MAY 1999





Financing Of Independent Films For The


There is only a certain recoupable value in the marketplace today,
so make a film that fits that pricing.
If the film cannot be made for less, find another film.

Greg S. Bernstein

If 1997 was the year of gap financing and 1998 was the year of gap insurance financing for independent films, given the year so far, is 1999 going to be the year of apocalypse for the Indies? If so, will the year 2000 he the industry's rebirth?

1999 is not looking too good for independent producers, banks, insurance companies or sales agents who are in the business of independent films. There was hope that this past AFM would see an improvement in sales in distressed territories and an up tick in prices and prebuys from the key buyers. Such was clearly not the case. The pessimistic optimism of the past year is now giving way to gloom and doom as bankers see more films not "cover the gap," insurance companies start to have calls made on the first policies they issued about a year or so ago, sales agents, having deferred their fees and expenses to recoupment by the banks and insurance companies, now find themselves with no money to operate, and producers find the options lapsing on their latest projects, having been unable to pull the financing together to get the film into production. At the end of AFM, hope turned to Cannes for deliverance.

As we begin this 1999 Cannes Market, the situation is likely to turn worse, not better. The oversupply of certain product (films with a budget value under $5,000,000 that, despite their promotion, are in all likelihood non-theatrical films in the United States) has caused much of the pricing and presale problems, and this problem is not likely to diminish in the near future. The glut of product that existed about a year or so ago is now complimented by the additional product entering the market; product that commenced production about a year to 18 months ago during the heyday of gap financing. As such, it is not likely that prices or purchases will rebound any time soon in Europe, nor will the Asian, Australian or Latin American markets find themselves anywhere near the pricing and purchasing of a few years ago, despite some rebound in their local economies. The fact is that most buyers can have their pick of any number of films, all with similar name cast, to adequately fill those timeslots that they seek to fill in their schedules.

The biggest fallout is yet to come as, ironically, a result of the bank and insurance company policies that were a cornerstone of gap financing. I am speaking of the policy of having sales agents defer most of their fees and expenses until the bank/insurance company was recouped in order to provide an incentive for the agent to provide honest estimates. While the rationale for the policy was sound at the time, the unforeseen product glut and downturn in certain economies has put the sales agent in the unfortunate position of not having funds to operate. Caught in a "Catch 22," many sales agents cannot afford to market the very same films that they need to sell to allow the banks and insurance companies to recoup their investments. The fallout of sales agents is just beginning. This coming catastrophe will place many more films and productions in jeopardy while sales agents try to keep themselves afloat and/or fall by the wayside.

The good news (yes, this is good news) is that the banks and insurance companies are financing drastically fewer films. As the total value of presales has been falling, the banks have been increasing the percentage of a film's budget that must he covered by presales (previously averaging 50% and now averaging 75%). That makes bank gap financing virtually impossible. During the past 9 months, I have seen a 90% reduction in films bank financed on a presale or gap basis.

As for gap insurance, don't get too excited. Gap insurance for single pictures is becoming as rare as 8 track tapes as insurance companies rethink their strategies, producers consider the cost of such programs and sales agents come to grips with the practical viability of the estimates needed to support such loans. (Gap insurance on single picture financings comes at a cost that is not realistic given the current marketplace for motion pictures. The gap insurance finance transaction can shoot the production cost up anywhere from 25% to 50% over the budget for a typical bank-financed gap loan. The variance depends on the size of the gap. Given the realities of the marketplace, namely that many films today can't even repay their bank financed gap loan, let alone a budget even greater than that, most of the single picture insurance hacked transactions are doomed to failure. Further, more and more sales agents are realizing that they cannot supply estimates to support such loans nor will they take the risks of fee deferment or damage to their reputation given the reality that bank recoupment is unlikely.)

So what does an Indie producer do in 1999 to get a film financed? Unfortunately, there are not a lot of possibilities. Since the banks want coverage of about 75% and presales covering only 40% of a budget are realistically possible, few single picture loans will occur in 1999. Those that happen will likely have equity to cover 1/3 of the budget or he lower in budget than the perceived value, thereby garnering presales proportionately larger than their actual cash budget. Only through this combination will a bank's lending criteria of 75% coverage he met. To try to meet the bank's coverage ratio, a good first step is, of course, to reduce the budget to hare minimum, and then reduce it again. There is only a certain recoupable value in the marketplace today, so make a film that fits that pricing. If the film cannot he made for less, find another film. If you don't think that is possible, then get into another business, for this industry is a business. You cannot make merchandise for a cost that exceeds the expected revenue potential. Cut scenes. Cut shooting days. Shoot in territories with reduced labor or other costs. Whatever it takes. Bringing the budget down makes it possible to cover a larger portion of the cost of the film with the few presales that still exist.

