the independent production, and lend funds on the basis of the production’s collateral.

To receive a commercial loan for creation of an independently financed film, the film company must credibly present evidence it will be able to repay the loan, and that it has sufficient collateral to cover the principle amount borrowed. Just as a home purchaser must show the intended property is worth at least as much as the loan, the filmmaker must demonstrate the value of the financed project exceeds the loan requested.

To serve as proof of value and collateral of the loan, the film package must demonstrate to the lender the value of the project. Since filming has not yet begun, the collateral includes the screenplay and story rights; legally binding commitments by the key personnel to participate in the film; the production budget – including a draw-down schedule for the use of the proceeds as they are paid to the filmmaker throughout production; and most importantly, legally binding guarantees for the territory sales, negative pick-up, or other financing arrangement. These contracts must specify the guaranteed minimum the filmmaker will be paid, and that amount can be used as collateral to be pledged against the value of the loan.

* Jon Garon is admitted in New Hampshire, California and Minnesota.

Adapted from Independent Filmmaking, The Law & Business Guide™ for Financing, Shooting & Distributing Independent & Digital Films, A Capella Books (2d Ed. 2009) (reprinted with permission). Jon Garon is professor of law, Hamline University School of Law; of counsel, Gallagher, Callahan & Gartrell.