How to Think Like an Investor
by Mark Litwak, Esq. | Published November 14, 1999
Most filmmakers begin their careers by persuading one or more private
investors to back them. Indeed, unless you are a Kevin Costner or
a Barbra Streisand, there are limited alternatives open to you.
It is rare for a distributor to back a first-time filmmaker. Banks
will not lend you money without substantial collateral. Loans based
on pre-sales are difficult because territory buyers typically insist
on packages with name actors from a director with a track record.
That leaves most filmmakers looking to mom, dad and whatever they
can scrape up from friends, relatives and Mastercard.
While such resources have financed many a film,
nowadays the bar has been raised as to what is considered marketable.
With the glut of independent films available, most buyers won’t
even consider acquiring a film unless it 1) is shot on 35mm stock
with name-talent, or 2) wins an important film festival.
Thus, filmmakers are being forced to raise increasingly
large sums of money to produce more expensive films with name
actors. Perhaps when digitally-shot motion pictures gain wider
acceptance, production costs will decline. At the moment, however,
there is a large pool of producers chasing a small pool of bankable
actors. This competition has driven up the price of talent, even
for low-budget indie films.
As a result, the ability to woo investors has become
a critical skill—one that is not taught in film school and
is rarely discussed in industry seminars or publications. Perhaps
the best preparation for an aspiring moviemaker would be to attend
business school and learn the intricacies of high finance. Even
if you didn’t pay much attention during class, you would
graduate with a bunch of eager MBAs who several years later would
be prime candidates to invest in your films. Better yet, go to
dental school.
Of course, most moviemakers hate to even think about
fundraising. As “artists,” they would prefer that someone
else deal with the somewhat unsavory task of asking for money. Filmmakers
without a godfather, rich uncle or willing spouse are forced off
their pedestals to beat the bushes for cash. Most underestimate
how difficult it is to raise money. Joel and Ethan Coen spent an
entire year raising funds to make Blood Simple. First they produced
a slick trailer. Then they contacted everyone they knew who could
potentially invest. Many of their friends who promised to back them
didn’t come through when the time to cut the check arrived.
But the Coen brothers were shrewd networkers. Even those persons
who were unable or unwilling to invest were asked to refer them
to other prospects. Whenever they talked to someone who expressed
any interest in the project, they would visit them and exhibit their
trailer.
The Coen brothers learned that the motivation for
people to invest in film has little to do with the financial merits
of the project. As will be discussed later, film is a lousy investment.
There are no special tax breaks and the risk is tremendous.
There are many reasons people invest in film, but
the primary reason is that they are attracted to the glamour of
the film business. If you think raising money for film is difficult,
imagine trying to convince investors to back you in your cinder
block business. People invest in films because they think making
a movie will be exciting and fun. They may be turned on by the enthusiasm
and passion of the moviemaker. They might want to rub shoulders
with the “stars.” They may have a special interest in
the topic. They may seek to impress their friends by inviting them
to a screening of “their” film. They may desire an “executive
producer” credit, a role for their niece, or the worst hidden
agenda, a starring role for themselves.
Your prime prospects are middle-class professionals:
doctors, lawyers, dentists, etc. Most working-class folks can’t
afford to buy a $10,000 unit in your limited liability company.
Wealthy individuals are difficult to solicit unless you have a pre-existing
relationship with them. Moreover, the rich tend to surround themselves
with investment advisors. These gatekeepers are financially conservative
types immune to stardust. They analyze investments on strictly financial
terms, and under such criteria, movie proposals fair poorly.
The ideal investor is a doctor who makes several hundred
thousand dollars a year and has substantial assets. He can afford
to lose his entire investment in your film and the loss will not
affect his lifestyle. This year instead of going to Las Vegas for
a week and blowing ten grand, he is going to give it to you in the
hope that it will be a more entertaining venture—though he
knows it certainly won’t be less of a gamble.
Never forget that the worst type of investor, the
one that should always be avoided, is the retired schoolteacher
who invests money she needs for her retirement.
You should know that film investments have a bad reputation,
and deservedly so. There are instances where financiers have been
cheated and have lost their entire investment. Consequently, investors
who have been burned, or those who have heard horror stories about
film investments, may simply refuse to consider film-related investments.
You will need to be persuasive and have your act together if you
hope to raise funds. You need to convince prospects that film can
be an intelligent investment for a portion of their portfolio.
While film investments are risky, the potential return
from a hit can be enormous. Not only can the film earn revenue from
box office receipts, but there are many ancillary sources of income.
