By Oliver W. Tuthill Jr. Guest Columnist
Reprinted courtesy of MovieMaker Magazine
Since Thomas Edison produced the first film of heavyweight boxing champion James J. Corbett engaging in a boxing match back in 1897, filmmakers and film producers have struggled with finding the resources to get their vision on the screen. Thousands of creatives see their film visions in their minds, but how many actually have the ability to master the creative, technical and financial process in order to see a film successfully completed? This article will focus on the financial process with gap financing being the primary concentration, but first, let’s start at the beginning.
When a film producer acquires a property, or the rights to a screenplay, the next step is attaching talent, be it actors, producers or a name director. This involves entering into discussions with international sales agents to ascertain if the talent she or he can attach will help sell the film in foreign territories. Then the producer goes after presales contracts.
Scott Freije handles sales and acquisitions at Artist View Entertainment, an international sales representation company located in Los Angeles, and he contends that gap financing plays a small but important role in getting a film made.
“We really see them in a way as finishing funds because sometimes you need that extra money to get your film finished.” Freije also recommends that a producer should, “Work within the parameters of a known genre that there is a demand for.”
David Sheldon, the CEO of Film Financial Services, spends his time co-financing films for Hollywood Studios and independent producers. Films’ budgets typically range from $10 to $50 million. His company pulls together elements of financing in a tailor-made structure for each film and he maintains that gap financing is an important component in the financial process. He calls the process structured finance.
“It contains various components of finance for a transaction, and each one of the components has a different risk/reward profile,” Sheldon said. He went on to list the various elements and explained each one.
1. Gap Finance – The bank takes very little risk, but its reward is limited to its interest and fees.
2. Presales Guarantees – The bank takes very little risk and is limited to its interest and fees.
3. Equity – This would consist of real cash equity that an investor has put in.
4. Service deferrals – Deferred salaries for talent and deferred fees for costs.
5. Subsidies or Tax Credits – This will be offered as a rebate when production is completed or as a partial write off on taxes. It can vary from state to state and country to country.
6. Product placement or cross-promotional contributions – Companies will pay the producer to place their product or service logo in their film.
“Gap finance is referred to by bankers as ‘Senior Debt’ because it is lending against the rights of unsold international territories, and the amount of the banker’s loan is dependent upon the value of those unsold rights,” Sheldon said. “The international sales company does estimates by country and the gap lenders will typically lend only for major international territories, not the small ones.” He is referring to large territories like Germany, France and Japan. A small territory would be considered a country like Vietnam or Laos.
Sheldon went on, “The banks insist that their loan is covered by 150% and there is no profit participation. It is a straight loan and the gap loan is the last financial component that comes into play.”
According to Jeff Colvin, the Senior Vice President and Group Manager at Comerica in Los Angeles, his bank is in business to provide gap financing to film producers. He is only looking for films that are produced for $10 million or above, and up to 20% of the budget can go towards gap financing. Colvin said it is not cost–effective for the producer of a low– budget film to utilize gap financing.
“We will do a loan against the presale contracts, the tax credits, rebates and foreign incentives. We do our own analysis to make sure our risks are kept to a minimum, but gap financing is not risk free,” Colvin said. “We are loaning against the unsold territories, and if the film turns out poorly then buyers will not want to license the rights from the producer. Sometimes even when the producer has a presales guarantee the buyer will default, and we will have to enter into arbitration. We will then resell those rights in the same territories but to different companies.”
Brenda Flewellyn is the President of FILMBANKERS International and is considered one of the premier finance professionals in the entertainment industry.
“Gap financing is lending against unsold film rights that have established values usually set by a sales agent and agreed upon by the financier,” she said. “The bank is taking a big risk because you do not know if the distributor will even like it once the film is ready for exhibition, and that is why gap is so risky.” She goes on to explain that a close relative of gap financing is bridge financing.
“It is when a film producer needs to start filming but does not have all the money to hire the talent and crew while waiting for his loans to close and fund. The producer will go to a finance company to ‘bridge’ the loan until the producer’s production loan comes through. The production loan can take a variety of forms. It could have a combination of presales, gap lending, equity, tax credits, and deferrals.”
Flewellyn, with her partner Harold Lewis, has created a new company to help aspiring producers have a shot at finding production financing for their dream film. It is a new website called Pitch2Me.com and she is currently enrolling bankers, distributors and investors so it will be easier for filmmakers to get their film produced. For a nominal fee the producer can upload the essential elements of their project. Financial professionals and distributors can then zero in on the type of project the distributor or investor is interested in financing.
