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

Hello. Welcome to Seven Thoughts, and what has become one of the most widely read articles on film financing on the planet. Thank you for attending. I’m Lee Rudnicki, an entertainment lawyer and producer based in LA and Italy.

First, a legal disclaimer:

DISCLAIMER.  This is a simple guide to a complicated topic, and it involves state and federal law. This 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 or you will could make huge expensive mistakes.

Still here? Cool, grazie.

Here we go!

Private Equity – In Plain English.

The first time a new producer gets in a discussion about raising money for a movie, the phrase that usually throws him/her out of their game 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 into a sea of meaningless jibber-jabber.

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

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

My point is, if you’re raising money for a film, you’re typically searching for equity investors. Uncle Bob, get out the checkbook.

How NOT to raise money.

One way “not” to raise money for your film, is to run around LA with a script and attachment letters and start taking money from random people. Worse yet, take out newspaper ads for investors. 

This can all physically be done, but the potential downside of a mistake 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 legal counsel, you’re probably going to assemble documentation that is commonly called a “private placement memorandum.”

Aka, a PPM.  Remember the acronym, PPM.

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

If properly drafted, a PPM will be highly customized to your motion picture, and it will give your 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 to appreciate about Hollywood, but perfect financial predictability for a specific film that is not even shot yet, is not one of them.  But – your investors will have confidence that your project is built to succeed, and that the deal terms 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 your 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. What is the “most” money you want to make your movie? And the answer to that question is NOT a trillion. 

You specify a maximum budget for many reasons, but #1, is that doing so protects the investors from having their investment diluted.

Making the example even more 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.  

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

Ahhh, but I digress. Anyway —

Let’s Say…

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 start spending the money in accordance with the minimum budget, because you know with 100% certainty you can finish the film. You can keep trying to raise money to hit the max 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 will invest $100,000. Thus, you need 8 investors to sign a PPM and invest before you are allowed to touch the money. If you don’t hit $800k, the money gets returned to the investors.

Now, you may have a development fund or other ways to finance development of the film until green light.  

But 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 spend all of the money on “location scouting” in Italy, and then have no idea how to make a film.  If you spend any of their money, they get a movie.

Quick Caveat.

There may also be a completion bond in play, aka an insurance policy that ensures you will finish your movie, including all sorts of ugly but standard legal mechanisms to ensure it gets done, one way or another.

That’s beyond the scope of this article.

$$$ The Waterfall $$$$

Let’s assume you successfully raised the money, and your PPM documentation is compliant with all applicable state and federal laws.

Rock-n-Roll.

[insert your successful shoot and post-production here]

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 gets paid back, plus a Premium

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

Your investors get paid back. 

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 indie film, where nothing concerning any given film is predictable and risk is an inherent part of the game, investors are typically offered a high rate of return. This can be as low as 5-10%, or as 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. Generally, a 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, is simple.

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 $500k actor fee, then commit to pay another $500k (or more) as a “deferment.”

On its face, this seems like a great idea, because it 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 problem, as you will see next, Step #3 in the financial waterfall are “net profits.” By adding Step #2 deferments, everyone’s net profits in Step #3 are diluted and pushed back in time, if not killed off completely in dramatic fashion.

Problem #2, a lazy or desperate producer may hand out deferments on a movie to everybody and their brother, and inadvertently kill everyone’s net profits in the process. Including his/her/their own.

Accordingly, my preferred financial structure, is to eliminate deferments entirely. Do not use. Kick them out. Bye. Sayonara. Ciao.

Getting rid of the concept of deferments enables you to confidently make certain legal representations to your investors and production team, as you will see below, which will make everyone and their brother very happy.

AND — as a bonus — your financial waterfall becomes transparent, simple, and crystal clear. And easy to explain to everybody.

On the downside.

You have to make your movie for the money you actually have.

Which isn’t really a downside.

In short, eliminating financial deferments on a motion picture transforms net profits from imaginary carrots in a contract … to a potentially valuable financial interest.

Step 3 – Net Profits.

The third and final step in the financial waterfall are what I will call net profits for our purposes here.  

Simply put, at this level, the money gets split into half.

One half (50%) of the “net profits” go to your equity investors, split pro rata, in relation to their investment.  Rarely, the investor side gets more than 50%

One half (50%) of all net profits goes to your producers.

KEP CONCEPT #1 – All net profits (aka “points”) that go to actors, writers, cinematographers etc., come from the producer’s 50%. Thus, Producers are inherently motivated NOT to give out net profits to other people (i.e., because they keep what remains from that 50% for themselves)

KEY CONCEPT #2 – A great reason to give someone net profits in a movie is to keep them engaged throughout the life span of the film. Even if their work is complete, it will always be in their best interest for your movie to succeed. Think about that.

Key Concept – Naming Contingent Compensation.

There are many, many different ways to name and/or define contingent compensation on a movie. For purposes of this article, I will keep it simple (net profits). But these “points” can be called net profits, adjusted gross profits, gross profits, producer’s points, and all sorts of wacky derivative names.

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 can be multiple levels and multiple 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, it is possible that everyone on a film may have a different definition of contingent compensation in their contract.

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

In Hollywood … all financial definitions, all deferments, every contingent compensation payment of every kind in the history of movies… only means what your contract says it means.

That’s a very important concept, and when I teach, I stress it each and every class. Unless there is some sort of underlying collective bargaining agreement or other controlling document that defines the contract terms, the contract stands on their own. And in terms of Hollywood contingent compensation, the contract states the rules of the game, so to speak, nothing else. SAG-AFTRA is not going to define net profits for a producer.

FACT – When someone offers you 5% net profits on a movie, you have no idea whatsoever the offer is, unless and until you can look at the contact definitions.

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. On the other hand, that same 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. Contingent compensation numbers don’t mean anything out of context of a contract, and the terms used to describe your contingent compensation don’t mean anything out of context of the contract. In Hollywood profit land, the contract defines and determines everything.

Forget this at your peril.

WATERFALL – Quick Review.

STEP ONE – Investors get paid back + a Premium

STEP TWO – PROFIT SPLIT.
Investors get 50% of net profits; Producers get 50%

If you keep the structure, you can tell investors: (A) You will get paid back from dollar one, plus a premium; and (B) the calculation of your profit is 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 knowing your financial waterfall is transparent and simple, and that mysterious Hollywood bullshit accounting mechanisms like deferments, do not exist on your movie.

And Finally.

Please remember, cats, 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.

Thanks for reading – Ciao!

Lee Rudnicki

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