These sources include revenue from television, home video, merchandising,
music publishing, soundtrack albums, sequels and remakes.
As an attorney who represents both movie investors
and moviemakers, I have found that investors generally have a limited
understanding of how movies are produced, marketed and distributed.
Likewise, filmmakers often don’t understand how to structure
their proposal in a way that makes it attractive to an investor.
To give moviemakers insight into the thinking of investors,
let me offer you my checklist for investors who are contemplating
a movie investment. This checklist is designed to help investors
protect themselves from unprofessional or unscrupulous moviemakers
and distributors. It is my belief that if a moviemaker understands
the investor’s perspective, the moviemaker will be better able
to address these concerns. This checklist is condensed; the full
checklist is available on my web site: www.marklitwak.com.
So let’s look at things from the investor’s
point-of-view:
DUE DILIGENCE: Thoroughly investigate the reputation
and track record of any moviemaker with whom you contemplate doing
business. No contract can adequately protect you against a scoundrel.
Speak to moviemakers and investors who have done business with a
candidate. Check court records to see if the filmmaker or his company
has been sued.
FULL DISCLOSURE: Federal and state security laws are
designed to protect investors. Offerings to the public generally
require prior registration with the SEC or a state agency. Usually
private placements are limited to persons with whom the offeror
has a pre-existing relationship. Even if registration is not required,
the anti-fraud provisions of the security laws require that the
offeror make full disclosure of all facts that a reasonably prudent
investor would need to know when deciding whether to invest. The
information disclosed should include a detailed recitation of all
the risks involved in developing, producing and marketing a movie.
Avoid any offering that appears to violate this requirement by making
less than full and truthful disclosure.
TRACK RECORD: Do not back a moviemaker or production
team that does not possess the proven skill needed to make a professional-looking
movie. Avoid first-time filmmakers unless you are absolutely convinced
they have the ability to make a professional-looking film. You are
safer backing filmmakers who have made shorts, television movies,
commercials, music videos, or industrial films. Partner with people
of integrity who possess the skills, expertise and resources that
you lack.
IDENTIFY THE POTENTIAL MARKET FOR THE MOVIE: There
is a very limited market, and modest potential revenue, to be earned
from short films, documentaries, black-and-white films, and foreign
language pictures. Distributors and exhibitors are still prejudiced
against motion pictures shot on videotape. They prefer films shot
on 35mm stock, although quality films shot on 16mm or Super16 mm
stock can obtain distribution. Most top festivals still do not exhibit
motion pictures on videotape.
Certain themes, topics and genres can be difficult
to sell. Religiously-themed pictures can easily offend audiences.
Cerebral comedies can be difficult to export because their humor
may not translate well. Movies with a great deal of violence may
be shunned by European television, which is a prime market for independents.
Films with explicit sex may not pass censorship boards in certain
countries.
Independent films without name actors are difficult
to sell. Of course, name recognition varies around the world. The
star of an American television series may be a big name in the United
States but unknown abroad. On the other hand, some actors have a
large following aboard, yet are relatively unknown in the United
States. There are several publications that can be consulted to
determine the commercial appeal of actors. The Ulmer Guide (julmer@primenet.com)
surveys financiers, sales agents and other industry insiders. Also,
the Hollywood Reporter (213) 525-2087 publishes its “Star Power”
guide.
AVOID DIRECTORS WHO DON’T CARE ABOUT THE AUDIENCE:
The director of the film is the key person who will
determine whether the final product is marketable. If a moviemaker
shows no concern about making a movie with audience appeal, you
can expect a film whose exhibition will be limited to the family
and friends of the filmmaker. This is not to say that the only films
you should invest in are low-brow fare like Dumb and Dumber. A well-made
“art” film like Elizabeth can win awards and make a handsome
return on investment. Filmmakers should give some thought beforehand
to the nature of the film’s intended audience. I once watched
a wonderful “Lassie” type film spiced with four-letter
words uttered by one character. I explained to the moviemaker that
his film would never sell in the family market because of the vulgar
language, and it was too soft a story to appeal to teens and adults.
The film was never distributed.
CONGRUENCE OF INTERESTS: It is best to invest in an
endeavor where everyone shares the same risks and rewards. A moviemaker
who takes a large fee from the production budget may financially
prosper from a picture that returns nothing to the investor. It
is better to back a moviemaker willing to work for a modest wage
and share in the success of the endeavor through deferments or profit
participation. An investor can take some comfort investing in a
motion picture on the same terms as a producer or distributor, where
all parties recoup at the same time. Beware of investing in a project
where other parties benefit when you lose.
