9 Gap Financing

If you think gap financing is to fix your kids' teeth, think again.

Lewis Horowitz, well-known film financier and banker

Gap financing, is a form of lending whereby a bank lends money against the value of unsold rights to a film. For example, if the budget for a film is three million pounds (£3 m) and two million pounds (£2 m) of the budget is already covered by pre-sales, tax funds, public subsidies and other collateral, the remaining one million pounds (£1 m) that is not covered by any collateral, is considered the ‘gap’.

In a traditional film financing transaction, a bank will only lend against existing pre-sales and those agreements that ensure some form of secure repayment. A bank in this case needs proper collateral as it will not lend against speculative pre-sales. Banks generally do not take risks and need to know exactly when they will be repaid.

When the United States domestic and international pre-sale market began to dry up in the early 1990s, many banks that traditionally only lent money against existing pre-sales looked to gap financing as an alternative means of earning fees. Certain banks who had specialist film financing divisions realized that unsold territories still had value, only that their value could not be determined until the film was completed. Therefore, these banks who had relationships with reliable sales agents, felt comfortable making loans based on sales estimates for unsold distribution rights. From the banks' perspective, they were not investing in the film but were lending against collateral that was not as strong as an existing pre-sale. Therefore, they would add a premium to the cost of such a loan.

Criteria for Gap Financing

The banks that are now involved in the gap financing business usually have certain requirements before approving a loan. Banks, typically, will gap finance between 10 and 40 per cent of a film's budget. However, most gap financiers tend to gap only 20 per cent of a film's budget. In general, banks will not gap finance a film unless there are already several major pre-sales in place. Having a pre-sale in place shows that there is a market for this type of film and that the sale estimates given by a sales agent are accurate.

One of the most important factors in a gap deal is the sales agent; the bank will need to be comfortable with who they are. They will look at how long they have been in business, their reputation and whether they have worked on previous gap deals.

The actual sales estimates for unsold rights are also a vital factor in considering whether to proceed with a transaction. Depending on which bank is involved, they will require that at least 1.5-2 times the amount of the sales estimates will cover the gap. This means that if the gap is one million pounds (£1 m) then the sales estimates must be at least one and a half to two million pounds (£1.5 m-£2 m). The next step is for the bank to analyse all sales estimates and decide whether they are comfortable proceeding with the deal. Most banks prefer lending not only the gap portion of the budget but the entire production loan, including existing pre-sales and other forms of collateral such as tax credits and public subsidies.

Financing the gap portion of a Film's budget can also be very expensive. Banks can charge anywhere between 7 and 15 per cent of the amount of the gap being financed, plus interest charges. This means that a bank who is financing the entire production will earn fees and interest on the traditional part of the financing and much larger fees and interest on the gap portion of the transaction.

Producers who are involved with a gap financing deal should be aware that, in such a transaction, the Bank will require a larger interest reserve than in traditional production financing. This is because there is an ongoing interest charge associated with sales being made after the film has finished. In a traditional banking deal, once the film is delivered, the distributors pay the amount owing to the Bank and interest stops accruing because the loan has been extinguished. In a gap financing deal the Bank will give the producer a period of twelve (12) to twenty-four (24) months to make the sales necessary to pay off the loan. Therefore, a bank will calculate an interest reserve to cover this additional period after completion of the film.

Gap financing a film can sometimes be very advantageous to an independent producer. In a typical film financing, the gap for unsold territories is usually financed by a sales agent who puts up an advance against sales. When a sales agent puts up an advance, they will charge a commission (25-40 per cent) on any sales made, plus costs and in most cases interest on the amount of the advance. In a gap financing deal, the sales agent will not advance any funds and will only sell the film on behalf of the producer and gap financier. In these circumstances, the sales agent is usually only entitled to a small commission (5-15 per cent) and limited costs. If the sales agent eventually sells enough of the film's distribution rights to repay the gap to the bank they will be entitled to a larger commission.

In many cases, a gap financing deal, even with higher bank fees, may result in a higher share of revenue for the producer.

The examples below highlight the savings to a producer.

Example 1 - Sales Agent Advance Against Sales

Budget - £3 m

1. Available finance (pre-sales x2, tax funds, other government subsidies) - £2 m
2. Gap - £1 m
3. Cost of sales agent's advance £1 m
4. Sales agent commission 30 per cent
5. Cost of sales (capped) 5 per cent
   Interest on advance 5 per cent
   

   [ ]
   Off the top of all Sales =40 per cent

Therefore - sales agent must sell approximately £1,667,000 before covering the advance against sales.

Example 2 - Gap Financing Deal (No Sales Agent Advance)

Budget £3 m

1. Available finance - £2 m
2. Gap - £1 m
3. Assume bank gap fee of 10 per cent - £100 k
4. Sales agent will charge 12.5 per cent commission
5. Capped costs of £25 k

Sales agent needs to sell approximately £1,280,000 before recouping the gap costs and fees.

Sample Sales Estimates

Used in a Gap Deal (UK/France/Germany Co-production) ASK PRICES (US$)

The foregoing projections are estimates only. No representation is being made that the projections will be realized. Actual results may vary materially from the projections for numerous reasons including, but not limited to, the final cast and creative elements of the picture.