Film Finance Recoupment For Private Equity Investors

Given the precarious state of foreign pre-sales nowadays, the majority of a film’s budget must come from private equity investors. However, equity investors are more conservative when it comes to pouring money into film, TV, VR and web projects. That list includes companies, mainly with private equity backing, that are currently active in production finance. This may mean that fewer (and hopefully better) projects are getting made. In this climate, you must work harder to get equity investors interested in your film and TV project. In that regard, it is necessary for the filmmaker to have amazing material and provide a clear picture of how the picture’s profits will be paid out, the order in which investors will be paid back and in what time frame (the recoupment schedule or revenue waterfall).

What to do Before you Start Pitching to Investors

Before you start pitching your project to potential equity investors, you must be able to show a clear path to recoupment. This is why you need a clearly thought out, well-researched, realistic finance and business plan.

Your film business plan should have a realistic recoupment schedule.  Since distribution is your typical first step to recoupment, your business plan should reflect what your distribution strategy is. Your business plan and distribution strategy must be unique and tailor-made for the type of film you’re making, in terms of the genre, type of story, the level of director and cast, etc. Hence, your recoupment schedule must be unique and tailor-made for your type of film or TV program, so that when you approach your investors and collaborators, you and your attorney will know what type of deal terms to negotiate for.

Things That Can affect Recoupment Schedule

The process of structuring the recoupment schedule is done when the producer or their attorney negotiates the agreements between the production company and the talent, investors and distributor. Therefore, the order in which the monies are paid out – and to whom – will vary from one project to another. For example, whether the parties agree that the investor gets any film tax credits awarded after production, or whether the production company uses the tax credits to cash flow production, is negotiated in the financing agreement with the investor.

Since the order of priority of payments is negotiated in advance, if the producers had already negotiated with talent for first position, there may be no room left at that tier for the investor, or in the case of an earlier investor, no room at first position for a later investor.

There are many financing structures available, each of which can increase the complexity of the recoupment schedule. This is why a well-structured business plan and an experienced film, TV and media attorney are so important to bring to the negotiations with key talent, financiers and other stakeholders.

Film Slate

Experienced investors usually don’t put all their money into one film. They and their financial advisors know that when they diversify, it is possible to reduce their risks somewhat.

If you are pitching a slate to investors, be realistic with what you are asking, be truthful about sales cycles and be careful to let investors know when their money will be used, and how long it will take to potentially get any of their investment back.

If you are just starting out a career in film and TV, forget about pitching a slate to investors. Unless you happen to be further along in your career, with a string of successful films, access to big name directors and stars, and aligned with a major Hollywood studio or large independent for distribution, you should focus on raising financing for single pictures.

Tax Credits

Film incentives help movies get made. Government subsidies help to mitigate the risk of investing in motion pictures, which in turn encourages investors to get involved with financing your movie and will finance more of your movies in the future. If you can actually show investors where their money could potentially come back from, you’ll significantly increase your chances of getting investors interested in your project.

A production can get back up to 80% of their budgets from government subsidies, tax shelters and tax schemes, grants and film funds. Therefore, if the production company takes advantage of a particular country’s film incentives, or state tax credits and rebates, and if the film is actually made, the investor should expect to begin to see a return of some or all of their investment, even before the film is sold.

If your production will qualify for tax credits, many equity investors would prefer that the tax credits not be used as part of the finance plan to cash flow production. Using the tax credit to secure the financing in debt or production loan, by either a bank or investors lending against the tax credits, usually involves interest and finance charges, and usually puts the lender in first position for repayment of the loan and interest. In addition, usually the lender will finance no more than 80% of the face value of the tax credit: they will discount it by a certain percentage to account for risk. Furthermore, as a prerequisite for a production loan, a bank or production lender will require the production company to obtain a completion bond (completion guarantee), which can further impact the recoupment schedule.