UNDERSTAND THE PARAMETERS OF A FAIR DEAL: Usually
investors are entitled to recoup all of their investment from first
revenues before payment of deferments or profits. Many times investors
are allowed to recoup 110 percent or more of their investment to
compensate them for loss of interest and inflation. Profits are
declared after payment of debts, investor recoupment and payment
of deferments. Profits are generally split 50/50 between the producer(s)
and the investors. Thus, investors who provide 100 percent of the
financing are entitled to 50 percent of the profits. Third-party
profit participants (e.g., the writer, director and stars) are paid
from the producer’s half of net profits.
OBTAIN ALL PROMISES IN WRITING: Don’t ever accept
oral assurances from a producer or distributor. If they promise
to spend $50,000 on advertising, get it in writing. If there is
not enough time to draft a long-form contract, ask for a letter
reiterating the promises. Retain copies of all correspondence, contracts
and any promotional literature. If a filmmaker makes fraudulent
statements to induce you to invest, you will have a much stronger
case if his statements are in writing.
Avoid moviemakers who make handshake deals. Such individuals
may neglect to obtain the necessary contracts needed to fully secure
ownership to their picture. To have a complete chain of title to
a film, one needs to secure written contracts with many parties
including actors, writers and music rights owners. Moviemakers who
fail to pay attention to such legal dirtywork lack the professionalism
needed to succeed.
SECURE AN ARBITRATION CLAUSE: Provide that any contractual
disputes be subject to binding arbitration, rather than litigation,
with the prevailing party entitled to reimbursement of legal fees
and costs. Arbitration is usually a quicker, more informal, and
less expensive method of resolving disputes than litigation. The
parties and the arbitrator typically gather in a meeting room. Each
side is given an opportunity to present documents and witnesses.
The rules of evidence do not apply. Parties may be represented by
counsel, or they may choose to represent themselves. Usually disputes
are resolved within a matter of months.
INTEREST ON LATE PAYMENTS: Remove any incentive for
a producer or distributor to hold onto your money. Courts may not
award pre-judgment interest to a prevailing party unless there is
a provision in the contract providing for such interest. Thus, if
you become embroiled in a dispute with a distributor who is unlawfully
holding onto $100,000 owed you, and after four years of litigation
you win the case, the court may award you $100,000 in damages without
interest. During those four years the distributor could invest your
money and reap the profits. Under such circumstances the distributor
has an incentive to delay payment.
COMPLETION BOND: A completion bond is issued by a
completion guarantor which is an insurance company that insures
the production against budget overruns.
Before issuing the policy, the completion bond company
will closely review the production personnel, script and budget
and assess whether they think this team of individuals can bring
in this script within the shooting schedule and proposed budget.
The completion bond company usually is quite diligent in its review
because if the film goes over budget, the bond company is financially
responsible. Having a completion bond should give investors some
comfort. They know that if the budget is inadequate to complete
the film, the investors will not confront the dilemma of either
putting up more money or owning an unfinished film.
TAKE AN ACTIVE ROLE: As a shareholder in a corporation,
or limited partner in a partnership, an investor has very limited
control over the management of the enterprise. In the past, investors
who wanted limited liability had to be willing to pay the price
of accepting limited control. With a Limited Liability Company (L.L.C.),
however, an investor can be one of the managers of the enterprise
yet maintain limited liability. Thus, the investor can have a vote
on critical decisions such as approval of the script, cast, budget,
and distribution agreements. By being actively involved in the production,
an investor will be better able to monitor the performance of the
filmmaker and discover problems while there is time to remedy them.
MAKE SURE FUNDS ARE SPENT ON PRODUCTION: During fundraising,
it is common for the moviemaker to set up an escrow account to hold
investor funds. The money stays in the escrow account until the
filmmaker raises the minimum necessary to produce the film. If the
filmmaker cannot raise sufficient money, the funds in escrow are
returned to the investors. By depositing money in an escrow account,
investors are protected because they know none of their capital
will be spent unless and until all the money needed to produce the
film has been raised.
After funds are disbursed for production, there should
be a system of checks and balances to ensure that all monies are
properly spent and accounted for. A budget and cash flow schedule
should be approved beforehand. Production funds should be placed
in a separate segregated account and not commingled with the filmmaker’s
personal funds. All checks withdrawing funds from the account should
be signed by two individuals. Investors may want to insist that
one of the signatories is a trusted person selected by the investors.
