The New Realities of Financing Film Productions

In past years, creative talent with enough stature to fill theaters in domestic or foreign territories, or both, have been able to negotiate extraordinary deal terms. For example, a marquee-value star could command a non-contingent fee of $20 million applied against contingent compensation of 20% of the distributor's first dollar gross receipts. In that situation, the actor would not receive any additional payments if the distributor's gross receipts were $100 million or less, but would receive $20 million for each $100 million in distributor's gross receipts in excess of $100 million.

One of the key points in negotiating such a deal would be how much of the revenues from home-video devices would be included in a distributor's gross receipts. In most cases, studios take the position that only 20% of home-video revenues are included, but established talent could bargain for the inclusion of 30% to 35%, and some could do even better.

Creative producers also could find comfort in the cushion of “first look” deals. These typically obligated a producer to offer new projects to a particular studio before presenting them to another. For this privilege, a studio might furnish benefits such as covering a portion of the producer's overhead or providing office facilities. Once presented with a new project, a studio with a first-look arrangement normally has a fixed period of time to decide whether to become involved or “pass.”

If the studio expresses interest, what happens next varies from deal to deal. In some instances, the financial details of the studio's involvement are pre-negotiated. More frequently, the terms for each project are separately negotiated, taking into account the star power of the actors, director and writer, the budget of the film and other relevant factors.

Weighting the Back End

More than $10 billion in tickets were sold in 2009 ' an extremely solid year for the motion picture industry ' but according to The New York Times, that is still about 12% less in inflation-adjusted dollars than the total in 2002. And as noted above, diminished sales of DVDs and piracy have taken their toll on the industry.

Owing to these factors and others, studios have cut back. They have cut staff and lowered compensation for writers, directors and performers. Those lucrative “first look” arrangements have become more scarce as studios resist the lavish treatment they previously afforded the higher strata of creative talent. Instead, studios are attempting to reduce substantially the up-front compensation to all but the most prominent of actors and creative producers while restructuring back-end compensation to what they consider a more equitable sharing of revenue.

Further, studios are producing fewer movies and concentrating their efforts on a limited number of big-budgeted franchise or “tent pole” films, with spectacular special effects replacing dialogue and with presumed worldwide appeal. These include expensive high-tech productions, including 3-D movies like Avatar for which premium-priced tickets can be sold. Some specialty divisions that produced lower-budget “smaller” films have been eliminated. Variety recently assessed the current situation as follows: “The major studios, having vandalized the indie sector, now insist that low-budget dramas are toxic and that the future belongs to franchises.”

'Talent As Partners'

These shifts have had ramifications for how deals are structured with creative talent, how films are distributed and how those with liquidity in a global recession are applying their resources to the motion picture business.

In one new pattern, financing entities have stepped up to help fill the vacuum in funding and in dealing with talent directly at the production stage. For example, Relativity Media, which underwrites portions of Universal's and Columbia's slates of films, has become a source of funding that can be approached with projects considered unsuitable for studio development because the project is not sufficiently in the mainstream, or because of high up-front compensation and first-dollar gross participations that studios do not wish to fund.

Relativity's CEO was quoted in Variety as stating that Relativity is using a risk-sharing formula that “[treats] talent as partners, not third-party hires” in which high-priced talent receives little or no non-contingent compensation, but a substantial participation (as high as 25% to 50%) in the revenues of the production after Relativity recoups the production budget, the costs of prints and advertising, and interest costs. These deals still require considerable negotiation respecting items to be included in gross receipts and allowable deductions. Notably, in some of these deals 100% of the revenues derived from home-video exploitation might be included in gross receipts for the purpose of this calculation.

Relativity might then turn to a studio for distribution and, having provided most or all of the production financing, can secure terms that are more favorable than a studio customarily offers ' such as a distribution fee that is significantly lower than the fee of 30% to 35% that a studio might normally charge. Relativity also maintains an ownership interest in distribution companies that, if used instead of a studio, charge an even lower fee for distribution services.

Other domestic companies also are utilizing these types of arrangements. For example, Alcon Entertainment, owned by FedEx Chief Executive Frederick W. Smith, produced and marketed the highly successful film Blind Side. According to the Wall Street Journal, Sandra Bullock, the star of the picture, accepted a greatly reduced up-front fee in exchange for a substantial portion of the company's profits. Her financial position reportedly benefited from Alcon's having a distribution arrangement with Warner Bros. with a reduced distribution fee.