Therefore, if you’re able to qualify for Government subsidies, that doesn’t necessarily mean you have to increase your budget incrementally. You may use the tax credits or rebates to pay back your investors, rather than scaling up the budget because of it. Therefore, up to 80% of your investor’s investment can be secured by subsidies. These government subsidies can act as a partial safety net for the investor, if and when the movie flops at the box office and VOD.

It is important to note, however, that the bigger the budget, the greater the risk for investors. Therefore, as budgets get bigger (budgets $3 million and up) it is generally much harder to secure all of the budget in equity, and thereby the need to cash flow the production with the tax credits and foreign pre-sales.

Pre-sales

Foreign pre-sale is a key source of revenue for independent films, and can serve as a primary source of collateral for a production loan since you may not be able to get a cash advance (up-front money) to pay for production and post-production expenses or to pay back equity investors.

But pre-sales are not attractive to all investors. While it is common to see the financing plans for projects with budgets $3 million and up consisting of foreign pre-sales, it is not so common below $3 million. In addition to the lack of a pre-sellable talent, the added fees and finance costs and any discounting that will take place for a foreign pre-sale deal make it impractical for lower budget films.

Very few independent films are pre-sold for a multiple of its production budget. Therefore, very few films will see the investor recoup from a sale at the script stage or the initial sale at a major film festival premiere or film market, such as Sundance, TIFF and AFM, unless the project has stars attached.

In addition, typically, the equity investors do not receive recoupment from the territories and markets that are subject to pre-sale financing, especially if the Minimum Guarantee (MG) was used to secure a production loan. Therefore, be careful how you do all rights deals. In most cases, no matter how well a film performs in a given territory, market or medium, the only money the producer will get is the MG.

Distribution

To actually generate revenue for your movie and pay back your investors, you need to have some form of distribution. Whether or not day-and-date theatrical and streaming or direct-to-digital release is part of your distribution strategy, you should show how a release will affect your recoupment schedule.

Unless you plan to do self-distribution (e.g., Reelhouse, Tugg and VHX), a good sales agent will have to be retained. A sales agent will be able to provide you with some sense of the estimated value of the film before he or she brings it to the film market and festival circuit. What the sales projections say about what the film should cost to make, will suggest the right budget and the right distribution strategy to use for your level budget and type of movie. Knowing this up front will help you present your investor with a more realistic recoupment schedule. But be careful how you use box office comparables to indicate a film’s potential success, as investors usually make their money back off territory sales once the film is completed, not box office sales.

Don’t just plan to rely on selling your movie to streaming companies like Netflix and Amazon. In the case of Netflix, which seems to increasingly prefer to finance their own “Netflix original” content from filmmakers that they approve, the pipeline for independent films may be becoming problematically constricted.

Marketing is Everything

Even if you plan to go direct-to-DVD or straight to VOD, you can’t just throw your film out there and expect it to make money. Unless you’re willing to do a full-on marketing campaign and mini theatrical release, your investors are unlikely to recoup their investment. Similarly, it’s not just about getting the film on Netflix, Amazon, Hulu, etc., It’s about getting people to watch the film on Netflix, Amazon and Hulu. You must spend money on either a small theatrical run and/or publicity campaign to drive sales.

The Real Money is in TV

The recoupment schedule will be different if you’re making a TV series than for a feature film. Television rights are currently the largest source of income for feature films, far more money than theatrical, DVD, VOD and streaming. However, each film will have a different income pattern, and some will earn more on other platforms than they do from television.

Private Equity/Debt/Co-financing

State and federal securities laws require you to provide potential investors with accurate information so that they can make informed investment decisions. Being truthful regarding the production and always letting your investors know who else is in on the deal, make legal and business sense.

Recoupment problems can occur when there are too many investors and/or you give away too much of the equity to initial investors, stake holders and collaborators, without leaving much room for others to come onboard the project later. Under the terms of most co-financing deals, the new investors are often the last in line to get back their investment.

