Most Canadian producers are looking for options beyond the typical film financing model, which relies heavily on government funds. With the rules often changing and no guarantees that public money will be accessed, producers have recognized the need to look elsewhere to build sustainable companies based on a solid slate of production.

The alternatives for Canadian feature film producers – beyond preselling the world – include private investors, venture capital groups, investor funds such as pensions, and making up shortfalls with gap or insurance-backed financing.

But feature filmmaking in Canada is a precarious business, and unlike other industries where market demand and potential upside can be predicted with some assurance, the success of feature films is largely unpredictable, making for a harder sell when a producer approaches prospective investors.

A further hurdle is that few investors understand the workings of the film industry, and although this is beginning to change, many are leery about entering the movie game.

Gap financing

Most Canadian banks only do interim financing for film and tv projects where the risk is minimal because presales and tax credits will cover the production budget and serve as collateral for the loan. The few banks willing to gap finance say yes only to established producers with a proven track record and well-known sales agents.

Producers have to analyze whether the high interest rates on these loans make the deal worthwhile in the long run.

Straight gap financing, says Ken Chartrand, a Winnipeg-based film and entertainment financing consultant, is usually reserved for projects where the shortfall is small.

For larger gaps, insurance-backed financing is the usual route, says Chartrand, formerly with the Royal Bank’s Entertainment Group and now president of Mantis Consulting Services.

The costs associated with insurance-backed gap financing are high, starting around 10% to 12% of the gap amount insured.

Insurance-backed

gap deals

Still, Malcolm Silver, who provides production financing for independent producers, says over the past year he has seen a greater interest in insurance-backed deficit financing and notes the deals are becoming more sophisticated.

‘There has been some poor press and some [insurance-backed deals] have not performed well,’ says Silver, ‘but there has been a weeding out of the market, which means the bad or weaker players no longer exist and the stronger and better thrive.’

There has been a move in insurance-backed deals to finance slates of films (six is typical) rather than one-offs, says Silver, which increases the likelihood of recoupment. But this makes it more difficult for the smaller producer to land insurance-based financing.

Also, the criteria for these insurance-backed deals is now tighter, particularly when it comes to the type of producer accepted and the production being handled. Typically, the projects have higher budgets and gap levels have lowered to 20% to 30%, he says.

Dan McMullen at HSBC Bank Canada also notes that insurers are now looking to cross-collaterize packages of at least six pictures so if they take a hit on one, they can make up on subsequent films. ‘That’s a new twist on where insurance product is going.’

But he adds that with a number of insurance companies pulling out of the film business, there is confusion at insurance companies about insurance-backed deficit financing and ambivalence about it at the banks.

Insurance company/bank model reduces costs

Independent Film Financing, a private Toronto company with an exclusive agreement for Canada with the Imperial Bank of Los Angeles, offers gap financing, but iff’s Laura Polley says the gap is being limited to 20% to 25% of the budget.

Another new option for the insurance company is to take part of the gap while the bank takes the remaining portion. This minimizes the risk for the various financiers and is less expensive for producers, she says. As well, in these deals, the gap financed can be as high as 40%, with the bank taking 20%. This scenario requires a slate of projects, not just one film, she adds.

iff will begin to work with a producer who has only 50% of financing secured to help make an additional presale to bring financing up to 75% and then gap the remainder.

Polley says the number of producers coming to iff for gap financing is not increasing. She would like to see more producers look to gap financing as a means to retain ownership and back-end revenues. While interest rates on gap financing may seem high, Polley points out that on the upside producers do not have to presell the world and instead can retain rights to their projects.

With gap financing, the producer controls the project, the distributor takes a fee and expenses, and once the bank is repaid, profits go to the producer.

As for the ability of producers to afford gap financing, Polley says: ‘We help producers get to the point where they are at a 20% gap, which includes the cost of financing. So if the gap is, say, 17%, we will increase it to 20% and include the cost of financing.’

Costs are reduced, she says, if a producer brings a slate of films, and although all projects are analyzed on an individual basis, if one doesn’t measure up, other pictures can be cross-collaterized, giving the producer more negotiating clout, she says.

New spin on

insurance-backed deals

Leif Bristow of Toronto’s Knightscove Entertainment has taken a different spin on insurance-backed financing.

Generally in insurance-backed deals, a producer goes to the investor with a slate of films, and under the terms of the deal, the producer is obligated to produce those specific films.

‘What happens if you give the investor a slate of 11 films and then three better ones come along? You are still tied to the projects you guaranteed to the insurance companies,’ explains Bristow.

Instead, Knightscove has raised an insurance-backed bond issue of $50 million with three international insurance partners which is tied to the financing of family films, but not to any pre-arranged slate.

‘What we have done differently is that we have raised the money, it’s in our bank account. Then I look at a project and if it makes sense I will fund x percent of the gap. We act like our own internal risk-management team and oversee the projects we invest in.’

