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 may be 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 that 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 ten 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. Next they go to the text and tables in the Financing section. 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 story 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. They are 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.” There are almost as many ways to finance a movie as there are people reading this edition. The truth is that finding the sources of the financing is hard work. If you think otherwise, forget it. 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. Creating a feeling of confidence is not easy, whether you are asking a money source to invest in one film or several. Any anxiety on the part of the investor about your lack of experience is only 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. Sometimes a certain formula will not work on a different person than it did on your first investor. You may not find money sources in the same place that your friend did. Who you approach and what they want to know will differ from investor to investor.

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 don’t make getting the money 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 intend to 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 Fox Searchlight paid $17.5 million for Nate Parker’s The Birth of a Nation, be sure to say: “It was reported at the Sundance Film Festival that Fox Searchlight paid $17.5 million for Nate Parker’s The Birth of a Nation.”

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 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 most of them 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. Why do they finance films? An investor may just be looking to hit the jackpot and is likely to invest in the kind of film; or she could just be looking for the profit. On the other hand, she might like a film that promotes a favorite interest, such as one that is political, social, or inspirational. The nature of an entrepreneur is to accomplish a certain goal. 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 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. In the 1990s, parents might help out with a $10,000 loan on their credit card. It is hard to find anyone with that much room on their 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. I prefer strangers, as filmmakers don’t want to ask family and friends sign legal agreements. You must have a legal agreement with family members who invest in your film.

Entrepreneurs

Private money for independent films comes most often from individuals or companies who are 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. Whatever their reasons for investing, these groups are not 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 Pictures in 1994 was Paul Allen, cofounder of Microsoft. Over the past 22 years, 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, founder of Qwest Communications and businesses in other industries started Walden Media and Bristol Bay. 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 early Internet site broadcast.com, formed Magnolia Pictures and bought the Landmark Theaters. Gary Gilbert, co-owner of the NBA’s Cleveland Cavaliers, set up Gilbert Films. Sidney Kimmel, a founder of Jones Apparel Group, formed Sidney Kimmel Entertainment. The late Adam Yauch of the Beastie Boys formed Oscilloscope Laboratories.

The sons and daughters of the rich also have been successful in the film business. 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. Bill Pohlad, the son of the owner of the Minnesota Twins, formed River Road Entertainment. Gigi Pritzker, heiress of the Chicago Pritzker fortune, owns Odd Lot Entertainment.

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 seem to be more every year 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. While other industries have investor groups, the high-risk level of film may not match their rules. For example, finders working with real estate investor groups used to approach 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. For a brief moment after the 2008/2009 meltdown, films actually looked like a better risk than real estate. That industry has rebounded in many states, however. Nevertheless, being able to make a presentation to a real estate group can be worthwhile. Individuals in the group often take the risk. Over the years, clients of mine have had real estate investors. In researching this business, you also should note that many founders of new production companies made their fortunes in the real estate business. The technology sector is another place to look for individuals with large amounts of money. If you look at the names in the previous paragraphs, however, you will see that film is a draw for entrepreneurs in a variety of businesses.

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 living 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 company information.) You may find untapped markets of entrepreneurs from very unglamorous local businesses. 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 focuses 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 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

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.”

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 125 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 bad habit of promising “points” (industry lingo for a percent of profits) to people for their efforts in making introductions to potential actors, directors, and other experts necessary in the film process. Directors and stars 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, especially Executive Producer. Save it. 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 that 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.

I often speak with filmmakers who say, “Investors are supposed to take a risk. I’m not going to waste all this time negotiating deals and signing documents. Big guys in New York are interested.” You can probably guess what happens. The filmmakers never hear from the “big guys,” never get the first film made, and go back to their day jobs. 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 Whiplash, The Visit, and God’s Not Dead can be irresistible. Very few other ventures, outside of Las Vegas, offer the potential of a 500 to 1,000 percent return on investment. 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 advance for a $1-million film.”

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 about forecasting in the next chapter and through doing the exercises provided in the financial files on the book’s companion website.)

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 nonmonetary rewards, 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 and an additional 3 percent plus 20 cents per pledge for third party processing. Indiegogo also has you set a funding goal, but you don’t have to get to your goal. They charge 5 percent on the money you raise plus 3–5 percent for PayPal and 3 percent plus 30 cents per pledge for credit cards. For current information, please check both sites.

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. Veteran filmmaker Bill Plympton has raised money ($100,000–$200,000) for films on Kickstarter three times. He told deadline.com. “Before (Kickstarter), I’d have to go out to Hollywood and do pitch sessions. That’s very frustrating. They don’t get it. I just said ‘Why don’t I go to my fans? They’re the proper place to go (to raise money).’ I really think it’s the wave of the future.”

Over the three years since the last edition, there have been several stories in the press of donors picketing a film at Sundance or complaining elsewhere that they did not get the promised gift. Be very clear about your offers and deliver them. You don’t want people standing outside a screening of your film calling you a liar or worse.

Crowdfunding for Equity Investment

On May 16, 2016, the SEC rules for Title III of the Jumpstart Our Business Startups Act formally launched a new type of crowdfunding. As a filmmaker, you must work with an attorney who is familiar with these rules in setting up your plans and documents. This book goes to the publisher one week later; therefore, I am summarizing the rules and disclosures from the SEC site (http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540017677).

