MAY 2002







In his annual article for the Cannes Film Festival,
Greg Bernstein analyzes the state of film financing

Greg S. Bernstein

For the past couple of years it seems as if all we talk about is how bad the financing for U.S. indie films has become. Doesn’t anyone have anything positive to say?  Well, maybe I have a little to say on the subject.  But, the fact is, that for various reasons, the financing for indie films has gotten worse and worse and worse. Seems that every time we think we see the bottom of this indie financing and sales pit we are in, someone digs the hole even deeper.

At first it was the over supply of product created as a result of the “easy money” that existed in the period 1997-1999. But, I am not sure if everyone really appreciates how significant this increase in production was and what impact, given the laws of supply and demand, it had, and stills has, on film financing and sales today.  

One trade publication that compiles a list of “debuting” films before each market showed that for the 1996 AFM there were 851 films debuting.  By AFM 2000, this number had climbed to 1148!  That is a 35% increase in product.  When OPEC decreases production to increase prices its usually only a 5% increase or decrease that causes a big jump in the market! And unlike OPEC, where changes in production are seen in the marketplace in a matter of months, the constriction in film financing and/or sales that ultimately decreases film production takes a year to eighteen months to be felt. Given that this constriction did not start until late 1999, and the films that had been “greenlit” by then were just going into production and would not reach the marketplace until the end of 2000 or early 2001, the affects of the glut and reduction in production is only now being seen in the market.  Thus, for the AFM 2002 there were still 993 films allegedly debuting at AFM despite over 18 months of contraction and retrenchment.  This is still a 17% over supply of films, not even taking into account decreased demand.

    Yes, not only was there an oversupply, but demand has been falling at the same time. So as fast as the market constricted financing and less films were being made, the market shrunk requiring an even greater decrease in production.  This decrease in demand was a result of further fall off in the world video market, but mainly the result of changes in the programming needs of the world’s television markets.  Many markets that used to rely heavily on US films for programming, are now shifting to more indigenous programs and reality shows.  Viewer tastes changed.  To make matters worse, we have turmoil or limited competition in such major television markets as Germany, Spain and Italy, which has further eroded buying and prices. 

    Isn’t it ironic that just over a year ago one would not even have given the likelihood of a German or Italian presale a second thought. It was a given. It was the cornerstone to any indie film finance strategy.  Yet, we all know that such presales today are very difficult. I recently had a project that is going into production with every major territory of the world pre-sold,  except Germany and Italy.  And even if you find such a presale, what is the likelihood that the buyer will be solvent when you are ready for delivery?

    Similarly, over the past few years, with sales becoming tighter and prices falling, gap financing as become tighter too, falling from a 1998 standard of about 50% to a 2002 standard of about 20%. With rapidly changing markets, prices, buyers and demand, the banks just don’t want to take the risks that they used to take.

So, given the cornerstones of film financing, German and Italian pre-sales, being virtually nonexistent, the US majors being very cautious in prebuying any film, and gap financing only at 20%, how does one, today, get an independent film financed?

    First, unlike years ago when most films all fit the same film finance mold, today each film is truly unique and no two films can be financed exactly the same.  Unquestionably,  non-genre films (drama, comedy, artsy, etc) are virtually impossible to be funded without one hundred percent equity or quasi equity financing. Modest budget genre films(US$10 to US$30 million), on the other hand,  will find a combination of presales (yes they are still doable in a number of territories including Japan, UK and France), equity, quasi equity (soft money) and traditional gap financing to be the most successful financing formula.  Low budget genre films may have to rely on a greater proportion of equity but again, some combination of presales, equity, quasi equity and traditional gap financing will be the likely prescription. A typical finance recipe for a modestly budgeted thriller (say US$10 million budget) might be 20% presales, 20% gap, 35% German equity funds, 10% UK sale leaseback and 15% Luxembourg credits.

    With 60% of the financing likely coming from equity or quasi equity, clearly these sources of financing have become the new cornerstones of financing indie films today.

    Equity, or cash investment, is an absolute requirement to finance any film today.  Equity may take the form of cash from the producer, or an investor (which may be a co-production partner, a distributor or a true investor), or, as has been the biggest source the last couple of years, German equity funds.

    Despite much press on the collapse of the Neuer market and the high flying companies it brought us, German equity funds still exist and are still accessible. The reason they still exist is that they are, after all, tax shelters at the end of the day, meaning that investment funds are available because of the investor’s need to reduce his or her tax obligation.  Since tax shelters, by definition, are providing a return to investors from the tax savings generated by the investment, regardless of the actual performance of the film, investors are not necessarily concerned with the financial results.  That said, its not quite the same game it was even a year ago.  Many of the German funds are having difficulty completing their investment raises, given prior economic results, lackluster stock market performance, investors having less income to shelter, and general world economic malaise.  Understandably, most German funds are now more selective as to the films in which they invest and the producers to which they partner. Further, all funds now require a greater guaranteed return (in the 65% to 80% range rather than the 50% range of just a couple years ago), not to mention satisfactory collateral to back up the guarantee.  