Philippe Diaz, the CEO of the prestigious social rights film distributor, Cinema Libre Studio, feels that you must meet certain basic requirements before you can even approach a bank about gap financing.
“Your film has to be more than $2 million and it must have name actors attached, actors that will sell overseas,” Diaz said. “You must have presales that can be verified as legitimate buyers and have 70 to 80% of your budget covered before asking for gap financing. You also must have a completion bond, which means a bond company will make sure the film will be completed and be ready for a distributor if for some reason the producer or director cannot finish the film on schedule.”
Colvin recommends you find a good international sales agent before approaching a bank about gap financing. “The earlier you have a foreign sales agent attached to your film the better,” Colvin said. “The foreign sales agent will help the producer find out what the best cast would be and help secure presales guarantees. The bank wants a good sales agent.” Colvin also offers advice on what to do if the bank is unsure about the distributor offering the presales guarantee.
“They can put up a letter of credit from their bank which is their bank’s guarantee that our bank would get paid. It would be acceptable then, because we would be taking a bank risk. Loan pricing against letters of credit would be cheaper because the risk we would be taking would not be on foreign distributors but on another big bank.”
Diaz explains how important it is to the bank, to know how foreign distributors will feel about the film and the cast. “They will call foreign buyers,” Diaz said. “They will ask them how much will they pay for this particular film with this particular cast before they make a decision on doing business with a particular producer.”
“The good days of film finance are behind us now,” Diaz continued. “With the great recession and the explosion of new product for growing networks, a lot of films were not commercially successful. In the last ten years we saw the death of the presales market. It is now dead for everything but the top movies. The presales market is dead for small films. Only the big films can obtain presales guarantees and that is because they can attach the top talent—the best known actors and directors.”
Producer Howard Burd, who just finished up shooting his new film, Criminal Activity, in Cleveland, Ohio, with John Travolta in the lead, has never used gap financing.
“I go out and I make calls on equity investors and can raise capital by monetizing the rebate that I work out with the states I film in, for shooting my film in their state. I shot my last film, Four Minute Mile, starring Kim Basinger and Richard Jenkins, in Washington State and received a 30% rebate after production. You can save a lot of money by doing that and getting loans from equity investors on the rebates.”
Sheldon opines the fact that many banks no longer make gap loans to film producers. “The 2008 recession was very devastating to the film industry. Some banks have gotten out of the business altogether, and all of them have cut back,” Sheldon said. “That is because the Feds have put requirements on the banks to retain more assets and collateral.”
When asked how much it costs to finance a gap loan, Colvin said, “First you have to check the LIBOR rate (London Interbanking Offer Rate) and see what the spread rate is. The bank will charge interest and fees on the loan. For a $10-million film you would be looking at a bench rate of about a quarter of a point, or .25%. The loan would be at the interest rate of LIBOR plus 1-2%. There would be a 2% fee and about $75,000 in legal costs. On a $10-million film you would be looking at around $775,000 in interest and fees.” This means the producer would have to get the film done for $9,225,000.
“You go to gap financing when you cannot get presale contracts or you do not want to get presale guarantees,” Diaz added. “You can make more money by licensing your film to a foreign territory after the film is completed and ready for exhibition and distribution. Also, if you are going to get your gap financing you will need a completion bond and that is going to add another 3-6% onto your budget.”
Diaz also explained about the possibilities of presales guarantees in the U.S. marketplace. “That is much harder to obtain,” he said. “You have to realize that all of North America is just one territory and bankers will not count on the U.S. market. Too much can happen, because you just never know how a completed film is going to turn out. If it is a bad film you are not going to make any money and this will have negative repercussions on your relationship with the bank.”
Sheldon concurs with Diaz. “The U.S. values are more difficult to attain,” he said. “You have to take into consideration how the film will be released, how much the P&A is, and what are the terms of the P&A recoupment and if it will leave anything for the producer. Who would the domestic distributor be? What are their arrangements for distribution in the theaters, television, PPV, VOD, and internet streaming? P&A recoups ahead of the banks and it is not assured what the given cost will be.”
Sheldon is optimistic about the future. “The whole entertainment arena has been hurt by the recession because advertising revenues have dropped a lot,” he said. “Bankers are more cautious, but business is slowly picking up again, but you need to work with big stars in action dramas if you want to be successful in this business. Gap financing is for producers who want to work with name talent on big budget films.”