The deal gives Knightscove the flexibility of choosing projects from all over the world at any given time. The game plan is to produce and finance 10 to 20 family films with budgets of $100 million over the next four years.

By focusing on children’s and family features, Bristow says Knightscove has a pulse on the market for these films and will develop a reputation as a specialist in the genre.

Once Knightscove selects a script, the project is submitted to the insurers for what Bristow calls ‘a quick technical, not creative, sign-off.’

A producer can take the script to Knightscove, and if it likes the project it will finance the shortfall in cash. Knightscove will gap between 25% and 70% of the budget on projects ranging between $4 million and $8 million, and occasionally up to $15 million. On a Cancon project, which accesses tax credits and government funds, Bristow says Knightscove will fill in the remaining financing and also help bring international distributors on board.

‘Done properly over time, this can be a very viable additional outlet for producers to access funds,’ says Bristow.

He also views his company as a faster, less expensive alternative to gap financing. Gap financing with a financier on a per-project basis can be quite expensive, says Bristow, with fees ranging from 15% to 50% upfront. On top of this are fees for legal opinions required by banks.

‘I have seen people get $2 million of insurance to take to the bank for a portion of gap and pay $75,000 to $100,000 for the opinions, plus bank charges for loans they set up,’ says Bristow. ‘It’s extremely expensive and can take two to three months. The bank expects $1.60 for every dollar they give you above all the fees they take.’

Knightscove takes an ownership interest in the projects it finances, depending on the level of investment, and an executive producer or coproducer credit.

The VCG route

Venture capital groups are another source of investment. According to Chartrand, vcgs seldom invest in a project, but rather invest in a company with a proven track record and a slate of upcoming projects. They take a percentage of ownership in the production company and look for a 35% to 40% return on their investment.

‘The vcg wants to see the upside of the project, but how do you prove that? You can’t. But if the company has seven or eight projects going into production, then there is a greater chance that two or three will make a return, so the potential upside is greater and the vcg may take a risk,’ explains Chartrand.

The producer gives up a percentage of the film’s earnings, plus the vcg takes money off the company’s return. A film producer has to generate high revenues to make such a deal worthwhile, he says.

Private investors

Smaller producers for which the vcg route is not possible can seek private investors who each take a small number of shares in the production company.

Investors receive tax deductions through rrsps for investing in companies, and some provinces provide additional tax write-offs for investing in small businesses. As opposed to a venture capital group buying around 25% of a company, explains Chartrand, each private investor has a small stake and therefore will feel less loss if the film proves unsuccessful. However, Chartrand points out that raising equity this way can take a long time.

One of the most innovative models, says hsbc’s McMullen is sodec in Quebec, which has created a pool of funds for gap financing which combines public and private money. ‘This is a great concept – everyone gets together and creates a fund and the risk is shared and there is a professional due diligence in the dispersal of money.’

Investor funds gain favor

Investor funds such as pension funds are also increasingly being talked about as a source of financing for the film industry. The closings are less complex, and unlike banks, which tend to want their money back not long after they lend it, roughly 24 months, funds offer 36 or 48 months, allowing the necessary time to exploit a film in the marketplace.

The plus of working with a pension fund, says Chartrand, is that it eliminates the need for a commercial bank.

Blackwatch Entertainment of Montreal picked up a $20-million investment from a Canadian pension fund last January and is contracted under the terms of the fund to produce 10 films in the next two years (Playback, Jan. 25, 1999). The pension money has been invested directly in the distribution division of Blackwatch, which provides advances to producers on films with budgets of $3 million or less.

The $20-million investment is repayable in four years and insured by London-based Screen Partners. The investor receives 85% of all gross revenues from the distributor.

Looking overseas

Silver is also seeing money coming from tax-shelter funds in Germany, as well as in the Netherlands, where cash is being put up for equity. While Germany does not require the project to have German involvement, in the Netherlands the films must have some local attachments, he says.

Canadian producers are working increasingly in coproduction arrangements with the u.k., and accessing the u.k. sale and lease-back, says Silver. The u.k. sale and lease-back is a form of financing in which the producer sells the cost of production to a leasing company so the producer can still exploit the film and make a 5% to 10% gain on the cost of production.

‘The producer loses ownership for the moment, but they can buy it back – and they receive money for doing this,’ explains Silver.

To take advantage of the sale and lease-back, a u.k. partnership must be in place and generally the film is already fully financed. However, Silver predicts that as leasing companies in the u.k. become more aggressive in this market, they will come on board prior to full financing.

Imperial Bank is looking to become much more involved in coproductions, says Polley, and, through its branches in Germany, Australia and a-soon-to-open u.k. division, use its connections in these countries to help producers structure coventures and access local subsidies and distributors.

P&A partnerships

David Doerkson at Saskatoon-based Edge Entertainment is looking into p&a limited partnerships as an additional source of funding for completed projects. Working with a security company, a p&a fund is set up for a slate of films, generally five projects, and partnerships are sold under the Revenue Canada Tax Act.