OBTAIN AN EXPERIENCED ADVISOR: Have an experienced
entertainment attorney review all documents. Make sure the filmmaker
has adequate representation as well. Filmmakers may be very capable
in the arena of production, and yet be unsophisticated in business
matters. Filmmakers can be badly taken advantage of if they attempt
to negotiate a distribution deal without assistance.
Since the investor generally shares in the revenue
paid to the filmmaker, if the filmmaker gets screwed, the investor
suffers. A skilled attorney or producer rep who represents many
filmmakers may have added clout in negotiations. Such a person is
aware of what distributors pay for films, and the concessions they
are willing to make. By virtue of the attorney’s or rep’s
relationships with festival directors and acquisition executives,
attention can be drawn to a film that might otherwise get lost in
the shuffle.
PROTECT THE MASTERS: The moviemaker or production
company should retain possession of all master elements. Original
film negatives, video masters, sound masters, artwork, still photos
and slides should not be delivered directly to a distributor. Instead,
the distributor should be given a lab access letter permitting the
distributor to order copies of the film to fulfill orders.
There are numerous reasons why a producer should retain
possession of master elements:
1) Masters may be irreplaceable. If lost or damaged,
the producer will incur a substantial expense to replace them, if
they can be replaced.
2) In the event of a dispute, it is best for the producer
to control the materials. If the distributor has defaulted, for
instance, the moviemaker may have a right to terminate the agreement
and seek a new distributor. The moviemaker will need access to the
materials, however, to make delivery to a new distributor.
3) If the initial distributor goes bankrupt, the moviemaker
will not want to have to go to court to extricate materials from
bankruptcy proceedings.
4) Several distributors may need access to the materials.
Typically, independent filmmakers enter into multiple distribution
deals. Often, one deal is concluded with an international distributor
(a.k.a. foreign sales agent) to distribute the film outside North
America, and one or more deals may be made with a domestic distributor
for distribution in the United States and Canada. The best solution,
when dealing with multiple distributors is to place the materials
in a professional laboratory. Each distributor is granted a lab
access letter enabling the distributor to order copies.
5) One can discourage cheating by keeping masters
in a laboratory and having the lab report to the filmmaker how many
copies have been duplicated. Suppose that at the end of one year,
the lab reports that 10 film prints have been made. The producer
report only indicates eight sales. This is a red flag alerting you
that sales may have been made that were not reported. Most filmmakers
would not know if their film had been licensed in Malaysia. Distributors
do not order copies of films without an order in hand. Typically,
they receive full payment for the film before they manufacture a
duplicate and ship it.
The lab access letter should include language permitting
the filmmaker to receive copies of all invoices or reports disclosing
the nature and amount of duplication performed. Some moviemakers
insist that the laboratory ship all copies directly to the territory
buyers.
OBTAIN AND REGISTER SECURITY INTERESTS: A security
interest gives the secured party rights in designated collateral.
A bank, for instance, has a security interest in the form of a mortgage
when it disburses a home loan. If the house is sold, the bank loan
must be repaid from the proceeds. In the movie and television industry,
film lenders may want to secure their financial interests by obtaining
a security interest in certain collateral, such as the film negative
and master materials.
Likewise, investors may want to make sure the filmmakers
protect their rights by having distributors grant the filmmaker
or production entity a security interest. The collateral here is
the proceeds derived from exploitation of the film. By having a
security interest, the filmmaker will have superior rights to unsecured
creditors. If a distributor goes bankrupt, its assets will be auctioned
off to pay the distributor’s creditors. One of the distributor’s
assets may be the right to distribute your film, and any revenue
generated from this right. If the moviemaker has a security interest,
then proceeds derived from it will be paid to the moviemaker first,
as a secured creditor, before payment is made to the distributor’s
unsecured creditors (e.g., the office supply store).
It is important not only to have a written security
agreement, but also to record it. The distribution agreement should
have a clause granting the moviemaker a security interest. A separate
long and short form security agreement is also signed by the parties,
as well as a UCC-1 form which is signed and recorded with the Secretary
of State where the collateral or distributor is located. The security
interest should also be recorded with the Copyright Office at the
Library of Congress in Washington, D.C. If you are not knowledgeable
about security interests, it is advisable to retain an attorney
to assist you.
DON’T INVEST MORE THAN YOU CAN AFFORD TO LOSE:
Investing in a film is a highly risky endeavor. If a film doesn’t
appeal to audiences, or is not marketable, one’s investment
can be completely lost. Unlike some other products, you cannot discount
the ticket price of a film and expect a line to materialize outside
the box office. Moviegoers will not watch bad films even if they
are offered for free. Consequently, investors should never invest
more than they can afford to lose. MM
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