Even if a film looks like it will be a commercial success "on paper", there is still no accurate method of determining the levels of revenue the film will generate.
In the United States, the value is typically based on a forecast of revenues (generally 10 years for films and 20 years for television shows), beginning with theatrical release, and including DVD sales, and release to cable broadcast television networks both domestic and international and inflight airline licensing.
Film finance is a subset of project finance, meaning the film project's generated cash flows rather than external sources are used to repay investors. The main factors determining the commercial success of a film include public taste, artistic merit, competition from other films released at the same time, the quality of the script, the quality of the cast, the quality of the director and other parties, etc.
In the past, risk mitigation was based on pre-sales, box office projections and ownership of negative rights. Along with strong ancillary markets in DVD, CATV, and other electronic media (like streaming video on demand -SVOD), investors were shown that picture subsidies (tax incentives and credits), and pre-sales (discountable-contract finance) from foreign distributors, could help to mitigate potential losses.
As production costs have risen, however, potential financiers have become increasingly insistent upon higher degrees of certainty as to whether they will actually have their investment repaid, and assurances regarding what return they will earn.
There are four main methods of financing the production of a film:
- government grants
- tax incentives and shelters
- private equity and hedge funds
- debt finance and equity finance
Government grants
A number of governments run programs to subsidise the cost of producing films. Governments are willing to provide these subsidies as they hope it will attract creative individuals to their territory and stimulate employment. Also, a film shot in a particular location can have the benefit of advertising that location to an international audience. Government subsidies are often pure grants, where the government expects no financial return.
Tax incentives U.S. states and Canadian provinces have between 15% and 70% tax or cash incentives for labor, production costs or services on bona fide film/television/PCgame expenditures.These so-called "soft-money" incentives are generally not realized until a theatrical or interactive production is completed, all payments are made to workers, financial institutions and rental or prop companies within the state of province offering the incentives. Many other limitations may apply (i.e., actors, cast and crew may have to take up residence in the state or province).
Often, a certain amount of physical shooting (principal photography) must be completed within the state borders, and/or the use the state's institutions. This would include rental facilities, banks, insurance companies, sound stages or studios, agents, agencies, brokers, catering companies, hotel/motels, etc.
Private Investors
One of the hardest types of film financing pieces to obtain is private investor funds. These are funds invested by an individual who is looking to possibly add more risk to his investment portfolio, or a high net-worth individual with a keen interest in films.
Pre-sales
Pre-sales is, based on the script and cast, selling the right to distribute a film in different territories before the film is completed. Once the deal is made, the distributor will insist the producers deliver on certain elements of content and cast; if a material alteration is made, financing may collapse. In order to gain the “marquee names” essential for drawing in an international audience, distributors and sale agents will often make casting suggestions.
Pre-sales contracts with big name actors or directors will often (at the insistence of the buyer) have an "essential element" clause that allows the buyer to get out of the contract if the star or director falls out of the picture and a marquee equivalent cannot be procured. The reliance on pre-sales explains the film industry's dependence on movie stars, directors and/or certain film genres.
Typically, upon signing a pre-sale contract, the buyer will pay a 20% deposit to the film's collection account (or bank), with the balance (80%) due upon the film's delivery to the foreign sales agent (along with all the necessary deliverable requirements.) Usually a producer pre-sells foreign territories (in whole or part) and/or North American windows/rights (i.e. theatrical, home video/DVD, pay TV, free TV, etc.) so that the producer can use the value of those contracts as collateral for the production loan that a bank (senior lender) is providing to finance the production.
Television pre-sales
Although it is more usual for a producer to sell the TV rights of this film after it has been made, it is sometimes possible to sell the rights in advance and use the money to pay for the production. In some cases the television station will be a subsidiary of the movie studio's parent company.
Negative pickup deal
A negative pickup deal is a contract entered into by an independent producer and a movie studio wherein the studio agrees to purchase the movie from the producer at a given date and for a fixed sum. Until then, the financing is up to the producer, who must pay any additional costs if the film goes over-budget. Superman and Never Say Never Again are examples of negative pickups.
