A simple guide to financing an independent film with private equity.

Hello. Welcome to Seven Thoughts, and welcome to what has [somehow] become one of the most widely read articles on film financing on the planet. It’s nice to see you here. My name is Lee Rudnicki, I’m an entertainment lawyer and producer based in LA, and sometimes, Italy.

First things first — thank you for attending.

And to those of you who have been to Seven Thoughts before and have become fans of one sort or another, thank you x 7 for your many emails and kind words. I appreciate it.

Finally, a quick legal disclaimer:

DISCLAIMER.  This is a simplified guide to a very complicated topic, and it involves both state and federal law. This article is not legal advice to anyone under any circumstances. There are a million different ways to structure the financing of an independent film, this is but one, and a simplified guide at that. These concepts will not work for everyone, nor every film. If you’re going to raise money for a film, you must hire a qualified attorney.

Still here? Bravo. Here we go.

Private Equity – In Plain English.

The first time a new producer sits in on a discussion about raising money for a movie, the phrase that usually throws him/her out of their game immediately, is ‘private equity.’ 

For whatever reason, most people coming into movie world have no idea what “private equity” means, and if you don’t, it can turn a discussion of financing a film into a sea of meaningless jibber-jabber.

Simply put, in the world of independent film, “private equity” usually means a financial investment in your movie. Aka somebody gives you money. There can be other contributions besides money, but let’s keep it simple for now.

If your Uncle Bob invests $10,000 in your movie, Uncle Bob becomes an equity investor in your movie. In exchange, Uncle Bob will get paid back from the profits, he’ll probably get a credit in your film, maybe executive producer or whatever, and he’ll get one form or another of “contingent compensation” from the profits of your movie, if any.  More on that in a second. 

The point is, if you’re raising money for a film, you’re typically going to be searching for, and acquiring, equity investors. Uncle Bob, get out the checkbook.

How Not to do it.

One way “not” to raise money for your film, is to run around your town with a script and attachment letters and start taking money from people. Worse yet, take out newspaper ads for investors. This physically can be done, but the potential downside is jail.

Read that 2x.

The penalties for violating securities laws when raising money for a movie can be criminal, as well as civil. Accordingly, as fun and exciting as it may be to treat movie money like the wild west, it is not advisable. You can find money for a film in a million different ways and places. But lawyers can only participate in film financing situations that comply with state and federal laws.

And so should you.

Raise the Money.

If you want to raise money for your movie in the United States via private equity investors, and you have competent counsel, you’re probably going to assemble documentation that is commonly called a “private placement memorandum.”

Aka, a PPM.  Remember this acronym. PPM.

A PPM is simply a collection of documentation that explains your movie, your team, and the film industry to investors. 

If properly drafted, your PPM will be highly customized to your movie, and it will give investors confidence and a solid understanding of your project, and the financial structure. They will not receive a guarantee that they will make money – there are many great things about the movies, but perfect financial predictability is not one of them.  But they will have confidence that your film project is built to succeed, and that all financial aspects are fair, clear and transparent.

My PPM will include items such as state and federal required investor notices, investment risk factors, professional bios of key producers and production team, cast attachments, a production timeline, a script synopsis, chain of title analysis, a director’s statement, description and updated description of the film business, offering information, use of proceeds, accounting information and most importantly, a clear financial map.

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Typically, when raising money through a PPM, I advise producers to structure it as a so-called mini-maxi.

First, we devise a minimum budget, which is the lowest budget that you still know with 100% certainty you can finish and deliver your film.  

Second, we arrive at a maximum budget.  And the answer to the question is not a trillion. The reason that you specify a maximum budget, is because it protects investors from having their investment diluted.

Making the example ridiculous, a $100,000 investment in a $100,000 film that does great in the box office, will result in original investor happiness. 

A $100,000 investment in a $100,000 film that accidentally becomes a project with a $10 million budget because a studio falls in love with it, will not result in original investor happiness, because his/her slice of the pie is suddenly tiny. Maybe their pie disappears …. because no one has ever recouped $10 million from a black and white seven-hour long animated art film that stars a depressed pencil who learns to speak Apache and kicks dogs.  

Or maybe it suddenly becomes an award-winning six-episode season on Netflix. Which is genius.

Ahhh, but I digress. Anyway —

Let’s assume you calculated the minimum/maximum budget, and you legally and properly launched a PPM.

Now, as you raise funds for your film, the money goes into an escrow account.

This money in escrow can NOT be touched unless and until you raise the specified minimum budget.

Once you raise the minimum budget, green light! 

You can start spending the money in accordance with the minimum budget, because you know with 100% certainty that you can finish the film. You can keep trying to raise money to hit the maximum budget, but you don’t have to.

So, let’s say your film has a minimum budget of $800,000, and a maximum of $1.5 million. And let’s say each investor you find will invest $100,000. Thus, you need eight investors to sign a PPM and invest before you are allowed to touch the money. If you don’t hit $800,000, the money goes back to the investors.

Now, you may have a development fund or other ways to finance development of the film until green light.  But the PPM money can not be touched under any circumstances, unless and until you hit the minimum budget.  This assures investor #1, for example, that you’re not going to run out and spend their money on location scouting in Bermuda, and then have no idea how to make the film.  If you spend “any” of their money, they get a film.

As an aside, there may also be a completion bond in play, which is a fancy phrase for an insurance policy that ensures you will finish the movie (including ugly legal mechanisms to ensure completion).  That’s beyond the scope of this article.

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We Raised the Money, Shot the Film. Now What?

