Union Patriot Capital

Indie financing fills in the gap / Banks' innovative methods bridge presales-budget difference

Feb. 27, 1997

By Robert Marich

If there is a given for independent film producers and distributors, it is that they always need money. Like legendary robber Willie Sutton, the first place most turn to is the bank -- because that's where the money is.

However, only a few years ago, financing of any kind for indie film and TV companies from banks had gotten extremely tight. In the wake of the withdrawal of Credit Lyonnais from the market, a number of high-profile bankruptcies, movies that failed to live up to expectations and other problems, the number of banks and the amount of money available to indies had shrunk.

As this year's American Film Market opens, the banks are back with more players, innovative financing plans that in some cases include insurance for investors, and a greater understanding of the global independent film marketplace. There are even banks willing to invest in films, and to provide crucial "gap" financing that bridges the difference between revenue guaranteed by presales and a film's budget.

"This is the most optimistic and creative time for financing since the 1987 and 1988 period, which marked the end of the video boom" for indies, said Nigel Sinclair, chairman of law firm Sinclair, Tenenbaum, Emanuel & Fleer .

"From a banking perspective, I don't think it's been better," agreed John Miller, managing director at Chase Securities Inc., the independent sector's biggest bank lender with a portfolio in excess of $1 billion. "Banks are willing to do unusual and exotic financings."

The reinvigorated banking sector could not have come along at a better time. With major studios that don't need bank financing taking an ever bigger bite of the marketplace, the financial pressure on indies has escalated in recent years.

At a time many of the action, horror and sex-comedy genre pictures that indies counted on as sure things are no longer working, the producers are being slammed by rising budgets, escalating star salaries and ever-increasing marketing outlays.

The most important element is the return of so-called gap financing, which as recently as three years ago was nearly impossible to find. Many banks simply considered it too risky. They didn't want to put up a dollar that wasn't guaranteed by presold distribution contracts for various markets around the world.

Today, gap financing is again a mainstream funding technique that helps to overcome the patchy nature of the presales market.

An early practitioner of gap financing was the Century City office of France's Banque Paribas, run by group portfolio manager and consultant Michael Mendelsohn, who has also led his institution into taking equity stakes in a number of movies. Mendelsohn said recent deals include the Jack Nicholson film "Blood & Wine," on which the bank covered an $8 million presales shortfall on the $30 million budget.

Film financiers say today there's plenty of money for projects with solid distribution deals, which is where the real obstacle lies. Distribution is difficult because a shakeout shrunk the worldwide buyer pool, especially in strategically important U.S. theatrical distribution market where indies Savoy Pictures, Vestron and others have exited the business.

There has also been a shrinkage in the number of indie distributors around the world as the major studios have increased their dominance, and in some cases made output deals that tie up former indies in long-term arrangements.

The indie distributors in various foreign countries, which remain are often much more hesitant to make presale commitments based only on a title, a concept and some casting. They want to see either a lengthy promo reel or the finished film.

"Gap financing is pretty much the only way independent films get financed these days," said Morgan Rector, president of Imperial Bank Entertainment Group. Noting that in the 1980s U.S. distributors were routinely able to fully presell a film before production, he said the project fully funded by presales no longer is feasible, with so many territories taking a wait-and- see stance.

For producers, the return of gap financing is like a man on the moon finding oxygen. Lewis Horwitz, head of a Century City, Calif.-based film lending boutique bearing his name, said gap financing, while an expense item for film producers, allows them to focus on filmmaking instead of selling. With gap funding, a film can began production on a firm schedule, eliminating delays that may cause cast members to drop out.

Banks themselves don't always provide gap money, but they tap nonbank sources for gaps, while lending directly on presale contracts, which are solid collateral. "On a single picture, we would probably source a gap financier," meaning an outside entity, said Anna Bagdasarian, San Francisco-based vp, manager of entertainment finance at Union Bank of California. "On a multiple-picture deal, the bank would consider lending directly on estimates."

Union resuscitated Oscar-nominated "The English Patient" when it encountered a financing crunch just before production, shortly after 20th Century Fox withdrew its support from the Saul Zaentz production.

As the money becomes more available, producers are also increasing the amount that they take. "The gaps started at 30% (a few years ago) and today that seems to be the minimum," added Horwitz, an entertainment banker for 27 years.

In other trends affecting financing, funding executives detect the following:

- Funding for English-language films from Europe is growing. For example, the United Kingdom is launching a program to use income from its national lottery to finance films. Elsewhere, French TV companies are active in co-venturing on English-language films.

- The completion-bonding crisis of the early 1990s, which came when the dominant company guaranteeing productions went bust, has passed. New firms entered the field and existing bonding outfits expanded. These bonds guaranteeing that there will be money to finish a film are crucial to making the banking arrangements with confidence.

- Prints-and-advertising funds, which paid for marketing costs of finished films, have disappeared. The reason is this "last money in/first money out" vehicle squeezed all potential income out of underperforming films, shortchanging other funders farther down the payout chain.

- Hollywood labor guild policy that indie film producers make upfront guarantees of downstream foreign residuals, which first surfaced in 1993, continues. Forking over residuals upfront adds to production costs.

Meanwhile, insurance to pay back financiers such as banks or equity investors is a novel financing technique that was unheard of just two years ago.

Peter Borisow, head of Film Finance Management Ltd., said such insurance works with a package where risk can be spread over six or 10 titles. "You can't really do it with just one single picture," said Borisow, who said he's arranged multipicture insurance but declines to name clients.

However, sources say London-based outfit C. E. Heath Ltd. provided insurance for backers of Mike Medavoy's Phoenix Pictures, which is based at Sony Pictures Entertainment.

Hollywood-based film producer and finance executive Peter Hoffman said such insurance adds to the cost of filmmaking, but gives funding entities confidence to go forward. Such insurance deals are complicated, so "Maybe it's too soon to know how widespread they will become," Hoffman said.

While the indie sector's financial service community has coalesced, the marketplace has not, with major Hollywood studio megabudget features dominated screens around the world.