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How to Finance Your Film: Part 2

Part Two of this article takes you through the ways of financing your films, considering the pros and cons of each. Also see part 1 of this article.

By Robert C. DiGregorio, Jr.

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Lender financing is one of the best ways for a filmmaker to secure funding for a picture without going through the studio system. Though lender financing is time-consuming and complicated, it is a great resource for independent producers.

Production Loans
Lender financing is the process of obtaining a loan from a lending agency to finance the development, production, and/or distribution of your film. When you are looking for a loan, you must first find out what your state usury laws are. Basically, usury is an excessive and ‘illegal’ rate of interest on your loan. Unfortunately, the usury laws do not apply to studio loans. In other words, you might have to repay your loan with excessive interest.

Third-party feature film development loans or non-bank loans may be secured by some form of hard asset and are usually recourse to the borrower. In other words, the lender may seek repayment directly from the borrower, personally, in the event of a default. Now, if a corporate production company is the borrower, the lender may make the principals of the corporation personally liable. Also, other grantors may be required to assure repayment of the loan’s principal and interest. In other words, one lender may hold a fellow lender responsible for repayment under certain circumstances.

With both bank and third-party lenders, you have a choice of loans. First, there is a resource loan, which is a loan made only if an endorser or guarantor (e.g., the producer) is made personally liable for payment in the event the borrower (e.g., the production company) defaults.

Second, there is a debt or equity transaction. With debt or equity transactions, you will have to make clear how the intended loan is to be characterized. For example, a loan to be used for development or pre-production expenses is classified as debt. The following are considered before a transaction is determine to be either debt or equity:

1. Is it a recourse or non-recourse loan?

2. Has a fixed repayment date been established?

3. Is the loan secured?

4. Is the rate of interest on the loan tied to the amount of profits earned by the film?

5. Does the lender exercise substantial control over production?

6. Does the lender take a subordinate position to third parties with respect to payments made from the film’s revenue?

7. Does another lender have lent funds on the same or similar basis?

What is an equity investment? In equity investment, the lender actually becomes an investor whose investment is at risk. As a result, there may be no obligation for you to repay the loan. Transactions resulting in equity participation may result in your having to sell an

unregistered security to a passive investor. In addition, the creation of an entity (e.g., joint venture or association) may have to bear tax consequences.

Production Loan Advantages
There are a few advantages with production loans: First, the lender does not share in the net profits; and second, the lender does not have any creative control. Also, you have the option of a non-collateralized loan, which is not supported by collateral and therefore may be suitable for development money or for financing an ultra-low-budget picture.

Production Loan Disadvantages
The biggest disadvantage with all loans is that they have to be paid back! Most lenders will require that the production company incorporate to avoid usury problems. Also, you may lose your collateral, and non-collateralized loans are limited. Loans also have a specific term. In other

words, they are repayable on or before a specific date, regardless of whether or not the film made money! Another disadvantage is that as producer, you may be personally liable for the repayment of the loan along with the liability of the corporate production company. Finally,

sophisticated lenders will require that you contract with a completion guarantor to protect the lender against the risk of budget overruns.

Negative Pickup Deals
The term "negative pickup" refers to the commitment made by a distributor to a producer to either purchase or license a film’s distribution rights from you, the producer. The distributor guarantees to pay an agreed-upon price when the distributor picks up the negative after delivery of the completed picture. However, if a film is independently financed and presented to a distributor for pickup, then that transaction is referred to as an acquisition or pure acquisition, which is included in an Acquisition Distribution Agreement.

When using the negative pickup method for financing your production, you will sell and/or license the film to a distributor in exchange for the distributor’s promise to pay an agreed-upon price. You can then take the negative pickup distributor commitment to a commercial bank, use the pickup letter as collateral, and borrow production funds from the bank. This same tactic can be used to secure funding from investors. The letter demonstrates a distributor’s strong interest in your production and provides the investor with an improved chance of recouping their investment.

Variables of Negative Pickup Deals
There are a number of variables involved with negative pickups.

1. Did you receive an advance payment after signing the agreement?

2. Did you get paid after delivering the completed film?

3. Did the distributor provide a guarantee to you?

4. Finally, did you obtain perpetual participation in the film’s revenue stream?

Producer Considerations for Negative Pickup Deals
The first consideration is the purchase price. The purchase price is the amount you receive, which is based on the negative cost (the amount of money it cost to produce the film) of the picture. The second consideration is the amount of profit participation. The amount of profit participation is dependent on the amount committed to be paid by the distributor, the rights acquired, anticipated profits, and the risk of the distributor.

Other important considerations relating to Negative Pickup deals are listed below:

1. Delivery requirements. You and your attorney must examine the distributor’s description of delivery requirements for the film, as well as required production element requirements. If these elements are not followed the distributor can refuse to pick up the film and the negative pick up agreement will not be acceptable to a financier.

2. Laboratory letter. A laboratory letter is a letter drafted by the film lab stating that the finished film is of acceptable quality, that the script adhered to the agreement, and that the pre-approved cast members appear in the final film in their proper roles.

3. Security for production loan or comfort for investors. You may be able to use the negative pickup as collateral on a production loan.

4. Distributors requirements.

5. Your net profit participation.

6. Criteria for delivery.

7. Distribution agreements similar to a P-F/D (Production-Financing/Distribution) deal. (The difference between the two is who provided the production financing.)