Equity crowdfunding expands to include non-accredited investor participation:

• Startups and small businesses can raise up to $1M in a period of a year.
• Investors making <$100,000 per year can invest the greater of $2,000 or 5 percent of annual.
• Investors making >$100,000 per year can invest up to 10 percent of their annual income.
• Offerings must be made via Broker-Dealer or Portal Intermediary.
• Significant disclosures are required for companies to help provide transparency.

Disclosures by Companies

Consistent with Title III of the JOBS Act, the proposed rules would require companies conducting a crowdfunding offering to file certain information with the SEC, provide it to investors and the relevant intermediary facilitating the crowdfunding offering, and make it available to potential investors.

In its offering documents, among the things the company would be required to disclose:

• Information about officers and directors as well as owners of 20 percent or more of the company.
• A description of the company’s business and the use of proceeds from the offering.
• The price to the public of the securities being offered, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount.
• Certain related-party transactions.
• A description of the financial condition of the company.
• Financial statements of the company that, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the company’s tax returns or reviewed or audited by an independent public accountant or auditor.

Companies would be required to amend the offering document to reflect material changes and provide updates on the company’s progress toward reaching the target offering amount. Companies relying on the crowdfunding exemption to offer and sell securities would be required to file an annual report with the SEC and provide it to investors.

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 those initial buyers. 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 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.

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.

You now know how presales work. I stopped putting “We will look for presales” into business plans, unless the filmmakers are experienced and dealing with budgets of $20 million or more. Post-2008, countries greatly reduced the amount of money that they would spend. If you have a low-budget film, it is unlikely that there will be presales available in other countries. Everything depends on the “eye of the beholder” which has become very conservative.

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 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 home entertainment, they are still occasionally a source 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 and advances 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 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.

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, the IRS 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 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 taxpaying investors an amount up to a maximum of $15 million per film or $20 million 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 million or $20 million per episode for up to 44 episodes. The original act was extended several times with the last extension ending December 2015 for films that commenced production before December 31, 2014 (Section 129 of H.R. 5771 “Tax Increase Prevention Act Of 2014”).

As with the original bill, the films could be completed later but one day of filming had to occur in the designed year, which is 2014. In addition, there had to be an Investor Offering drafted.

Every time we have been told that it will never be extended again. This may or may not be true, as that has been said after every extension. Since it was extended in 2015 for the year 2014, “For a bill that is supposed to stop ‘runaway’ production from going overseas, this extension looks backwards not forwards,” as Alex Ben Block stated in The Hollywood Reporter. We have a presidential election this year (2016), which could change the makeup in the Congress. Over the past two years there has been much lobbying by very conservative groups in individual states to kill the “Hollywood handouts,” their description of film incentives. If new lobbying in 2017 or after brings another extension, I will post the details on the book’s companion website.

Section 199

Congress also adopted “Section 199 Manufacturer’s Deduction” in 2005 to stimulate and preserve manufacturing jobs in the United States. Film production businesses are considered “manufacturing businesses” under the definition. From 2010, manufacturing businesses can deduct from their qualified production activities income an amount equal to 9 percent of such income. For example, if $100 were 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.

State Film Incentives

State film 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 state 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. This has been a busy year for changes in film incentives. Some have been lowered and others left to “sunset” (end) at close of the fiscal year, which varies from state to state.

If you know in which state 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.

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?

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 financial problems―in some cases the 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 Liability Companies

The most commonly used structure for independent film finance is the limited liability company (“LLC”). LLCs are a hybrid combination of the partnership and corporate structures. The investors are the “members” of the LLC. Members are similar to shareholders in a corporation in many ways. The producer is usually the “manager” of the LLC. The manager runs the day-to-day operations of the LLC and makes all decisions regarding the picture without interference from the members. The members generally recoup their investment and share in the profits derived from the exploitation of the picture as generally outlined in the offering document and operating agreement of the LLC. As a general rule, the members of the LLC have no personal liability and are protected by the “shield” of the entity. Theoretically, the worst thing that can happen is that they lose their investment. An LLC member can participate in the entity’s management without risking loss of limited liability.

For federal tax purposes, the LLC generally is taxed in similar fashion to a partnership, where the profits and losses are “passed through” to the investors/members and are incorporated into their personal tax returns. The same is true in most states—the operative word here being most. Before creating an LLC in a given state it would be a good idea to look into how the entity is taxed in that state.

The most important thing to know is: DO NOT WRITE YOUR OWN LLC OR OFFERING DOCUMENTS. Can I say that too often? When you hire an attorney, however, be sure that he or she 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 laws and programs (both state and federal) appearing on a regular basis, you also may need to consult with a CPA familiar with IRS statements. (Ed. Note: Attorney Michael Saleman, www.movielaw.net, contributed to this section.)

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 his or her 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. 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. Unlike most of the rest of the world, the United States government does not have coproduction treaties. You must find a production company in another country that has coproduction deals with the country in which you want to make your films.

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.

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. On June 23, 2016 the United Kingdom voted to leave the European Union; however, it may take two years for the country to formally withdraw. Other countries are currently having liquidity problems. 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, “Other People’s Money,” we discuss more about investors, who they are and what they want. In Chapter 14, “Raising Money,” filmmakers also share their experiences, which may prove useful to you. Keep in mind, however, that you may have totally different results to share with readers in this book’s next edition.

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!”