One thing I have noticed is that all sales agents are not created equal. And I don't mean reputation. I mean that some agents seem to have stronger personal relations with the buyers than others. With a glut of product, every sales agent has the same product at the same price. Some agents make the sales and some don't, usually because of the personal relation. Find the sales agent that has relations with key buyers to get those remaining presales. As previously noted, in today's market, these presales will likely cover about 40% or so of a typical Indie budget. However, if the budget is reduced, say by 25% (which is more than possible by a savvy, and hungry, producer), those same presales now cover more than 50% of the budget.

In order to meet the current bank requirement of covering about 75% of a budget, at which point the bank will cover the balance of the budget on a gap basis, another 2 5-30% of the budget needs to he covered by equity or a U.S. prebuy. With the U.S. average cable/video prebuy hovering between 25% and 30%, the possibility of getting the film off the ground is now in the realm of possibility. Once again, relationships, either your own or by partnering with one who has the relationships, will make the deal.

Insofar as finding equity, luck is the key. Given that one cannot count on luck, especially today, the alternative is to take advantage of financial incentives offered by several jurisdictions. There are subsidies, grants and tax advantaged programs in countries like Canada, Ireland, Luxembourg and Australia, to name a few. These countries provide financial incentives, some of which require production in their country and some do not. These financial incentives can cover anywhere from 10% to 30% of a film's budget, even more in some jurisdictions. Sometimes the incentives in two jurisdictions can he combined (such as Ireland and the U.K.). Sometimes the cost of shooting in the jurisdiction outweighs the incentives, so he careful. As for insurance, insurance programs will continue to he a hot item in 1999 and into 2000, hut not on single picture financing. Insurance programs that hack equity or debt (such as Flashpoint or Destination) or bank financing of slates of films (such as Phoenix Pictures or Franchise Pictures) will become the flavor of the week as 1999 progresses. Wall Street might even join in promotion of debt and equity programs the way they promoted the Silver Screen type programs of the 1980's.

These debt and equity programs are the same insurance that guaranteed banks that they would not lose on their production loan (after a period of time if the bank did not recoup its loan from proceeds from distribution of the film, the insurance would pay any loss). In both cases, investors are ultimately looking to an insurance company for repayment of their investment (and possibly nominal interest) if the investment itself defaults. As such, investors look to see how reliable the insurance company is and the likelihood that it will he able to pay when the time comes, rather than the production company or the success of the film. Given the very limited financial risk, investors, who might otherwise find motion pictures an unattractive investment, knowing the vagaries of our industry, now find the risk, which is basically reduced to cost of money risk, acceptable, especially given today's low interest rate markets. The Destination transaction reportedly' carries a minimal interest rate of about 6.5%, which is reflective of the market's view of the low risk of the investment. Equity deals combine this low investment risk with substantial upside potential should the films he successful. This combination of low risk, high reward is very attractive to many investors. Reportedly, the Destination transaction was sold mainly to institutional investors, which is a tough group to sell an offering to when the issuer, like Destination, has no track record of its own.

The insurance companies find this form of insurance much more attractive than the single picture financing insurance. First of all, insurance companies base their risk analysis on the law of averages. A group of films, in their mind, has less overall risk than a single picture. They have determined that, historically, over a large group of films, the anticipated losses are less than the premium they are charging. (This is no different than auto insurance. There is no way to predict when someone will have an accident hut, statistically, over a large group and time, there will he so many accidents and so much in insurance payouts. Based on the insurance companies experience, they set their premiums at a level that will cover the payouts and still leave a profit.) Second, the premiums are huge and the costs of implementation and monitoring run about the same as a single film financing. Moreover, in these equity and debt insured transactions, more of the true production cost is being insured rather than a budget inflated by bank fees, interest reserves, etc. As such, there is more likelihood of recoupment of the actual investment, thereby reducing the likelihood of a call being made on the insurance.

As for the sales agent, these forms of transactions usually enable the sales agents to not only include some fee and expense reimbursements in the budgets for the films but also allows them to take an ongoing sales agency fee rather than deferring all or most of their sales fee. In addition, as the sales estimate does not need to be bulked up to cover bank charges, interest reserves and other costs, it is more likely that the film can achieve recoupment.

In summary, not much will change for the financing of a single picture until supply of Indie films falls. The decrease in bank funding and gap insurance policies, the dissolution of sales agents, and independent producers not being able to get their projects off the ground, is all part of the bloodletting process that will help reduce the supply of films. As less films are produced, the glut will be reduced. As with any other commodity, as supply falls and demand rises, prices will rise. At some point, as competition for films increases, buyers will have to return to prebuying films or lose out on product. As prebuys and prices increase, more films will return to being financed by presales and banks.

It will take some time for the glut of product to diminish but, eventually, supply and demand will equalize, with prices returning to levels that can support an appropriate production cost level. Of course, four or five years from now we will be discussing the latest calamity to befall our industry and what can be done to find a way out.



Reprinted with permission by The Business of Film

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