In this tight money market, producers are looking for more ways to tie a production’s equity, including equity held by public agencies such as Telefilm Canada, to private sources of financing and lending. Many look to augment budgets already supported by Telefilm or the Canadian Television Fund with equity financing from Canada’s private production and development funds, which on an aggregate basis invest up to $30 million a year. In the past year, there has also been an increase in the number of producers with Canadian equity financing looking for some measure of gap financing on more exportable projects.

Gap financing has historically allowed producers to complete their production financing requirements while holding on to equity and limiting presale requirements in favor of the perceived back-end potential for distribution revenues.

Toronto-based Independent Film Financing, exclusive Canadian representative of Comerica Entertainment Group, is seeing an increase in projects with Telefilm support. ‘More than not we are asked to participate and provide the producer with gap as well as to hammer out a recoupment position that is satisfactory to both the bank and to Telefilm,’ says IFF president Laura Polley.

Although the gap financier has traditionally held the first recoupment position, as a lender and not an investor, Polley says there is an effort to evolve a position that works for the gap financier and investors such as Telefilm and The Harold Greenberg Fund and other sources of private and public equity. The challenge for the bank and the equity investors, she says, is to negotiate ‘a workable split’ of the export revenue stream.

The split reduces the amount of gap the bank can offer because the revenue is shared.

Robert Beattie, Canadian representative of The Lewis Horwitz Organization, a division of Imperial Capital Bank, says he is also seeing more projects with Canadian equity involvement, but they come with challenges.

‘Gap lenders typically require that equity investors recoup from profits. And as a gap lender, our view is there can be no profits until such time as the budget has been covered by sales,’ says Beattie. In other words, as the lender, the gap company is not looking ‘to share an upside. As equity investors, they get the upside, we don’t.’

Market unpredictability

Based in Montreal, FIDEC did $10 million in gap financing in 2002. FIDEC is a limited partnership with shareholders including The National Bank of Canada and SODEC. It has $45 million in available capital.

In addition to gap services, FIDEC will act as an equity investor on a project basis for a share of profits. The programs are open to Quebec and foreign companies engaged in strategic alliances with a Quebec company or of benefit to the local economy, says managing director Pierre Leblanc.

FIDEC has closed a couple of deals with Telefilm equity involvement, but those deals were ‘the subject of tough negotiations,’ in view of the agency’s requirement for a reserved revenue corridor or territory, says Leblanc.

On the issue of export sales, Leblanc says, ‘The market is so tough. It’s become unpredictable.’

FIDEC introduced short-term interim financing in ’02 and also supports two financing programs reserved for Quebec companies, including investments in rights acquisitions up to $2 million per project and an investment in equity, quasi-equity or debt. The latter financing takes the form of a direct holding in the capital stock of an enterprise at the request of the Fonds d’investissement de la culture et des communications (FICC).

The ‘gap’ deal

In the past three years, Canadian producers have seen the gap-financed portion of budgets reduced from 25% and 35% to 10% and 15%, ‘and in a perfect world, 20%,’ says Polley. (On TV loans, LHO says this is generally reduced to 10% to 12%.)

Typically, gap-financing companies in Canada want to see close to 80% of the cost of production covered through presales and soft money. Within the 80%, they will need to see presales to at least two major foreign territories, indicating a project is sellable in other major territories.

And gap financiers need to see 2:1 coverage out of primary territories (the sales projection should be double the size of the gap), and presales to typically two (or three) of the primary territories. These areas are understood to mean North America, the U.K., France, Spain, Italy, Germany, Benelux, Scandinavia, Japan, Australia, South Africa (usually), and sometimes pan-Asian satellite TV and Latin American pay-TV. ‘It demonstrates the product is sellable and that the sales agent still has access to international buyers,’ says Beattie.

According to Beattie, the cost components of gap financing include the interest on the loan (typically prime plus 2%), a setup fee, a percentage of the overall size and complexity of the loan (normally 1.25% to 2.5%) and a gap fee (typically 7% to 8% of the amount of the gap). And then there are legal costs associated with the loan procedure, also incurred by the producer.

Polley says that typically IFF is looking at project budgets in the $3-million to $20-million range, with productions in the $8-million to $10-million area the more difficult proposition, especially without a genuine international theatrical release.

Smarter banks

Beattie says the multi-jurisdictional aspects of production have become increasingly complex, covering legal, tax, copyright and agency issues.

Based in Vancouver, Beattie says he’s seeing ‘projects from sophisticated producers who are able to access those programs and manage those programs, and because they are more complex, they also take more time and money to manage.’

Beattie says the first requirement for LHO ‘is an experienced producer who has a history of delivering product to the international marketplace. If he or she has no experience doing that, how can we determine [whether] the product is going to be acceptable?’

Secondly, LHO looks for international sales expertise – in effect, access to local buyers or distributors, or a recognized contracted sales company. ‘If a project is attached to the right sales agent, it gives it a degree of credibility,’ he says.

‘Banks are doing less, analyzing more, and they are smarter,’ says Polley.

She adds that IFF’s Canadian profile is evolving, pointing to Comerica Bank’s recent closing of a $100-million-plus facility with Fireworks Entertainment.