Another problem pertains to seeking additional investment for P&A. P&A investment are generally riskier than production investment: The P&A investor comes in last (although some deal can be structured so that the P&A financing is “last in and first out”), and if the movie is a flop at the box office, the P&A investor loses all their investment.

Be careful not to give away too much to early investors, collaborators and talent, that you do not have some equity left to offer the financiers who can actually greenlight the project. One could argue that the filmmaker could go back and renegotiate the terms of the investment with all the earlier investors, but the earlier investors may or may not agree to the changes. Having all capital sources in a given round investing under the same terms and conditions is often the more prudent option.

But, if there happens to be people who are in favorable positions, who get in line ahead of your key investor, the challenge is finding a way to get the investor to recoup sooner. One way is to structure the investment as debt. Debt typically comes out ahead of equity. The only problem is that the rate of return on the debt deal is 10%-15%, mezzanine is 15%-20%, while equity is 5%-20%. Debt is lower cost of capital compared to equity.

There are some film funds which provide soft loan (also referred to as soft money). They include national, regional, local and multinational funders who invest in production in return for receiving a share of the revenues, and the money is only returned to the financier if there is revenue, rather than guaranteed to be returned (as in a “hard” loan from a bank).

To avoid or limit recoupment problems when there are too many investors, you should use a single equity source (an individual or intuitional investor, equity fund or venture capital firm) or a co-financing with a distributor.

Deferred Compensations, Bonus and Profit Participations

The investor will have an interest in how the bonus, deferred compensation and contingent compensation provisions for talent are negotiated, because these will affect the investor’s recoupment schedule and ROI.

Bonus

the parties may negotiate a bonus fee (such as award bonuses or box office bonuses) to be paid to talent upon completion or sale of the picture or upon the picture reaching certain revenue milestones. For example, Will Smith’s total compensation for the movie Concussion broke down his points, citing a $15 million quote (fixed compensation) and an additional $5 million in bonuses tied to various worldwide box-office benchmarks.

Deferred Compensation

Deferred compensation is a production expense that covers income earned but not paid to talent. For example, if a producer chose to invest or defer his/her fee in the movie (called deferred producer’s fees), the investor should be aware of how these affect their recoupment position in the revenue waterfall.

Deferred compensation can be paid out of gross revenues, net receipts, or paid before, with or after equity investors. You will need to address these issues regarding the timing of payment of deferments: are they to be paid out of first dollar participation, adjusted gross, net profits or producer net profits?

Profit Participations or Contingent Compensation

Profit participation (also called contingent compensation) is payment in the form of a share of the “profits” to talent, financiers, sales agent, and other stake holders and collaborators, based upon a percentage of “gross receipts” or “net profits” from a motion picture. Profit participation was designed to enable producers, writers, directors, actors, music composers, equity investors and others to participate in the financial success of a motion picture.

A-list talent sometimes work at scale (at lower fixed compensation levels) – if the project is right – in exchange for a higher back-end (profit participation). As such, you may use contingent compensations as an important tool to attach name talent and experienced cast – even if they are not of “star” caliber – to your project. If the movie turns out to be a hit, a relatively small percentage of the profits can yield a tremendous return for a participant.

However, due to the changeable nature of the definition of gross receipts, whenever talent says they want profit participation on gross receipts, the producer or their attorney needs to ask, “which gross receipts?”

Types of Profit Participations:

There are two basic types of profit participations: gross profit participations and net profit participations.

1. Gross Participations

    • First Dollar Participations

      – This is gross participations based on the gross receipts (including discounts and rebates) earned and actually received by the distributor from all markets, territory and media (before any deductions for distribution fees or distribution expenses, production costs (negative costs), before equity investors and private lenders recoup their equity investments or loans, respectively, and deductions for deferred compensation and participations for talent and financiers).

When the production company and distributor are the same entities, these would be the production company’s gross receipts.

“First dollar” participations are quite rare and are reserved only for those few superstar producers, directors, and cast with the bargaining power to negotiate such a deal.

