LOANSLoans can be secured or unsecured. A secured loan is supported or backed by security or collateral. When one takes out a car or home loan, the loan is secured by that property. If the person who borrows money fails to repay the loan, the creditor may take legal action to have the collateral sold and the proceeds applied to pay off the debt.
An unsecured loan has no particular property backing it. Credit card debt and loans from family or friends are often unsecured. If a debtor defaults on an unsecured loan, the creditor can sue for repayment and force the sale of the filmmaker’s assets to repay the loan. If the filmmaker has many debts, which is often the case, the sale of a debtor’s assets may not be sufficient to satisfy all creditors. In such a case, creditors may end up receiving only a small portion of the money owed them.
A secured creditor is in a stronger position to receive repayment. In the event of a default, designated property (the secured property or collateral) will be sold and all the proceeds will be applied first to repay the secured creditor’s debt. Unsecured creditors will share in whatever is left, if anything.
The advantage of a loan is that the transaction can often be structured in a fairly simple manner with minimal legal expenses. A promissory note can be used and the transaction often isn’t subject to the complex security laws that govern many investments. Keep in mind that if the agreement between the parties is labeled a “loan,” but in reality it’s an investment, the courts will likely view it as an investment. For example, if you give a creditor a “piece of the back end,” or otherwise give the creditor equity or profit sharing in the project, this transaction is likely to be treated as an investment by the courts.
The difference between a loan and an investment has to do with risk. With a loan, the debtor is obligated to repay the loan and whatever interest applies, regardless of whether the film is a flop or a hit. The creditor earns interest, but doesn’t share in the upside potential (i.e., profits) of a hit. Since the creditor is entitled to be repaid even if the film is a flop, the creditor doesn’t share in the risk of the endeavor. Of course, there’s some risk with a loan because loans aren’t always repaid, especially unsecured loans that don’t have any collateral backing them. That risk is minimal, however, compared to the risk of an equity investment.
In a pre-sale agreement, a buyer licenses or pre-buys movie distribution rights for a territory before the film has been produced. The deal works something like this: Filmmaker Henry approaches Distributor Juan to sign a contract to buy the right to distribute Henry’s next film. Henry gives Juan a copy of the script and tells him the names of the principal cast members.
Juan has distributed several of Henry’s films in the past. He paid $50,000 for the right to distribute Henry’s last film in Spain. The film did reasonably well and Juan feels confident, based on Henry’s track record, the script and the proposed cast, that his next film should also do well in Spain. Juan is willing to license Henry’s next film sight unseen before it has been produced. By buying distribution rights to the film now, Juan is obtaining an advantage over competitors who might bid for it. Moreover, Juan may be able to negotiate a lower license fee than what he would pay if the film were sold on the open market. So, Juan signs a contract agreeing to buy Spanish distribution rights to the film. Juan doesn’t have to pay (except if a deposit is required) until completion and delivery of the film to him.
Henry now takes this contract and a dozen similar contracts with other buyers to the bank. Henry asks the bank to lend him money to make the movie with the distribution contracts as collateral. Henry is “banking the paper.” The bank won’t lend Henry the full face value of the contracts, but instead will discount the paper and lend a smaller sum. So, if the contracts provide for a cumulative total of $1,000,000 in license fees, the bank might lend Henry $800,000. In some circumstances, banks are willing to lend more than the face value of the contracts (so-called gap financing) in return for charging higher fees.
Henry uses this money to produce his film. When the movie is completed, he delivers it to the companies that have already licensed it. They, in turn, pay their license fees to Henry’s bank to retire Henry’s loan. The bank receives repayment of its loan, plus interest and fees. The buyers receive the right to distribute the film in their territory. Henry can now license the film in territories that remain unsold. From these revenues, Henry hopefully makes a profit.
Juan’s commitment to purchase rights in the film must be unequivocal, and his company financially secure, so that a bank is willing to lend Henry money on the strength of Juan’s promise and ability to pay. If the contract merely states that the buyer will review and consider purchasing the film, this commitment isn’t strong enough for the bank to lend against. Banks want to be assured that the buyer will accept delivery of the film as long as it meets agreed upon technical standards, even if the film is a disappointment artistically. The bank will also want to know that Juan’s company is fiscally solid and likely to be in business when it comes time for it to pay the license fee. If Juan’s company has been in business for many years, and if the company has substantial assets on its balance sheet, the bank will usually lend against the contract.
Banks often insist on a completion bond to ensure that the filmmaker has sufficient funds to finish the film. Banks aren’t willing to take much risk. They know that Juan’s commitment to buy Henry’s film is contingent on delivery of a completed film. But what if Henry goes over budget and can’t finish the film? If Henry doesn’t deliver the film, Juan isn’t obligated to pay for it, and the bank isn’t repaid its loan.
To avoid this risk, the bank wants an insurance company, the completion guarantor, to agree to put up any money needed to complete the film should it go over budget. Before issuing a policy, a completion guarantor will carefully review the proposed budget and the track record of key production personnel. Unless the completion guarantor is confident that the film can be brought in on budget, no policy will be issued. These policies are called completion bonds.
First-time filmmakers may find it difficult to finance their films through pre-sales. With no track record of successful films to their credit, they may not be able to persuade a distributor to pre-buy their work. How does the distributor know that the filmmaker can produce something their audiences will want to see? Of course, if the other elements are strong, the distributor may be persuaded to take that risk. For example, even though the filmmaker may be a first-timer, if the script is from an acclaimed writer and several big-name actors will participate, the overall package may be attractive.
If you don’t have a rich uncle to finance your film, you might try raising funds through websites like Kickstarter and Indiegogo. Veronica Mars was a television series that ran from 2004 to 2007. Fans were disappointed when the series ended. In 2013, however, a crowdfunding campaign was launched on Kickstarter. The campaign raised $5,702,153 from 91,585 donors, making it one of the most successful crowdfunded projects of all time.
Gifts from friends, family and Internet websites like Kickstarter and Indiegogo should be distinguished from raising money from investors, which I’ll discuss in the next issue. There’s no problem with people giving you gifts, and you giving them screen credit, T-shirts and other swag. Gifts aren’t investments and not subject to the complex security laws that govern equity investments.
Editor’s Note: In the next issue, Mark continues his discussion of the methods of film financing—the pros and cons of equity investments, financing from producers, networks or studios, and soft money in the form of tax credits and incentives, co-productions and subsidies.
Mark Litwak is a veteran entertainment attorney and producer’s rep based in Beverly Hills. He’s the author of six books, including “Dealmaking in the Film & Television Industry,” “Contracts for the Film & Television Industry” and “Risky Business: Financing & Distributing Independent Films.” He’s an adjunct professor at the USC Gould School of Law and creator of Entertainment Law Resources. You can reach Mark at [email protected]; visit marklitwak.com.