Looking Abroad

Foreign sources of production financing are also stepping forward. During the past few years, several prominent production entities whose principals include the cream of Hollywood creative talent have signed agreements directly with foreign financing entities. Some of the deals involve first-look arrangements that had been offered in greater abundance by U.S. studios. These financing entities not only are investing, but are also attempting to influence the content and creative process at an early stage while obtaining distribution rights in their own territories ' and perhaps other territories as well. Although many of them ultimately seek some type of partnership with a studio, such as for distributing a film, they represent a source of financing for creative talent that is either unable or unwilling to start a project with a studio.

For example, Imagenation Abu Dhabi has a substantial film fund to finance projects for the international marketplace. Variety reported that Imagenation recently provided the prominent producing team of Parkes and MacDonald with a revolving development fund. (The recent problems of Dubai World in repaying a $4 billion bond has given pause to those who were flocking to the Middle East for financing, but does not appear to have impeded Imagenation's efforts in regard to involvement in film production.)

The highly publicized efforts of Reliance ADA Group, based in India, also has provided a source of funding to creative talent who seek to develop films outside of traditional studio development. As first-look and similar arrangements previously offered by the Hollywood studios become less available during the current cycle, alternatives such as Reliance ' which offers first-look deals ' have become increasingly important to filmmakers around the world.

Creativity Required, But No Guarantee

The motion picture industry has gone through many cycles during the last few decades and there is no telling how long the current one will last. But creative talent who seek to produce films that do not fall into the category of franchises, and are willing to be creative in the deals they negotiate, do have alternatives for developing their product. Predictably, these alternative sources of financing are being flooded with proposals and, as before, the chances of getting one's film developed and financed remain relatively small.

Reduced sales of DVDs and increased piracy of filmed entertainment are affecting the profits of studios and other financiers of motion pictures. To lessen this impact, changes are being made in deal terms offered to creative talent ' such as actors and creative producers ' and new relationships are emerging among such talent, financiers and distributors of theatrical motion pictures.

Although the U.S. motion picture business is one of cycles, some patterns have remained constant over the past several decades, during which studios accounted for the bulk of production and marketing budgets. Last year, the combined production and marketing costs of an average studio film exceeded $100 million. For the most part, only studios could afford to finance sums that large, counting on global revenues from theatrical exhibition, DVD sales, and pay, cable and free television to generate profits. The studios in turn received liberal lines of credit from banks and offset risk (albeit while limiting their upside) by partnering, for individual films or slates of films, with domestic and foreign film investment companies, hedge funds and other sources of financing.

Involving the Stars

In past years, creative talent with enough stature to fill theaters in domestic or foreign territories, or both, have been able to negotiate extraordinary deal terms. For example, a marquee-value star could command a non-contingent fee of $20 million applied against contingent compensation of 20% of the distributor's first dollar gross receipts. In that situation, the actor would not receive any additional payments if the distributor's gross receipts were $100 million or less, but would receive $20 million for each $100 million in distributor's gross receipts in excess of $100 million.

One of the key points in negotiating such a deal would be how much of the revenues from home-video devices would be included in a distributor's gross receipts. In most cases, studios take the position that only 20% of home-video revenues are included, but established talent could bargain for the inclusion of 30% to 35%, and some could do even better.

Creative producers also could find comfort in the cushion of “first look” deals. These typically obligated a producer to offer new projects to a particular studio before presenting them to another. For this privilege, a studio might furnish benefits such as covering a portion of the producer's overhead or providing office facilities. Once presented with a new project, a studio with a first-look arrangement normally has a fixed period of time to decide whether to become involved or “pass.”

If the studio expresses interest, what happens next varies from deal to deal. In some instances, the financial details of the studio's involvement are pre-negotiated. More frequently, the terms for each project are separately negotiated, taking into account the star power of the actors, director and writer, the budget of the film and other relevant factors.

Weighting the Back End

More than $10 billion in tickets were sold in 2009 ' an extremely solid year for the motion picture industry ' but according to The New York Times, that is still about 12% less in inflation-adjusted dollars than the total in 2002. And as noted above, diminished sales of DVDs and piracy have taken their toll on the industry.