  • Deductions “Off the Top”

    – This is gross participations that is not a “first dollar” participation. It includes certain “off the top” deductions, including certain distribution expenses, such as sales taxes; guild payments (residuals); trade association fees and industry assessments; conversion/transmission costs; collection costs; checking costs; and advances not earned. P&A costs (sometimes referred to as “releasing costs”) typically are not included in “off the top” deductions.

  • The “Adjusted Gross” Participation – This is gross participations on gross receipts after deducting the “off the top” deductions plus distribution fees (such as P&A costs) and any advance/MG paid by distributor. The size of the distribution fee generally increases with the amount of the MG, since the distributor’s risk of not recouping the advance is greater. These are the sums the production company receives from the distributor and are usually referred to as the “adjusted gross”. These gross receipts are usually called the production company’s gross receipts.

2. Net Profit Participations

    • Net Profits

      – Net profit participations is usually based on the gross receipts remaining after deducting the distribution fees, distribution expenses, negative cost (this is how much it costs to produce and shoot the film), interest on negative cost (this is usually interest on the investment), production company overhead, deferments and gross participations, and adding back tax incentives and rebates.

The net profits consists of 100 points (or percent) to be divided, usually equally (50/50 split), with 50 points for the producer to keep (this what we call “producer net profits,” “producer pool” or “producer share of profits”) and 50 points to be shared by the equity investors (the “investor pool”).

The producer pool is divided among talent, such as the producers, actors, writer, director and music composer. The investor pool is divided among the investors, pari passu, that is, according to the amount of each investor’s investment divided by the total recoupable cost of production.   Note that the 50/50 split is not always the case. Some equity investors may require a 55/45 split, or even up to 70/30.

“Recoupable Cost of Production” is the total cost of production minus any amounts which are not repayable to a financier by the producer (for example: grants, television license fees, minimum guarantees and advances by international sales agents and distributors, awards and prizes.)

The “producer net profits” participations comes in last among participants, after the “net profits” participations.

Note that there are a thousand or more ways that gross proceeds can be measured or defined. As a result, the above is a simplified version of determining “gross profit participations,” “net profit participations,” “gross receipts,” “net profits,” “net receipts” or the timing of participations. A more in-depth analysis is beyond the scope of this article. The bottom line is that there are a dozen different ways to structure an investment agreement, and it will be crucial to have a good attorney to work through the process with you.

Payment of Residuals to Unions and Guilds

If it is a guild/union picture, applicable collective bargaining agreement usually requires production company to pay residuals (aftermarket payments) to the respective guilds or labor unions, such as the American Federation of Musicians (AF of M or AFM), Directors Guild of America (DGA), Screen Actors Guild‐American Federation of Television and Radio Artists (SAG-AFTRA), Writers Guild of America (WGA) and International Alliance of Theatrical Stage Employees (IATSE). As mentioned above, these residuals that are due to any talent or other persons employed in the production of the picture are usually deductible “off the top” as a distribution expense. These “off the top” deductions are typically from pay television, cable, home video (DVD, Blu-ray, videocassette) and free TV exploitation. Although no residuals are due for worldwide theatrical exploitation, these can amount to substantial payments to the talent guilds. The production company is responsible for these residual payments. However, the guilds or labor unions may require the production company to have the distributor sign an assumption agreement requiring the distributor to pay the residuals directly to the guild or union.

Sharing Revenues Amongst Co-producers

Co-productions may be based on the collaboration between two or more producers from the same or different countries for the creation of a film or television program, for example, a project that is an official treaty co-production amongst two or more countries under a bilateral agreement.

A co-production may include a reduction in the cash needs of the production budget, and reduction in the recoupable cost of production. A co-producer may have put equity in the project or have otherwise contributed to the project. For example, a foreign co-producer may pre-buy the film in exchange for a license fee or MG (in cash) plus goods, services and facilities (i.e. equipment, use of the studio or station’s production staff and access to sound stages, edit suites, etc.) and it may allow producers access to soft money, such as tax incentives, grants, soft loans and equity investments.