Negative Pickup Deal Advantages
One of the advantages of a negative pickup deal is that in the event a studio enters into such an agreement, the studio has an obligation to pay if the negative is delivered according to the requirements imposed by the studio. This is also true regardless of the creative quality of the film. Negative pickup deals can be fairly easy to get because the distributor paid a fixed sum to obtain a complete picture that has certain agreed upon elements. This sum is not payable until the picture is delivered. Another advantage of a negative pickup arrangement is that the

distributor does not share in the risk of the film running over budget, because the completion guarantee is provided by the producer. The distributor in this arrangement holds little financial risk if the film is not delivered as agreed. Negative pickup deals can provide some assurance that the film will be released domestically. Finally, negative pickup deals removes the risk relating to the lack of distribution in financing.

Negative Pickup Deal Disadvantages
The biggest disadvantage of a negative pickup deal is that you have to come up with the financing of the picture from sources other than the studio or distributor. A negative pickup deal is less expensive for a distributor to make a commitment to purchase the film before the film is

complete as opposed to after the film is finished. From the distributor’s point of view, the negative pickup is a speculative deal. Negative pickup deals are very complex transactions and time-consuming. Also, negative pickup deals go to producers who have a proven track record and

established relationships with studios, distributors, and lenders. Negative pickup loans are generally only available through banks or other lenders. (Firms with the most expertise in this area and are based in either New York or Los Angeles.)

Presale Financing Deals
Presale financing ("presales") is the funding of a film’s production costs through the granting of a license for the film’s rights by a producer to a distributor in a particular media or territory before the completion of a film. Presales can take the form of funds, guarantees, or commitments. For example, if you have a contract for the presale of your film to a domestic distributor, then you may be able to present the contractual commitments to a bank or lender and walk away with cash!

Presales Used to Finance Production Costs
When you decide to use presales to finance your production, the first thing you should do is obtain an experienced sales agent to make the presale arrangements on behalf of the film. As producer, you can expect the sales agent to receive a 10 percent to 20 percent deposit at the time of signing. The agent may also want to get a minimum guarantee payable on the delivery of the picture to the buyer. The sales agent will typically get a presale agreement that is sometimes backed by the presale purchasing entity’s letter of credit or other form of financial guarantee. You may be required to assign a portion of the picture’s net profit to the grantor for providing the guarantee.

With this agreement in hand, you may then go to a lender and use it in conjunction with distribution agreements and guarantees, other presale agreements, or other forms of collateral to obtain a production loan. You may borrow money by pledging the presale agreement itself. In general terms, a letter of credit is considered more bankable than a contract to pay the same amount of money.

Ultimately, a lender will decide to lend on a given presale agreement independently based on the reputation and track record for the presale purchasing entity and the terms of the agreement. Also, once the lender determines the amount, the lender then discounts the loan amount to get the production funds.

The quality of the picture, the competitive environment, and the demand for that genre of picture will determine whether or not the sales agent can sell your picture. Genre, censorship, the amount of deposits paid by the buyer to the sales agent are the primary concerns that relate to what rights are included in the presale agreement.

It is best to contact a sales agent as soon as possible. The sales agent will need a completely packaged film before he/she will be taken seriously by a potential purchaser.

Presale Financing Advantages
Presale agreements can provide for a big portion of production financing. Also, there is less creative intervention. Presales involving loans do not have the kind of creative control issues that a studio-financed production imposes on the producer/production team. If you are not confident in the economic upside potential of your picture, then a presale arrangement is a viable option.

Presale Financing Disadvantages
Since presales are based on contingencies, collecting the money from the lenders can be difficult. Also, increased prints and advertising (P&A) costs make presales less practical. Moreover, domestic presales may eliminate certain distributors. Domestic distributors insist on all or substantially all rights of a picture to help recoup their costs, not only of advances to the producer, but distribution costs as well. Ancillary rights that have significant value may be demanded by the distributor as a prerequisite of distribution. Presales bring lower prices, since the buyer will pay less for a film before it’s completed. Finally, feature films financed with presales not only increase the number of films produced in a year, but they increase the demand for and cost of various film elements that are limited in supply. There are more films produced each year than there are capable and willing distributors to distribute. This creates an oversupply of films, and as a result, creates an imbalance in the bargaining strength between you as producer and distributor.

Conclusion
As you can see, lender financing is both time-consuming and very complicated. When deciding how to finance your film, you must seriously consider all forms of financing, the reason being is that each producer’s situation is unique. The bottom line is that you get your message out.

Bibliography
Abreu, Carlos de, and Howard Jay Smith. "Opening The Doors To Hollywood." Three Rivers Press, A Division of Crown Publishers, Inc. 1995.

Cones, John W. "43 Ways To Finance Your Feature Film – A Comprehensive Analysis Of Film Finance." Southern University Press, 1995.

Cones, John W. "The Feature Film Distribution Deal – A Critical Analysis of The Single Most Important Industry Agreement." Southern University Press, 1997.

Litwak, Mark.. "Dealmaking In The Film and Television Industry – From Negotiations To Final Contracts." Silman-James Press. 1994.

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Film Funding

Dear Sir/madam:

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Kind Regards

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