The production company is the general partner which owns the fund, and limited partnership units are sold off, typically at $10,000 to $25,000 per unit. Investors get a tax deferral, putting them in a better income tax position. On a five-project slate, approximately $5 million can be raised, says Doerkson.

In addition, he views insurance-backed private placements with pension funds as having promising potential. ‘The investment is not made in a film but rather in the corporation, so there is less risk because of diversified revenue streams.’

Presales

Presales remain one of the least risky ways of financing production of a film, particularly if the producer is working with a highly reputable distributor.

Peter Simpson at Toronto’s Norstar Filmed Entertainment, for example, is staying away from private investment.

‘First you have to raise the equity financing, and then you have to convert the equity into sales. So on a $20-million picture you have to raise the $20 million in equity and then make $20 million in sales. In the end, you have raised $40 million and you are still just as far from a profit.’

Simpson finances his films, which are budgeted at anywhere between $4.5 million and $45 million, through a well-placed distributor with access to bank lines and presales to major markets such as the u.k. and Germany. He goes to the bank to finance the balance.

Middleman financing

Ken Nakamura of Toronto based Tsunami Entertainment says the presale route isn’t always the best option. For less experienced producers, the sales are difficult to make because distributors want to see an established track record, and when presales are secured, the paperwork can mean long delays and high legal fees.

Nakamura is a former founder of Dai-ichi Motion Pictures in l.a. and structured distribution licence agreements for Dances With Wolves, Total Recall and Basic Instinct. On his most recent, yet-to-be-released picture, The Spreading Ground from director Derek Van Lint and starring Dennis Hopper, Nakamura went the presale route, closing 14 territories.

‘Because of the number of presales, I went through a horrifying closing period,’ he says.

Banks require distributors to sign notice of assignments (which bind distributors to pay directly to the bank) before banking presale contracts, so Nakamura had to work with lawyers to have 14 different notice of assignments prepared. Some proved more difficult than others, as was the case with Germany, which has a technical acceptance clause stating that if the final product does not meet German broadcast standards, the German broadcaster doesn’t have to pay. In the end it took two bankers, an attorney working at us$350 an hour and a bond company to close the deals, says Nakamura. Cumulative legal fees were us$200,000.

‘Having gone through this, I said there has to be a better model,’ explains Nakamura, and gap financing did not appear to be it.

‘Typically, the setup fee is binding even if the picture falls apart and then there’s interest reserve, gap fees, plus penalties if you don’t fill a certain amount of the gap by a certain time. These soft costs can add up to 25% of the budget.’

Instead, Nakamura decided to form his own middleman financing company. He set up a first-look agreement with Medienbeteilligungsund Produktion – an accelerated capital cost allowance equity fund in Germany, which allows investors to write off concurrently with the year they invest.

Through the fund, Nakamura can pick up 50% to 70% of the project financing, so long as the fund approves the budget, director and lead actor. The fund retains all rights, including theatrical, video and pay-per-view.

Nakamura explains that the equity fund is not subordinate to any bank or lender, it recoups its 50% as the first dollar out.

In Europe, a number of major buyers have been consolidating and becoming large buying consortiums which make pan-European deals. clt-ufa, for example, has a monopoly on the European pay window, and Kirch Group on free television, with stations all over Europe.

Nakamura, a former Asian buyer, set up relationships with three such European superbuyers and says with one sale he can raise 50% of a budget. Some of the European superbuyers, such as clt-ufa, have a soundstage and producers and will come on board as coproducers, he adds.

Between the German equity fund and the pan-Europe presale, the full budget of a film can be financed, says Nakamura. And with only two deals required to reach full financing, he says the paperwork can be closed within three weeks, meaning less expensive legal fees.

Furthermore, producers can wait until the film is finished before selling the remaining territories – North America, Latin America and Asia. Sales agents take higher commission rates on presales, says Nakamura, charging between 20% to 25% on each sale. However, the fee for taking a finished film to three markets is generally around $100,0000, with 5% to 10% sales fees, he says.

Nakamura does not take any credits or rights on the film. He charges an appraisal fee to determine if the project fits with his mandate, and once the project is approved for financing, he charges $250 an hour (which he says is far less than the 20% commission a producer would pay to a sales agent) and drafts the Pan-Europe and equity investment agreement.

Nakamura takes on only commercially driven projects with international appeal – either features, mows or tv series with high- to low-end budgets.

‘I act like a bank – I evaluate each territory, and if the investment is $5 million, then there better be potential for $10 million in sales,’ he says.

As producers and investors gain more experience in film financing options, most of the industry is confident that these and other financing options will become more viable. Furthermore, as Canada’s feature film industry begins to mature and gains an increasing amount of international recognition and box office receipts, most producers are confident that financing feature films will be less of a hurdle.

As McMullen points out, ‘Nothing works better than success – that’s how you attract money. And we are on the verge of producing films in the $8 million to $10 million range that recoup their costs.’