For those not familiar with most German fund investments, the funds usually invest an amount equal to 100% of the budget of a film, but require a guaranteed return of anywhere from 60% to 80% of the investment.  Moreover, the guaranteed return must be secured by a letter of credit, presales or other collateral.  Assuming that the fund required only a 65% guaranteed return, a producer could take 65% of the investment and set it aside in a bank account to collateralize the repayment obligation, leaving a net investment available for production equal to 35% of the film’s budget.  

But this still leaves 65% of the budget yet to be financed.   Since presales and gap financing should finance another 40% to 50%, the producer will usually find themselves still short by 15% to 25%.  This is where soft money benefits come in.  Current centers of soft money contribution are the UK, Canada and Luxembourg, although the Isle of Mann, Netherlands and Ireland have accessible programs.  Also, the benefits from several jurisdictions can be aggregated.

There is no question that the UK sale-leaseback has become the most frequent source of soft money financing.  The value which can be derived from a UK sale-leaseback varies from 8-12% of the budget, depending upon the supply (of films seeking these funds) and demand (of tax investment capital).  In the current market, as I’m writing this article, the rate is 10 ½ % of the budget.  Access to a UK sale-leaseback requires a significant UK (or Euro or co-production combination) spend.  Obviously a film being shot in the UK is a likely candidate, but because of co-production treaties, a film shot in Europe, Canada or elsewhere might qualify if as little as 20% (10% in some jurisdictions) were spent on UK residents (such as for post production or on UK residents as cast and crew).  

    Shooting in Luxembourg can provide a benefit of about 15% of the budget.  Ireland, about 12%.  The Isle of Mann can provide benefits ranging from 20%-60%, depending upon the budget and what benefits are being accessed (the Isle of Mann has a number of programs, some of which take the form of subsidies and others are actual cash investments). 

Its relatively easy to combine a European benefit (say Luxembourg) with a UK sale leaseback to bring the total benefit to around 25%. However, keep in mind that the more complex the transaction, the more costly it is to derive the needed benefit and the longer it takes.  Inter-jurisdictional issues can also hamper the transaction.  For example, if the German’s want ownership of the copyright to qualify for their tax benefits and you need to vest the copyright in the UK to access the UK benefits, what happens?  Not insurmountable but definitely complex.  Also, it is generally more expensive to shoot in Europe than in the United States when such factors as exchange rates, cost of living and travel costs for key actors and crew are taken into consideration.  Except for the UK sale leaseback, its usually not cost effective for films with budgets under US$5 million to attempt to access most of these benefits.

Which leads to what many in the United States are calling runaway production.  Namely, films leaving Los Angeles and New York to shoot in Canada.

With its common language, favorable exchange rates, lower cost of doing business, substantial film infrastructure, relative minor additional location costs and more friendly business environment, even without government financial incentives, it is an attractive destination for film production.  But with the added bonus of  financing 10% of your budget just for shooting there, plus probably another 10% in terms of cost savings alone over places like LA or NY, and even  higher benefits available if one the production can avail itself of the “content” benefits, given how difficult it is to find that last 10% to 20% of a film’s financing, its not a surprise that Canada leads the pack in indie film production.  So is it any surprise that most US telefilms (cable or network), as well as a majority of indie films with production budgets over US$1 million, are shot in Canada.  

    And yes, its even possible, through qualified co-productions, to combine Canadian benefits with other benefits, such as a UK/Canadian co-production which can garner a 25% budget benefit, in exchange for compliance with very stringent content rules.

    So how does that US$10 million budgeted thriller get made using these various current financing methods?  If shot in Luxembourg with the post in the UK and financed with  German film funds, with sufficient name cast to garner a few presales and support the gap estimates, the following would be plausible:

(a)    Pre-sales-$2.0 million.
(b)    Bank GAP financing-$2.0 million.
(c)    UK sale-leaseback proceeds-$1.0 million.
(d)    German Equity funds (net benefit)-$3.5 million.
(e)    Luxembourg tax shelter benefits = $1.5 million.

    The same principals that are outlined above with respect to a $10 million feature can also equally apply to a $1.2 million feature. However, at the lower budget level, the cost of accessing European benefits becomes prohibitive. On the other hand, its likely that the presales will be a larger portion of the budget since its easier to pull together a number of smaller sales, say $300,000. With Canadian benefits of $250,000 (assuming content), plus gap financing of $250,000 and net German or other equity funding of $400,000, you are there.

So pack your bags, smile for the passport photo, brush up on your German and French and stock up on the Valium and Rogaine, but with some patience, creativity and luck, your UK-Canadian-British-Luxembourg-German-French co-production of that action - coming of age - romance about corruption in the LAPD you have been dying to make is just a Shilling throw’s away.    



Reprinted with permission by The Business of Film

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