Owing to these factors and others, studios have cut back. They have cut staff and lowered compensation for writers, directors and performers. Those lucrative “first look” arrangements have become more scarce as studios resist the lavish treatment they previously afforded the higher strata of creative talent. Instead, studios are attempting to reduce substantially the up-front compensation to all but the most prominent of actors and creative producers while restructuring back-end compensation to what they consider a more equitable sharing of revenue.

Further, studios are producing fewer movies and concentrating their efforts on a limited number of big-budgeted franchise or “tent pole” films, with spectacular special effects replacing dialogue and with presumed worldwide appeal. These include expensive high-tech productions, including 3-D movies like Avatar for which premium-priced tickets can be sold. Some specialty divisions that produced lower-budget “smaller” films have been eliminated. Variety recently assessed the current situation as follows: “The major studios, having vandalized the indie sector, now insist that low-budget dramas are toxic and that the future belongs to franchises.”

'Talent As Partners'

These shifts have had ramifications for how deals are structured with creative talent, how films are distributed and how those with liquidity in a global recession are applying their resources to the motion picture business.

In one new pattern, financing entities have stepped up to help fill the vacuum in funding and in dealing with talent directly at the production stage. For example, Relativity Media, which underwrites portions of Universal's and Columbia's slates of films, has become a source of funding that can be approached with projects considered unsuitable for studio development because the project is not sufficiently in the mainstream, or because of high up-front compensation and first-dollar gross participations that studios do not wish to fund.

Relativity's CEO was quoted in Variety as stating that Relativity is using a risk-sharing formula that “[treats] talent as partners, not third-party hires” in which high-priced talent receives little or no non-contingent compensation, but a substantial participation (as high as 25% to 50%) in the revenues of the production after Relativity recoups the production budget, the costs of prints and advertising, and interest costs. These deals still require considerable negotiation respecting items to be included in gross receipts and allowable deductions. Notably, in some of these deals 100% of the revenues derived from home-video exploitation might be included in gross receipts for the purpose of this calculation.

Relativity might then turn to a studio for distribution and, having provided most or all of the production financing, can secure terms that are more favorable than a studio customarily offers ' such as a distribution fee that is significantly lower than the fee of 30% to 35% that a studio might normally charge. Relativity also maintains an ownership interest in distribution companies that, if used instead of a studio, charge an even lower fee for distribution services.

Other domestic companies also are utilizing these types of arrangements. For example, Alcon Entertainment, owned by FedEx Chief Executive Frederick W. Smith, produced and marketed the highly successful film Blind Side. According to the Wall Street Journal, Sandra Bullock, the star of the picture, accepted a greatly reduced up-front fee in exchange for a substantial portion of the company's profits. Her financial position reportedly benefited from Alcon's having a distribution arrangement with Warner Bros. with a reduced distribution fee.

Looking Abroad

Foreign sources of production financing are also stepping forward. During the past few years, several prominent production entities whose principals include the cream of Hollywood creative talent have signed agreements directly with foreign financing entities. Some of the deals involve first-look arrangements that had been offered in greater abundance by U.S. studios. These financing entities not only are investing, but are also attempting to influence the content and creative process at an early stage while obtaining distribution rights in their own territories ' and perhaps other territories as well. Although many of them ultimately seek some type of partnership with a studio, such as for distributing a film, they represent a source of financing for creative talent that is either unable or unwilling to start a project with a studio.

For example, Imagenation Abu Dhabi has a substantial film fund to finance projects for the international marketplace. Variety reported that Imagenation recently provided the prominent producing team of Parkes and MacDonald with a revolving development fund. (The recent problems of Dubai World in repaying a $4 billion bond has given pause to those who were flocking to the Middle East for financing, but does not appear to have impeded Imagenation's efforts in regard to involvement in film production.)

The highly publicized efforts of Reliance ADA Group, based in India, also has provided a source of funding to creative talent who seek to develop films outside of traditional studio development. As first-look and similar arrangements previously offered by the Hollywood studios become less available during the current cycle, alternatives such as Reliance ' which offers first-look deals ' have become increasingly important to filmmakers around the world.

Creativity Required, But No Guarantee

The motion picture industry has gone through many cycles during the last few decades and there is no telling how long the current one will last. But creative talent who seek to produce films that do not fall into the category of franchises, and are willing to be creative in the deals they negotiate, do have alternatives for developing their product. Predictably, these alternative sources of financing are being flooded with proposals and, as before, the chances of getting one's film developed and financed remain relatively small.