Let’s assume you successfully raised the money for your film, and your PPM documentation is compliant with all applicable state and federal laws. Rock-n-Roll.

Next, “how” the money will return to you after the film is sold, licensed, put in theaters, on TV etc, is commonly called a financial waterfall in Hollywood. 

Or more simply, the “waterfall.”

To keep this simple, let’s assume there are no bank loans, and your movie is fully financed by private equity. Uncle Bob and his pals went nuts. Grazie, Uncle Bob.

Step 1 – Investor get paid back + a Premium.

The first step of the equity waterfall, is a basic principle.

Your investors get paid back first.  They also get what you want to call “interest,” but what is typically called a “premium” on their investment.

In a normal low risk real world venture, investors typically get a low but predictable rate of return.

In movie land, where nothing is predictable and borderline-insane risk is an inherent part of the game, investors are typically offered a very high rate of return. This can be as low as 5-10%, but it can be a high as 35% (ouch).

The rationale behind offering a huge premium to investors, is to acknowledge and reward the fact that an investment in an independent film is an inherently risky venture. In fact, the only generally accepted manner in which to make investing in film a somewhat predictable commercial enterprise, is to invest in slate. Then, the one film out of 12 (or worse) that makes a profit, will more than pay for the 11 flops. These metrics are the primary reason why movie studios do not fail. When a movie on a slate hits, it hits big all over the world, the adjoining flops are a tax write off.

Step 2 – Deferments (Bad Idea).

Simply put, deferments are a tool for a producer to get a movie into production, with less money than he/she actually needs.

The way it works is, for example, if Tom the Actor commands $1 million fee per film, but you only have $500,000 to hire Tom, you might pay Tom a $500,000 actor fee, then another $500,000 (or more) as a “deferment.”

On its face, this seems like a great idea, because it seemingly doesn’t hurt anybody, the deferment is “free,” and at the end of the day, investors get paid back before anyone gets paid their deferment anyway. Yay team. What a genius idea.

Not so fast, cats. 

Two problems.

First, as you will see, Step #3 in the waterfall are “net profits.” By adding Step #2 deferments, everyone’s net profits are diluted and pushed back in time, if not killed off.

The second problem is that a lazy producer may hand out deferments like candy, and inadvertently kill everyone’s net profits in the process.

Accordingly, my preferred financial structure, is to eliminate deferments entirely. Ciao.

This enables the producers to make certain representations to investors and production team, as you will see below. And — as a bonus — if you kill deferments, your financial waterfall becomes transparent, simple, and crystal clear to investors. On the downside, you have to make a movie for the financing that you actually have. Which isn’t really a downside.

In short, killing off deferments transforms net profits from nonsensical carrots in a contract … to a potentially valuable financial interest in a motion picture.

Step 3 – Net Profits.

The third and final step in the waterfall are what I call net profits.  Simply put, at this level, the net profits get split into half. One half (50%) of all net profits go to the investors, split among them pro rata, in relation to their investment. And one half (50%) of all net profits go to the producers.

SAFETY TIP – All net profits (aka “points”) that go to actors, writers, cinematographers etc., come from the producer’s side.

That is why producers are motivated “not” to give out net profits. On the other hand, giving people contingent compensation is a strong motivation to keep them engaged throughout the entire life span of a film.

Important Concept – Naming Contingent Compensation.

There are 101 different ways to name and/or define contingent compensation on a movie. It can be called net profits, adjusted gross profits, gross profits etc.

Furthermore, the definition of net profits can be a short as one sentence, or 10 pages or more, depending on the studio and the contract. There may also be multiple levels and different profit definitions. If you are on a film with Spielberg, the definition of contingent compensation in your contract is probably going to differ from Steven’s, no?

Point of fact, everyone on a film may have a different definition of contingent compensation.

It is a fair and reasonable conclusion from the preceding sentence that the film industry is insane, and film accountants are definitely not from this planet. However, if you remember one simple concept, it will help you navigate the film world —

In film contracts, the financial definitions only mean what the contract says they mean

Ponder this – a good film attorney can draft a contract that will give you .01% net profits, and the contract will make you insanely rich if the film hits big. On the other hand, that same film attorney can draft a contract that will give you 25% so-called ‘gross’ profits, but ensure you will never see a dime, even if the film makes $100 million at the box office. 

The point is not to suggest berserk renegade contract drafting, but rather that you absolutely can not know what ANY contingent compensation numbers mean in a contract–until and unless a lawyer or other qualified professional takes a good look at your contract and the definitions contained therein. Don’t get fooled by Hollywood smoke and mirrors.

Review.

In summation, the financial waterfall that I recommend for independent film is the following

First – Investors get paid back + a Premium

Second – Investors get 50% of the net profits; and Producers get 50%

If you keep the structure as described above, you will you be able to tell investors that: (A) You will get paid back from dollar one, plus a premium on your money; and (B) the calculation of your profit is exactly the same as every other person on the film, including every producer and the director

Now, there is a lot more to the presentation, of course.

But, if you do this correctly, your investors will feel secure in the knowledge that your financial waterfall is transparent and simple, and that mysterious Hollywood accounting mechanisms like deferments, do not exist on your movie.

And Finally.

Please remember, this is not legal advice. This is a simple article to explain basic concepts, and my approach to independent film financing. There are many concepts and facets of the discussion that are not present here.

I have 20 years of experience in entertainment law, and I work on film and television productions all over the world, as lawyer and producer. If you need a PPM or production lawyer for your movie, please visit my law firm website and drop me an email. I will be happy to set up a no-cost consultation, to see if I can help you.

Thanks for reading – Ciao!

Lee Rudnicki

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