The modern day economics of film financing

Only 2 per cent of the total movies released in 2016 in the US were computer graphic (CG) animation, yet they grossed more than 21 per cent of the US box office collection. Strong animation brands have longer shelf-life and generate revenue for years.Franchises like Cars have grossed over $10 billion in merchandising alone. Similarly, Toy Story has earned over $11 billion till date with a new sequel to be released in 2019. While the returns are disproportionately higher, the cost of making these movies are also, typically higher. CG animation content has been highly capital intensive and time-consuming. The budget for such tent-pole animated movies can be anywhere in the $100-$200 million range. The independents, however, are able to produce content at much reduced budgets. With such high funding requirements, the process of film funding is also undergoing some radical changes.

Film funding is predominantly done through three main ways and a combination of such - namely debt financing which is the use of loans for an interest payable, to finance the production; equity investment which may come from investors, and lastly, capital that is raised by selling the rights to distribute and commercially exploit the film prior to the film's completion (a pre-sales).

The basics of film funding has, however, remained the same, but the combination and structure of these various instruments have given way to many financial and strategic investors who are able to take more aggressive and calculated approaches than traditional lenders like banks previously would. This has opened multiple ways to finance content.

While pre-sales is still the backbone of the ‘independent’ content business, distributors have become cautious of what movies they commit to. For example, it is very difficult to pre-sale horror films because of censorship issues in different international territories. Similarly, it requires a certain amount of effort to also pre-sell comedy, contrary to what we’d imagine, as comedy translates very differently on the screen when translated in different territories. Therefore buyers like to see the film before buying.

This leads to a shortfall between the cost of production and how much the producer is able to raise. “Gap financing” has emerged to bridge the difference. Companies like Aperture, VX119, Silver Reel and Prescience are some of the key players who provide gap financing anywhere between 10-40 per cent of the film’s budget. These independent financiers now play a key role in the underwriting of almost every kind of movie and more often, they are the originating financiers who greenlight many of the most successful commercial films.

Alternatively, as the budget shortfall increases, producers also start looking at public funds which are generally referred to as “soft” money. This soft money usually is received in the form of tax incentives when a movie is shot in certain regions. Many countries including Canada, France and Australia act as a magnet to draw film shoots, due to the availability of public and government funds.

It is not uncommon for two or more creative entities to own and finance a movie with divided equity stakes. For example, Norm of the North, 2016 CGI animated movie was co-produced by Splash Entertainment, Assemblage Entertainment and Telegael and distributed by Lionsgate in North America. These strategic deals not only provide financing but also reduce the risk exposure of the parties involved. For example, Luc Besson’ movie Valerian performed poorly in the box office, but it had a minimal financial risk. Euro Corp distributed the movie in France and had a deal with STX to distribute in the US and other territories even before the movie was made. Valerian covered 96 per cent of the budget with pre-sales minimising the financial risk.

Hedge funds and private equity players who are the relatively “new kids on the block “are actively investing in co-financing vehicles with studios generating returns not correlated to the equity markets.  These investments not only bring diversification to the portfolio but also benefit from tax breaks such as capital gains deferred tax, loss relief and inheritance tax exemption. Most of these co-financing deals are approached as a content-slate where the investments are made for multiple movies across different time frames. Slate financing is largely focused for portfolio diversification and spreading single-project risks.

New-age financing? Still a long way to go

With digital platforms gaining increased acceptance, Netflix, Amazon, Hulu and Apple now join the race to acquire content for exclusive digital releases. After Sony’s deal with Warner Brothers expired in 2015 for the James Bond franchise, Apple and Amazon have now emerged as potential suitors to gain the film’s distribution rights. While the new-age exclusive digital release is increasing, there is not a huge drastic change in the existing financing models. Digital content platforms also engage in “output” deals, which are largely fixed price contracts for a volume of work that they need to feed through their pipes.

Crowd funding, also relatively new has been used by independent film producers to raise financial support through websites like Kickstarter and Indiegogo. However, these fundings are incentive type i.e., backers usually receive merchandising in exchange for contribution.

With the dawn of blockchain technology, the crowd funding model is evolving to a place where backers contribute to a film funding in exchange for equity participation. Braid was the first film to use this method to raise funding of $1.7 million. While this method is popular in Europe, Hollywood and the rest of the world are considering legal and regulatory aspects of implementing the model.

Supply-Demand mismatch

With increasing funding options, there’s more money chasing fewer projects. There’s a supply / demand mismatch with abundant liquidity and dearth of high-quality investment opportunities available.  Content types like animation, which can appeal to global audiences and have a huge shelf-life and residual library value, will always stand out to investors who are willing to take calculated risks with superior return opportunities. The intricacies of the nature of financing are key to make the economics of such content production work.

Article by,
A K Madhavan,
CEO, Assemblage Entertainment Pvt Ltd.

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