HISTORY OF FILM INVESTMENT IN AUSTRALIA
The first full length feature film ever produced was the story of Ned Kelly Gang in 1906. Up until the 1930’s the Australian film industry flourished as an innovator and creator of content until the American film studios captured the world feature film market. The Studio system took advantage of the economies of scale it created. The risk mitigation it enjoyed by protecting itself with slate production and the fostering of a ‘STAR’ system of contract players. So, both the size of the American feature film market and the financial model used by the large American film studios facilitated and protected the growth of the Hollywood Film Studios.
In the 1970’s the newly elected Labour Government under Gough Whitlam introduced significant tax benefits for investors in Australian feature films. This was meant to encourage the production of Australian feature films.
It led to an increase in production of Australian films but did not always ensure quality, thereby producing a mixed bag of content – some successful, some not so.
MOTIVATION FOR INVESTMENT: TAX VS PROFIT
One of the consequences of facilitating film production by income tax incentives was to create an environment where the income tax deduction superseded the profit motive. Many film projects were being marketed to investors around the income tax deduction rather than the profit that would be earned by the investor.
In my view, this led over the years to many films being produced that weren’t of sufficient quality for the market and did not have the elements necessary for the film to be profitable. Many of the film projects made during these times did not in fact even make it to distribution and screening. The producers were earning their salaries through the film budgets however, profits earned by investors in most films produced during this period were few and far between.
In addition, significant financial engineering of the tax benefits led to the Australian Taxation Office taking a hardline on what was and wasn’t tax deductible and this finally led to the repeal of many of the major tax benefits that were in the Income Assessment Act.
When investors came to the realization that profits from film investment were being earned on only a very few film projects and that the tax deductibility of the investments was now in question, investment in film projects dried up.
Even today, 30 years on – Australian film producers looking for investment funds for film projects in Australia will come up against the view from investors that generally, films are a tax driven investment and don’t make profit. This view does not correlate to the reality experienced in Hollywood.
Good Film and TV content makes good profit returns for their investors. Like most manufactured product it comes down to the quality of the raw materials. In this instance; the production process, risk management of that process, the financing structure and marketing strategy.
INVESTING IN FILM IN AUSTRALIA vs. INTERNATIONALLY
Australian films are generally funded by family, friends and acquaintances of the producers with some financial assistance from Film Australia. These are generally single film projects that have not been sold to a distributor prior to commencement of production. In most cases they are produced and then marketed into the various film festivals and distribution outlets. This is a high-risk strategy which almost always ends in a loss to the investors. Some notable projects such as Mad Max, Crocodile Dundee, Saw etc., are the exception, and have gone onto achieve great success.
However, investors in film can increase their likelihood of receiving returns on their investment by actively considering a series of measures, milestones and benchmarks when considering an investment in film.
How do the investors and film production companies make the significant profits that film projects can and do achieve?
Consider the thoughts of Hollywood’s biggest banker at the time as reported by Michael White in The Los Angeles Business Journal, Nov 29, 2004.
‘HOLLYWOOD’S biggest banker John Miller, head of JP Morgan Securities Inc.’s entertainment group–and responsible for authorizing multibillion-dollar lines of credit for DreamWorks SKG, Metro-Goldwyn-Mayer Inc., Sony Pictures and Warner Bros.–says he often doesn’t even know the names of the films he’s financing. The bank is currently financing about US$7.5 billion in entertainment loans.
New York-based JPMorgan Chase, the second-largest U.S. bank by assets, is the lead bank in arranging 95 percent of financing for major movie studios and independent film producers. In 32 years of lending to the entertainment industry, Miller, 59, has bankrolled some of Hollywood’s best-known films, including “Gladiator,” “Seabiscuit” and many of the James Bond movies. He credits his success in part to how little he knows about such matters as plot, dialogue and special effects. He bases his decisions on numbers. “The movie business on a single picture is volatile,” he said. “Odds are that if you take a slate of 12 to 15 films, it’s almost statistically predictable. It’s quite amazing how predictable it is. You can get it within percentage points of accuracy.”’
