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DEALMAKING DONE RIGHT: A Back-to-Basics Approach to the Byzantine World of Waterfalls, Hurdle Rates and Preferred Returns

Posted By Daniel Lawrence Abrams, Monday, August 10, 2015

Before you can negotiate your own deal as a producer, you should have a strong understanding of how revenue waterfalls work and how the future "pie” can be split up. Here we provide some rough outlines of how money often flows through a production. There are standard players involved, and their placement in the revenue waterfall is often similar.

The EXHIBITOR is the theatre or theatre chain that sells the movie ticket to the customer.

The DISTRIBUTOR is the company that normally provides "P&A” (prints & advertising—a bit archaic since the advent of digital cinema) and then connects the PRODUCTION COMPANY to the Exhibitor.

The Distributor also connects to:

• TVOD companies (Transactional Video On Demand, e.g., cable VOD, iTunes, Amazon, Google Play, etc.)

• SVOD companies (subscription-based VOD, e.g., Netflix, Amazon Prime)

• AVOD companies (advertising-based VOD, e.g., Crackle, Hulu, Maker)

• PAY TV companies (HBO, Showtime, Starz, Epix, etc.)

Increasingly, ISA (International Sales Agents) often function as Distributors, making the line between the two increasingly blurry.

There are many differences between studio financing and independent film financing. But either way, you will likely be interested in finding equity investors.

When you’re courting investors, the ideal scenario is to secure sufficient equity funding for the full amount of the film’s budget. This is rare, especially as budgets get bigger. Often a film will raise a substantial fraction (25% to 60+%) of the budget in equity from private investors, and then use that to secure the "package”: script, director, producer colleagues and, most importantly, the stars.

At this point an ISA can do "presales,” taking three to nine or more months going to the major film markets (AFM, EFM, Cannes, etc.) and getting minimum guarantees (MGs) from buyers in countries worldwide. These buyers agree to book the film at a discount; buyers who wait to see the completed film could pay more. A producer might then get financiers to "cash-flow the MGs,” giving your project a loan against those sales contracts as well as against any expected state/provincial/national production incentives or tax credits. Finally, other higher-risk financiers might provide any necessary "gap/mezzanine financing,” giving your project a higher-interest loan to cover any part of the film’s budget not covered by equity, MGs and tax credits. Once everything is in place, you can consider your picture greenlit.

When it comes to the deal with your equity investors, virtually anything goes so long as you follow the rules of the SEC (U.S. Securities and Exchange Commission). You’d be wise only to pursue accredited investors who can demonstrate they are "high net worth individuals.” There’s greater liability when taking investments from unaccredited investors.

Almost no two investment agreements are exactly alike. But there is a "Standard Deal” structure that’s reasonably popular, for low-budget films in particular. It can be succinctly explained as "After Payback, Hurdle Rate, then Split into Two Pools”.

It works something like this:

a) 100% of first revenue to the Prodco/project (assuming all project’s costs, obligations to unions, loans, sales agents, etc. have been paid) first pays back investors’ principal pari passu, which means pro-rated on equal footing. (Exception: Gap or mezzanine financiers will typically be paid at a higher negotiated rate.)

b) Then subsequent revenue pays investors a one-time "Hurdle Rate” (aka "Preferred Return”), often between 5% and 20%, for the entire duration of the investment (i.e., not compounded annually).

c) Then any remaining revenue/proceeds is split 50/50 into two pools: the "Investors’ pool” and the "Producers’ Pool”

- Investors are paid pari passu from the Investors Pool.

- Producers, director, actors and other profit participants receive "upside” in the form of proceeds from the Producers’ Pool. Note that the 50/50 split assumes that the team in the Producers’ Pool is working for discounted rates, which are thus balanced by a substantial share of the back end. Some equity investors may require a 55/45 split, or even up to 70/30, but in that case the team should get paid their full rate for weekly full-time work.

Another structure can be described as a "Revenue Corridor Split,” whereby funds flow in and are split into different "corridors” (percentages), which can change according to milestones.

For example: First revenue to the project (after all costs, etc.) is split so 80% goes to the Investors’ Pool and 20% to the Producers’ Pool, up until the investors are paid back their entire principal + their Hurdle Rate.

Any remaining dollars are then split 50/50 between the two pools. This way, the "corridors” ensure that at least some initial revenue goes to the non-investor profit participants in the event the project earns money but not enough to make the investors whole. It’s a useful means of addressing the concerns of profit participants skeptical that the film will earn enough revenue to make worthwhile a late placement in the waterfall.

For bigger budget films (say, more than $20 million), producers often employ a very different structure whereby the split tilts more heavily to the financier’s favor due to the greater risk of losing very substantial amounts of money. Alternatively, profit participants might receive a schedule of bonuses based on box office milestones, or simply a smaller percentage of the gross revenues instead of a share of a Producers’ Pool. Producers, directors, stars and other profit-participants might agree to this because those percentages may yield considerably greater returns if the film becomes a blockbuster. The bottom line is that there are a thousand ways to structure a contract, and each has its own pros and cons. Having a good attorney to work through the process with you is crucial.

($30 million film budget that earns $150 million in Worldwide Theatrical Box Office)
*Click for full version. Also attached at bottom of article

BOTTOM LINE RECAP: >>> All Media WorldWide Gross Revenue = $240 Million

Work 2 to 5+ years for… >>> Lead Producer’s Profit Participation Share = $1.9 million

Splitting the Future Pie

The bad news is that in the indie world, many films lose money. If you’re using the standard structure, you should be prepared for your points to end up worthless. Consequently, filmmakers may want to include a profit-participation "floor” in their contract to guard against notorious "Hollywood accounting.” That agreement should be coupled with strong auditing rights, giving the producer the ability to fully audit the books, initially at her own expense, at least once per year. Insist on serious penalties should the distributor ever underpay by more than 10% (perhaps reimbursement of the cost of the audit plus triple the underage).

How should you split up the pie? There are some standard ranges to consider.


Assuming budget under $5M:

• "Produced By” Primary/Lead Producer: 10% to 40% (often 20%) depending on development expenses

• Director: 2% to 15% (often 5%)

• Writer: 1% to 10% (often 5% if not WGA)

• "Name-Above-the-Title” Actor: 3% to 20% (often 5%)

• 2nd Name Actor: 1% to 10% (often zero)

• 3rd Name Actor: Zero to 5% (often zero)

• Name Cameos/Rest of Supporting Cast Collectively: Zero to 10% (often zero)

• DP: Zero to 5% (depending on if he/she cut their rate)

• Editor: Zero to 5% (likewise)

• VFX/Other Key Dept. Heads Collectively: Zero to 5% total (likewise)

• Other Producers, Collectively (i.e. not Executive Producers/financiers): 10% to 20%

• Line Producer: Zero to 5%

• Executive Producers: 1% to 5% of the proportion of investment they bring in

• Entertainment Attorneys: Zero to 7% (often zero if not discounted rates)

• Packaging Agents: 1% to 5% (only if they provide three or more major elements)

Remember, this money is paid separately, out of the Producers’ Pool, not from the gross revenue to the project.

Daniel Lawrence Abrams produces feature films (including Mining for Ruby) and television (including the Emmy-nominated The Writers Room on Sundance Channel). Special thanks to Stephen Marinaccio for his assistance in preparing this feature.

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Posted Friday, September 4, 2015
This is a very helpful article. Thank you for posting!
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