You have a great script, right? You have an incredible director, cast and team, right? You’re passionate about making this film, right? Sounds like a slam dunk, right? Wrong! You still need the money! (And, in an ideal world, the distribution to pay it back!) Well, you ask yourself… How tough can that be?
Today, with all these digital technologies, it’s cheaper to make a film than ever before, not to mention distribute one. Additionally, in today’s fragmented marketplace, it’s easier to find an audience for your independent movie than ever before. Assuming you can make your movie at a cost and deliver it to your potential market, should raising money for an independent movie be the science that financiers and investors make it out to be? And if you couldn’t meet the above assumption, doesn’t that make the investment decision even less of a “science?”
Of course, we’re talking about film—an asset class known to defy all logical reasons for investment. So herein lies the challenge: Finding “smart” money to defy logic and make the characteristically “dumb” decision to invest in film. (And, of course, finding the “dumb” money to continue to invest in it.)
Okay, so the above shouldn’t be news to you… Everyone knows how damn hard it is to raise money for an independent film. After all, aren’t you really asking smart money to behave in a dumb way, or hoping to find dumb money to continue to behave dumb? Both seem like hoping for a miracle, but the latter might seem more plausible in light of film’s historical attraction to “dumb” money. Nonetheless, over the last five years, a boom in the private equity and hedge fund industries has suddenly made film an extremely attractive asset class for “smart” equity investors.
Since August 2004, over $10 billion in capital has been committed to co-finance films, albeit largely studio films. While some of this capital came in the form of debt, a significant portion is equity or an ownership position in film. Is there something moviemakers can learn from these deals that can help them develop innovative ways to finance their own films? After all, understanding what attracts smart money to a traditionally dumb investment opportunity can only bode well in understanding what might attract even more dumb money to the asset class moving forward—understanding, of course, that that the nuances of independent films make the investment decision even riskier than studio films. Independent films, after all, have no dough for the talent traditionally driven to studio films… and the talent that traditionally attracts mass market audiences. In any event, there are lessons to be learned from the evolution of film investment that provide the context to develop the art of film finance as something that is capable of defying the logic of film investment.
Context: The Evolution of Film Investment
Third-party financing began in the 1970s, when unique tax incentives within the U.S. tax code made it attractive for studios and individuals to engage in limited partnerships. However this specific method of financing basically went away in 1986 due to tax reform.
The next wave of capital came from large pension funds and insurance companies. Almost all of their investments were in the form of debt. This continued through the 1990s and into 2000. Along the way, there was an increase in foreign investment in the U.S. film industry as investors sought to take advantage of our tax credits. For the most part, before the influx of private equity/hedge fund money, film co-finance deals where really only attractive to investors seeking a tax advantage or large risk averse institutions (debt). This dynamic has changed recently for a number of reasons.
First, the private equity and hedge fund industries have grown exponentially over the last five years. These investors have been forced to be more creative and aggressive in sourcing interesting investment opportunities. Across the industries firms are dealing with significantly more capital than they have had in the past and they are doing so in a much more competitive environment. As a result, firms have had to pay higher prices for deals in order to have sufficient deal flow. As capital continues to become available, private equity and hedge funds become “commoditized.” Recognizing this issue, investors proactively began to pursue industries that had historically not absorbed significant amounts of equity capital with the rationale that they might offer better opportunity. Film was initially thought to be an ideal target.
As is highlighted above, with little equity capital being committed in the past there were no private equity firms or hedge funds with deep roots in the industry. Furthermore, the film business is capital-intensive in nature, which bodes well for investors looking to deploy sizeable amounts of capital. One of the biggest concerns for funds going into new industries/market is whether the investment potential of that industry is large enough to really support the effort. Firms do not want to commit to networking and learning a new industry if their investment would represent only a small percentage of their overall fund. The film industry has an almost limitless need for capital so there was a logical marriage from that perspective.
Finally, a collective belief was formed within the film and investment communities that you could apply the “portfolio theory” to films. Slate financing, for instance, are now commonly sliced into a variety of different branches allowing for a variety of different investors to participate. Deals have also involved larger slates providing greater diversification. This portfolio theory approach has helped private equity firms/hedge funds become more comfortable with film as an asset class. With fewer capital inflows, a large appetite for capital and frameworks for higher risk-adjusted returns, the film industry seemed ripe for increased attention from external capital sources.
Even though demand has increased and investors have become increasingly sophisticated in their approach, significant risks remain. First, there is the issue of information as studios control the lion’s share of data on film distribution, P&A and other ancillary costs (much of which is not publicly available). It follows that it is therefore extremely difficult for private equity firms or hedge funds to monitor how efficiently capital is being put to use across 20 to 25 films. Minor changes in areas like P&A or distribution, or the positioning of those items on the cash flow waterfall, can lead to dramatic swings in returns.
So What Does All This Mean For The Independent Moviemaker?
When talking to people about investing in your film, or what everyone knows is likely a very dumb investment, you’ve got to understand the context of film investment and the other investment opportunities afforded these investors. Be smart and know how to put together the right investment presentation that will give you the very best chance to succeed. The right presentation, for one, requires not just an understanding of risk and reward but also an understanding of the lessons learned regarding risk diversification—namely, that it can be “less” risky to raise money for a slate of independent films than it could be for one film. Yet, how hard is it to raise money for even one film? Well, it took the Coen brothers three long years to find the $250,000 it took to make Blood Simple—and it took more than 40 investors to raise it. The reality of anything on the level of a “true” independent film with a possibility to be sold is slim, simply because production values are not likely to be competitive in the marketplace. So manage your expectations and those of your investors, because any hopes of another The Blair Witch Project or El Mariachi will have to rest on the notion that you are trying to make a phenomenon, not a film.
Many dollars are spent by distributors to increase the production values of independent films to release level, and how many totally unknown independent films are there for every Blair Witch or El Mariachi released into the market? In today’s world it’s likely going to take you close to $1 million to give you the ability to put together a team of professionals both in front of and behind your camera to make and market a feature film with the chance at distribution sales to make financing a film more plausible, although not necessarily more easy.
There are other hurdles too, like dealing with the age-old question of “What happens to an investor’s money if you do not finish the movie?” Completion bonds are another discussion, but it’s safe to say it is one under the realm of risk diversification, making them an essential consideration for any moviemaker looking to make a serious independent film.
Raising private financing for an independent film presents enormous challenges but by all means, not insurmountable ones. There are many artists who are meeting these challenges every day—including many who lack the storytelling and moviemaking skills to fully realize the fruits of their labor. It’s these skills, together with an understanding of the context of film investment, that make the art of film finance all the more “scientific” to defy reason and continue to attract either smart or dumb money to the business. In the end, it will be the most imaginative and compelling stories that will attract capital and inspire moviemakers to develop the most innovative of ways to secure it.
Nelson Gayton is the managing director of The Wharton Media & Entertainment Initiative, a global “think tank” for knowledge development in the media and entertainment industries. In this role, he manages all industry relationships for the school, including the development of an experiential and interdisciplinary curriculum in partnership with industry sponsors. Gayton also continues to serve as a general partner for Crayon Ventures, a venture management firm with interests in entertainment, technology and education. He remains a frequent speaker, panelist and jury member at film conferences, festivals and universities, including UCLA and NYU.