Playing the Indie Film Market Through Funds

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When

Miramax

paid $6 million for "Next Stop Wonderland" at the

Sundance Festival

in Park City Utah last week, most observers thought they were making a preemptive bid to extend their dominance over independent film distribution. But making, buying and investing in movies share one thing. They're all subjective. "There is no way to value a film's worth until you see what someone is willing to pay," says Billy Minot, president of Boston-based

Media Financial

, which specializes in entertainment investments.

Through entities like

Media Financial

and the

Shooting Gallery

, a New York-based production company, individual investors can access structures whose expertise at managing the risks of film investing is not unlike the acumen of professional money managers. In fact, both these ventures employ a portfolio approach in a fund setting that offers diversification and, in the case of Media Financial, even a guarantee of principal.

Reasons abound to consider alternatives to the customary route of backing an individual project or start-up company. Despite returns measured in thousands of percents earned by independent hits like "The Full Monty," the current environment is far riskier than it was even two years ago.

Bennett Pozil, group head of

Entertainment Finance

,

Natexis/BFCEBennett Pozil

, asserts that "there is more competition for theatrical release. Markets that were opting to buy lower budget films now have enough product. Domestically, new video stores don't need video-based release to fill the shelves anymore. As direct to video is dying down, producers are looking toward foreign TV and direct-to-cable. But Europe, Asia and Latin America have bought so much product that they can be choosy now, too."

The difficulties for independents have been heightened by the loss of once-secure foreign sales to a flood of high-budget Hollywood movies, resulting in greater pressures for a favorable domestic release. The problem, observes John Lawrence Re, chairman of

Northern Arts

, an indi film distributor, is that "only one independent film in 20 finds domestic distribution, and no none knows until after the film is shot whether it will."

With the vanishing of the old guarantees from video and foreign sales, says David Hutkin, vice-president of

Lew Horowitz Organization

, a major financier of independent films, filmakers "are now relying on foreign cable and TV. It's a much tougher sale."

The shakeout among local video stores and foreign sales companies, says Re, is only one reflection of the realty of these risks. Against the 2000-plus screens available for major releases, the concentration of a hundred-odd screens among a handful of exhibitors for independent cinema is another.

Add to this the consolidation of virtually every leading independent distributor under major studio ownership. Miramax was recently purchased by

Disney

and

October Films

was acquired by

Universal/MCA

. It's crucial that investors understand this conglomeration, says Hudkin. "Armed with the global clout of the studios, independent distributors are purchasing foreign rights themselves and cross-finance the domestic release far more efficiently than sales agents could by separately selling off foreign rights on a country by country basis."

From an investment standpoint, the fluidity of these arrangements, together with the added liquidity of institutional lenders, has enhanced capital flows. That facilitates innovative investor-backed financing vehicles like Media Financial and Shooting Gallery.

Armed by a major insurance source, Media Financial is creating a five-year, $60-$80 million gap finance fund that will cover the difference or "gap" between the financing provided by a bank against foreign pre-sales and the film's production budget. "Banks will give you 75% against foreign sales. The gap fund will do what the bank does not." explains Minot.

While gap financing backed by big insurance companies or other institutional players is a well-established avenue of film finance -- the Lou Horowitz organization has done it for years -- its application in a fund structure accessible by private investors is relatively novel.

The fund, which will be sold to wealthy individuals, corporations, or pension funds, is fully insured, and will return principal to investors after each five-year period. The projected returns average 30% on each investment consistent with worldwide sales estimates.

Enhanced returns are possible here, observes Minot, because gap financing allows the producer or sales agent the discretion of postponing the sale of some foreign territories until after the film is shot, when they could be worth much more. "If I can get twice as much from the Germans or the British with a finished film, I will finance it from the gap fund instead of bank loans based on sales estimates of a floor of what a given market will pay for a particular actor or director. You work the spread between the estimated and the actual price." The minimum unit investment in Media Financial's Fund will range from $50,000 to $100,000. Sub-unit participation for qualified investors starts at $25,000.

The Shooting Gallery, which produced the break-away hit "Sling Blade," operates what CFO Steve Carlis describes as a film portfolio structured like a mutual fund. Over the next two years, investors can buy into the $20 million fund, $12 million of which has already been raised, which will finance six films per year.

Investors will put up 75% of all financing costs, while as both producer and distributor, The Shooting Gallery will put up 25%, but it will not take producer or distributor fees. Once investors are paid back 130% of their investment, it will share equally with investors and other equity holders, such as actors and directors who may have deferred part of their pay as an equity stake.

Carlis says "everyone in the industry takes production and distribution fees. We want to put as much value on the screen as possible. We ask talent to work for less and we are just as willing to take the risk."

The fund accepts participation from accredited investors in a range between $10,000 to $1 million. Still, gaining entry to such illustrious company is not easy, says Hudkin, because the funds tend to deal with the same small group of investors repeatedly. Carlis counts a host of Wall Street types among the Shooting Gallery's investors -- managers of LBO and hedge funds, managing directors of major brokerage firms and officers of public companies. Some investors find their way in through relationships at top banks that do entertainment lending like Paribas, Natexis/BFCE, Imperial Bank of California or the Royal Bank of Canada.

Diversification in itself does not guarantee success. "The portfolio approach does not diversify all the risk away," says Hudkin. "Funds tend to focus on films within the same budget range, which are all subject to the same buyers. If the TV market in a given territory is going through a hard time, all the films budgeted between $1-3 million could be hurt." On the other hand, diversification by genre can diminish risk. Say Minot: "Erotic thrillers, physical comedies, and action adventures are historically a good mix almost everywhere."