Each co-producer may recover their recoupable cost of production, first from their country, and secondly from a share of revenues from the rest of the world. Each co-producer may also be entitled to receive deferred producer fees from the revenues and may also participate in the net profits.

Timing of the Recoupment schedule

The following are, in general, some of the things your investors will need to account for in terms of recoupment:

  • It may take 18-24 months from completion of the film through to the film’s sale and start of any positive cash flow.
  • Some equity funds try to recover P&A principal and interest within 12 months of placement of principal funds.
  • The timing for VOD revenue greatly depends on any adherence to the theatrical windowing model, before VOD release or streaming them for Netflix, Hulu or Amazon Prime subscribers.
  • Depending on whether it is a union/guild picture and what back-end agreements were struck with talent, residual payments and talent participations might kick in, usually within 60 days of the film’s release.
  • In New York, the turnaround time for getting the tax credit is generally 30 to 60 days of submitting the final application for a Tax Credit Certificate. However, when the system is backed up, it can take 16 to 18 months after completion of production to get the tax credit, and it can take years for a film to file all the paperwork necessary to get the up to 30% reimbursement for production costs.
  • Once the production budget and any preceding overheads and development costs are recouped, the film is said to have reached its point of profitability or break-even point. This then triggers net profit participations. But, since interest continues to accrue until production costs are fully recouped, interest (together with distribution fees and expenses which are also recouped first), these may significantly delay the break-even point.
  • One of the reasons why investors like to keep budgets low is that this accelerates the break-even point and improves the internal rate of return on the investment. Too big a budget, especially in these times of diminishing pre-sales, and your investor’s investment is stuck.

What A Realistic Recoupment Schedule Looks Like

Although no two investment agreements are exactly alike, there is nevertheless a certain standard deal structure for recoupment that is reasonably popular, particularly among low-budget indie films. Below is a generalized example of the stages money passes on its journey down the revenue-sharing waterfall from movie-consumers to the investors:

  1. 1. First, distributor is paid from sources, such as film rentals from gross worldwide box office revenues;  theatrical outright license; Government subsides; home video; pay television; pay cable; streaming; VOD; airlines (non-theatrical); free TV; syndicated television; music publishing; music recording; merchandising and other ancillary and allied sales revenues – after deductions for exhibitor’s fees (usually 40%-65% of box office gross) and four walling expenses.
  2. 2. Second, distributor makes deductions for distribution expenses, such as sales taxes, collection costs and residuals that are due to the talent guilds and unions.
  3. 3. Third, distributor takes a distribution fee (usually 10%–30% of gross receipts).
  4. 4. Fourth, gross participations are paid to A-list talent.
  5. 5. Fifth, bonuses are paid to A-list talent.
  6. 6. Sixth, distributor deducts the advance/MG paid to production company.
  7. 7. Seventh, distributor deducts its P&A and publicity costs.
  8. 8. Eighth, the rest of the money goes to a collection account manager (CAM), who takes its commission and expenses for administering the collection account on behalf of beneficiaries.
  9. 9. Ninth, the sales agents are paid their sales commissions (usually 5%-35% of gross receipts) and expenses;
  10. 10. Tenth, Interest on production costs is typically recouped before production costs (debt is paid first, then equity investor is paid).
  11. 11. Eleventh, production loans are paid.
  12. 12. Twelfth, equity investors are paid their equity investments.
  13. 13. Thirteenth, deferred fees and bonuses are paid to talent.
  14. 14. Fourteenth, completion guarantor recoups any amounts advanced towards the production under a completion bond;
  15. 15. Fifteenth, at this point the net profits are reached. The film may be said to have reached its break-even point. The net profits are divided between the producers and financiers. The talent is paid their net profit participations from the producer pool. The investors share in the investor pool, pro rata.