Generally, a producer will have a bank/lender lend against the value of the negative pickup contract as a way to shore-up their financing package of the film. This is commonly referred to as "factoring paper". Most major North American studio and network contracts (incl. basic cable) are collateralized/factored by the bank at 100% of the contract value and the lender just takes a basic origination/setup fee. This is not the case with foreign contracts[citation needed], which the bank will usually only lend 80%, 50%, or 0% of the value of the contract, depending on the bank's history with the buyer, country/territory, and/or seller.
Splitting the roles of studios and networks necessitated a means for financing television series appropriate to the varied risks and rewards inherent in the separation. A practice known as "deficit financing" consequently developed - an arrangement in which the network pays the studio that make a show a license fee in exchange for the right to air the show, but the studio retains ownership. The license fee does not fully cover the costs of production - hence the "deficit" of deficit financing.
Deficit Financing developed after the varied risks and rewards were determined and carried out through film financing. Deficit financing occurs when the license fee for a show doesn’t fully cover production fees. A studio has ownership of the production, but as license fees are handed out in exchange to air a show, the phrase deficit financing comes into play as costs were not being met and paid.
Gap/SuperGap
Gap/Supergap financing is a form of mezzanine debt financing where the producer wishes to complete their film finance package by procuring a loan that is secured against the film's unsold territories and rights. Most gap financiers will only lend against the value of unsold foreign (non-North American) rights, as domestic (North American: USA & Canadian) rights are seen as a "performance" risk, as opposed to more quantifiable risk that is the foreign market.
In short, this means that the foreign value of a film can be ascertained by a Foreign Sales Company/Agent by evaluating the blended value of the quality of the script, its genre, cast, director, producer, as well as whether it has theatrical distribution in the US from a major film studio; all of this is taken into consideration and applied against the historical and current market tastes, trends, and needs of each foreign territory of country. This is still an unpredictable practice.
Domestic distribution is also unpredictable and far from ever a sure thing (e.g. just because a film has a big budget and a commercial genre and cast, it could still be unwatchable and thus never receive a theatrical or television release in the US, thus being relegated to being a big budget, direct-to-video film.) Any certainty in the entertainment business, lending against foreign value estimates is preferable to betting on strictly a domestic success (comedies and urban films being two notable exceptions: they are referred to as "domestic pieces" or "domestic plays".)
A gap loan becomes a supergap loan when it extends beyond 10-15% of the production loan required to shoot the film (or in other words, when the percentage of the gap required to complete the film's financing package becomes greater than a bank is willing to bear, which is traditionally 10-15%, but can sometime be a flat dollar threshold like US$1,000,000.)
Gap/Supergap lending is a very risky form of capital investment and accordingly the fees and interest charged reflect that level of risk. But at the same time it is not unlike buying a house: nobody pays 100% of the purchase price with cash; they pay about 20% in cash and borrow the rest. Supergap financing works by the same principle: put down 20-30% cash/equity and borrow the rest.
Over the years, because of the high risk nature, many supergap companies have come and gone, but a few established players have survived the ups and downs of the markets with Relativity Media, Screen Capital International, Grosvenor Park, Helios Productions, Endgame Entertainment, Blue Rider, Newmarket Capital, Aramid Entertainment, MDG Entertainment Holdings, Limelight, RJG Entertainment and 120dB all active in the current debt financing space.
By combining national and regional financing components including a Supergap loan, it is possible to finance up to 50% - 65% of the entire film project budget.
Product Placement
Income from product placement can be used to supplement the budget of a film. The Bond franchise is notable for its lucrative product placements deals, bringing in millions of dollars. In the film Minority Report, Lexus, Bulgari and American Express reportedly paid a combined $20 million for product placement, a record-high amount. Product placement may also take the form of in-kind contributions to the film, such as free cars or computers (as props or for the production's use). While no money changes hands, the films budget will be lowered by the amount that would have otherwise been spent on such items.
Source: Wikipedia.com