Disclaimer – This is a plain-English commentary on the general revenue “waterfall” on a independent film. This is not legal advice to anyone under any circumstances, nor is it commentary on any specific film.
Still here? Okay, here we go.
CONCEPT #1 – If you are considering producing or investing in an independent film, it’s important that you understand as much as you can about this unique business model, especially in regards to how the money works.
To jump into the film business blind, and assume the financial model that applies to real life also applies to film — to “not” understand the rules of the game you’re trying to play — is to doom your film to chaos, bad decisions, and surprises along the way as a result of poor planning.
As a producer, you must understand the financial model AND be able to explain it to potential investors, or forget it.
Solution? Educate yourself.
There are a lot of great books on the market by very good lawyers and producers — grab four or five and dive in. The more you know, the easier your journey into the motion picture world will be.
As a small starting point, let’s take a look at the very end of the game. What happens with the money your movie makes in the theaters, from DVD sales, Netflix, HBO etc. AFTER the distributors and sales agents have taken their fees and expenses. Your horror movie is out in the world, and here comes the money back to your production company.
Generally speaking, now what?
STEP 1 — Your Investors get paid back. No money goes to anyone else unless and until the investors get paid back in proportion to their investment. If your budget was 200k, and Sally Smith invested 100k, Sally gets 50% of the money that comes in at this stage of the game.
After the investors are paid back —
STEP 2 — Your Investors get paid a “premium.”
Put simply, your investors get paid back and then some, usually a percentage of their investment. The percentage varies, but due to the risk in investing in film, producers sometimes treat this like the Wild West, offering percentage returns as high as 35-40% or more as additional incentive.
After the investors are paid back + their premium —
STEP 3 — Deferments are Paid (if any).
This step may or may not exist, depending on the project.
What is a deferment? It is basically a tool for producers to bring in crew or talent when they can not afford to pay at their usual rate.
So, for example — you might hire a Director, offer them a $ 25,000 fee plus a $ 25,000 deferment. Which means they get $25k in the normal course of production, and they get the second 25k ONLY if the Investors recoup in Steps 1 and 2. Accordingly, accepting a deferment as a portion of your compensation is a movie industry lottery ticket of sorts — it may not happen. And if the film doesn’t make enough money to pay your deferment, there is no liability on the part of the production company. Aka you’re out of luck. One good side of deferments? They get people more interested in the future success of the film.
Once the Deferments are paid (if any) —
STEP 4 – Contingent Compensation
Again, every deal is different, but generally, as this stage of the game, the money that gets this far down the financial waterfall, it is split in half, 50-50.
Depending on the agreement, this compensation can be called “Net Profits” or “Distributable Cash” or “Contingent Compensation” or maybe even “Adjusted Gross Profits.” Producers and agents may use the word “points” as they sip a martini. Don’t worry about what term is used, look at the contract.
Why? Unlike real life, in a film contract, the financial definitions only mean what that particular contract says they mean. For purposes of this article, we’ll call the money that gets this far down the “waterfall” the Distributable Cash.
Fifty Percent (50%) of the Distributable Cash gets paid to the happy-happy Investors. This the so-called “Investor’s Half.” The economic reality of the business model means that investors may not see Distributable Cash. But when they do, it can be epic, and potentially involves stupid amounts of money and a hangover.
Fifty Percent (50%) of the Distributable Cash gets paid to the Producers. The so-called producer’s half.
Really? Genius! Oh wait. Everyone other than the investors get their percentages of Distributable Cash paid out of the Producer’s half. And to close the deals, you had to give 10% to a famous actor, 5% to another actor, 10% to the director, 5% to the Writer. Got money?
WARNING — This model above is simple. However, there can be many different definitions and “levels” of contingent compensation on any given film. The higher the budget, the more likely it is that the financial definitions are varied and complex.
You’re a co-producer of a horror film, and you have been offered “5% NET PROFITS“.
Is that good?
FUN FACT#1 – You don’t know, nor does your lawyer until he/she looks at the contract. You must review the definition of “Net Profits” in your contract to know anything (literally) about those five “points.” Your profit definition may be amazing. It can also make your receipt of money from your “points” about as likely as the Cleveland Browns winning the next World Cup.
STRATEGY – There is a concept in transactional law called “most-favored-nations,” MFN for short. Basically MFN is a creative tool for comparing a contract term to that of the other cast or crew on the film, to ensure you get no less favorable treatment.
So, for example. As your lawyer, I’m going to ask for 5% net profits, calculated, defined and paid on an MFN basis with the producers of the picture. There is more to the contract language etc., but suffice it to say, the concept is to tie your profit definition to the key players on the film, and you know the producers are not going to have a crappy definition of net profits in their contracts (they created it).
The concept can work relative to the director or a specific cast member’s agreement (or all cast members, for that matters). On a low budget simple film, everyone often has the same definition, so no one will care if you cask for MFN status. On a big picture, asking for MFN status compared to the star may cause drama, a screaming agent and the mobilization of the National Guard. As an aside, the MFN concept works with pretty much everything — per diem, housing situation, days off etc.
SAFETY TIP – As a producer, you need to keep good records if you use the MFN tool, as it can backfire and suddenly make production expensive if you lose track and have to change deal terms later.
A FINAL WORD – AUDIT RIGHTS —
If you are getting contingent compensation on a movie of any kind — Distributable Cash, Net Profits, whatever it is called — you MUST have audit rights provision in your contract, aka the right to inspect and review the financial records involving your movie.
If you leave this provision out, you have no contractual right to inspect the books concerning the money your movie made. Read that 2x.
Here a general out-of-context example of an audit provision:
Audits. A certified public accountant on Producer’s behalf may, at Producer’s expense, no more frequently than one each year, examine the Distributor’s books and records regarding the Picture, during Distributor’s usual business hours and upon reasonable notice, solely for the purpose of verifying the accuracy of any Statement rendered hereunder. Producer may not examine Distributor’s books or royalty records relating to a specific accounting period more than once. Each Statement shall be binding upon Producer and not subject to any objection for any reason unless specific written objection is furnished to Distributor by Producer within two (2) years after the date that Statement is rendered.
Btw, although this is a critical provision, many companies don’t put this in the agreement by default.
If you don’t ask for it, it will not appear. Then, the only way to audit the distributors book’s without them doing so just to be nice (will not happen) is to file a lawsuit and go through the not-so-happy process of discovery. I was an entertainment litigator back in the day, I can tell you this is not a fun process for a producer. Get the audit rights in the deal.
Please remember, every deal is different. This article is just a brief general discussion, you can and should read books on the topic and get as much experience and knowledge as you can.
Lee Rudnicki is a Los Angeles-based entertainment lawyer, producer and writer. For information on his law practice, visit The Rudnicki Law Group.