SECURING YOUR INVESTMENT
Investors in film projects are able to protect to some extent the downside risk in their investment, and in some cases lock in a level of profit or return on their investment by ensuring a number of basic elements exist. Sometimes called the studio model.
|Number of projects invested:||10 to 12 film projects|
|Budget range:||Minimum $3million to a maximum of $20 million per project|
|Finance security:||All projects are to be cross collateralized so that benefits of a diverse portfolio of investments are realized.|
|Government benefits:||Each film project has to qualify for the Australian Government QAPE rebate
(Other foreign jurisdictions have similar benefits that should accessed)
In addition, State Government also provide grants and rebates for film production in their State
|Market Place attachments:||All film projects should be presold to “bankable” distribution entities before production commences. These can be against forecasts foreign sales and/or forecast domestic US sales.|
|First place in recoupment:||The investor should be first place after the bank and distributor in recoupment of interest, if any, and their capital invested.
The investor should then be sharing in 50% of all profits from all revenue streams.
|Completion Bond:||To ensure strict budgetary control, compliance to the qualifying Australian elements and the appropriate completion and delivery of the film all productions must be insured through an internationally recognized completion bond company.|
|Finance and banking in place:||A bank or other form of financier is generally required in order to fund the film projects and cash flow the Government benefits attaching to the projects.|
The importance of having each of these elements in place for each film project cannot be underestimated for an investor in film, particularly those investors who may not have the expertise in film production.
In many ways the interests of the investor are aligned to those of the bank/financier, completion bonding insurer, distributor and Government agencies.
Matters such as confirmation of chain of title, alignment of script and budget, project marketability, production capability and expertise, ability to deliver the projects on time and on budget will be matters which each of these organizations will have deep interest in understanding, approving and ensuring compliance.
A TYPICAL INVESTMENT SUMMARY
|ASSUME TOTAL BUDGET OF:||$50 million|
|Foreign distribution guarantee 30%||$15.0 million|
|Commonwealth Government QAPE 35%
(QAPE is 40% of qualifying expenditure)
|State Government Grant/Rebate 5%||$2.5 million|
|Investor 30%||$15.0 million|
The bank/financier would “wrap” the above securities and provide the $50 million to fund the budget. It should be noted that the budget includes all costs, including costs of financing.
Note in this model some territories have not been pre-sold. US domestic and China being two that in many cases are not pre-sold and left open until sold after completion in order to maximise the revenue from these territories. These unsold territories therefore act as further security for the investor.
RETURN ON INVESTMENT
The returns to the Bank/Financier, after exhibition fees, are paid first.
Distribution guarantee of 30% is paid on delivery of each film.
The QAPE of around 35% is paid on lodgment of the income tax return for each film.
The State Government Grant is generally paid on delivery of each film and any rebate of costs occurs during the period of production as part of the production budget. This will amount to around 5% of the budget.
Once these amounts have been collected, they are paid to the bank for principal and interest. The bank is paid out early in the revenue cycle with the remaining balance then paying out the distributor investment and costs from first receipts from exhibiting the film.
Any receipts after paying the distributor principal and interest costs are paid to the investor against interest and the investment.
As can be seen from the example any receipt above the distribution guarantee of $15 million plus interest will then be paid to the investor. If the projects recover the budgeted costs of $50 million then the investor will have recovered its investment plus interest and be collecting its share of the profit. In the example above the film projects need to generate revenue from all sources of $30 million plus interest in order to repay both the distributor and the investor. Half of the revenue above this amount would then be returned to the investor as profit.
This demonstrates the importance of investing in a number of cross collateralized film projects rather than investing in an individual film project.
If there is interest in investing in film projects, it is possible to achieve healthy returns on the investment and also reduce the associated investment risks.
- Invest in a slate of 8 to 12 film projects
- Projects must be cross collateralized – investor must have interest in the whole slate of projects.
- Bankable distribution guarantees for all projects in place
- Completion bonds in place
- Bank/financier will cash flow all projects
- State and Commonwealth Government financial benefits confirmed
- Investor receives its interest and principal after bank/financier and distributor but before any other parties to the film projects.
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This article does not take into account the investment objectives, financial situation or needs of a particular person or entity. Before acting on any investment strategy or advice you should first consult with your current ASIC accredited investment professional or seek out a compliant investment professional for such.