Borrowing Against Pre-Sale Agreements
by Mark Litwak on February 18, 2015 in Legal
In a pre-sale agreement, a buyer licenses or pre-buys movie distribution rights for a territory before the film has been produced. The deal works something like this: Filmmaker Henry, or his sales agent, approaches Distributor Juan to sign a contract to buy the right to distribute Henry’s next film. Henry gives Juan a copy of the script and tells him the names of the principal cast members.
Juan has distributed several of Henry’s films in the past. He paid $50,000 for the right to distribute Henry’s last film in Spain. The film did reasonably well and Juan feels confident, based on Henry’s track record, the script, and the proposed cast, that his next film should also do well in Spain. Juan is willing to license Henry’s next film sight-unseen before it has been produced. By buying distribution rights to the film now, Juan is obtaining an advantage over competitors who might bid for it. Moreover, Juan may be able to negotiate a lower license fee than what he would pay if the film were sold on the open market. So Juan signs a contract agreeing to buy Spanish distribution rights to the film. Juan does not have to pay (except if a deposit is required) until completion and delivery of the film to him.
Henry now takes this contract, and a dozen similar contracts with buyers, to the bank. Henry asks the bank to lend him money to make the movie with the distribution contracts as collateral. Henry is “banking the paper.” The bank will not lend Henry the full face value of the contracts, but instead will discount the paper and lend a smaller sum. So if the contracts provide for a cumulative total of $1,000,000 in license fees, the bank might lend Henry $800,000.
Henry uses the loan from the bank to produce his film. When the movie is completed, he delivers it to the companies that have already licensed it. They in turn pay their license fees to Henry’s bank to retire Henry’s loan. The bank receives repayment of its loan plus interest. The buyers receive the right to distribute the film in their territory. Henry can now license the film in territories that remain unsold. From these revenues Henry makes his profit.
Juan’s commitment to purchase the film must be unequivocal, and his company financially secure, so that a bank is willing to lend Henry money on the strength of Juan’s promise and ability to pay. If the contract merely states that the buyer will review and consider purchasing the film, this commitment is not strong enough to borrow against. Banks want to be assured that the buyer will accept delivery of the film as long as it meets certain technical standards, even if artistically the film is a disappointment. The bank will also want to know that Juan’s company is fiscally solid and likely to be in business when it comes time for it to pay the license fee. If Juan’s company has been in business for many years, and if the company has substantial assets on its balance sheet, the bank will usually lend against the contract.
In some circumstances, banks are willing to lend more than the face value of the contracts. This is called gap financing, and since the bank is assuming a greater risk of not being repaid its loan, higher fees are charged. Gap financing is helpful if the filmmaker is unable to secure enough pre-sales to cover the loan. The bank lends more than the amount of pre-sales based on its belief that the gap will be covered when unsold territories are licensed. Before agreeing to supply gap financing, the bank will carefully review the existing pre-sales and extrapolate from those sales an estimate as to what other territories might fetch. The estimate might be based on the bank’s experience that a film licensed to Italy for $150,000 usually fetches $100,000 in Spain. Of course, there is no guarantee that when the film is completed that a Spanish buyer will license the film, so the bank wants to see projected revenue that is at least twice the amount of any gap. This ensures that even if some territories remain unsold, the gap is likely to be covered. Moreover, the bank will rely on the reputation and track record of the sales agent and/or producer in judging whether these estimates are realistic. Banks may decline to lend funds based on projections from a sales agent with a history of overly optimistic projections.
The bank often insists on a completion bond to ensure that the filmmaker has sufficient funds to finish the film. Banks are not willing to take much risk. They know that Juan’s commitment to buy Henry’s film is contingent on delivery of a completed film. But what if Henry goes over budget and cannot finish the film? If Henry doesn’t deliver the film, Juan is not obligated to pay for it, and the bank is not repaid its loan.
To avoid this risk, the bank wants a completion guarantor, a type of insurance company, to agree to put up any money needed to complete the film should it go over budget. Before issuing a bond, a completion guarantor will carefully review the proposed budget and the track record of key production personnel. Unless the completion guarantor is confident that the film can be brought in on budget, no completion bond will be issued.
First-time filmmakers may find it difficult to finance their films based on pre-sales. With no track record of successful films to their credit, they may not be able to persuade a distributor to pre-buy their work. How does the distributor know that the filmmaker can produce something their audiences will want to see? Of course, if the other elements are strong, the distributor may be persuaded to take that risk. For example, even though the filmmaker may be a first-timer, if the script is from an acclaimed writer, and several big-name actors will participate, the overall package may be attractive.
Additional information can be found in the book Risky Business by Mark Litwak