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Media bonds: mitigating risk when investing in film production

Friday 10th July
Media bonds: mitigating risk when investing in film production

Investing in film or TV production can be both exciting and rewarding. The market is growing globally, and video streaming platforms such as Netflix and Amazon have injected technological innovation and new sources of investment into the industry – contributing to bigger budgets, creative productions and lucrative financial returns. However, the risks and uncertainties associated with film and television production remain. Mitigating those risks is an essential component of any successful film investment strategy.

Understanding film investment and involved risks

There are two core phases to any film or television project: the development required to launch a production – during which the rights to a script, or other intellectual properties are acquired, and a script produced. This is followed by the more intensive part: the production process itself.

Levels of investment may start from as little as £10,000 for a smaller project. Investing in an independent film with a smaller budget can provide an opportunity for greater returns and may carry less risk than a big budget film; you don’t necessarily have to back a box-office smash in order to receive a satisfactory return on investment.

The benefits of film investment

The film industry is a resilient and buoyant investment vehicle
UK cinema has a strong global presence; success on the world stage has generated demand, which is reflected in year-on-year financial growth. According to the BFI’s Statistical Yearbook 2019: ‘total industry turnover increased by 132% from £6.4 billion in 2008 to £14.8 billion in 2017, largely due to the increase in production and distribution turnover.’ Between 2016 and 2017, turnover increased by £1.5 billion: up from £13.3 billion to £14.8 billion.

A healthy level of public funding has also been made available: £634 million in 2017/18, an increase of 9% from the year before. £78 million of that was made up by way of HMRC tax relief. What’s more, during times of financial recession (such as 2008/09), the industry remained resilient due to its independence from stock-market performance, allowing investors to build a diverse portfolio to help minimise overall risk.

Potential for significant financial returns

The return on your investment will vary, but there is room for impressive gains. For example, one investment company lists 20 of the most profitable movies made among its successes (based on overall ROI). Those returns vary from 1.28% to 19.76%.

Paranormal Activity (2009) topped that list with a production budget of $450,000 and approximate profits of $89,362,022. This was by no means the biggest box-office hit. Returns of 10% per annum are regularly touted as being possible.

Returns extend further than box office takings

Financial returns and profits don’t necessarily end with box office sales. There are also sales of film franchises, DVD/Blu-Ray, TV airings, Video on Demand (VOD) subscriptions and merchandising to consider. Some of these can provide excellent long-term returns.

Tax incentives associated with film investment

Significant tax incentives are available for private investors, the most common of which is to invest via the Enterprise Investment Scheme (EIS): a UK government initiative designed to encourage investment in smaller higher-risk trading companies (typical of those producing independent films) by offering a range of tax reliefs to investors who purchase new shares.

For example, investors can claim up to 30% income-tax relief. They can also take advantage of inheritance tax relief and pay zero capital gains tax on any profits.

EIS is often used by entrepreneurs as a means of tax-efficient profit extraction from their own business. However, before you consider this option, it’s recommended that you consult with a professional financial advisor.

The Enterprise Investment Scheme: what should you consider?

The EIS is not necessarily cheap, and investors must use the scheme for a minimum of three years in order to qualify for the full suite of tax reliefs. Historically, several specialist film industry organisations have offered a variety of EIS investments and some have offered guaranteed returns. You may be charged both an upfront fee, an annual fee and a performance fee depending on the organisation you choose.

It’s no secret that HMRC scrutinises investment schemes. If a scheme is deemed to be a tax avoidance vehicle, investors can face devastating tax bills and fines.

EIS rules in respect of film investment have recently changed because of concerns regarding a perceived lack of risk for ‘guaranteed’ returns schemes. In order to be HMRC compliant, there must be a significant risk to capital at the time of investment.

Miscellaneous rewards of film investment

Finally, investing in film can also come with a whole raft of ancillary advantages. These can include:
• your name or business name appearing in the film credits;
• a chance to meet the cast;
• invitations to VIP or red carpet events.

These all have their own appeal and value, but should never be a primary reason to invest funds.

Risks to consider when investing in film

Box office profits are misleading

Box office takings and investor profits bear little relation to one another. In addition to investors, there are numerous other stakeholders who will claim a slice of a film’s revenue.

Costs to come out of box office figures include advertising (typically as much as 20% of production budget), cinema takings (at least 50% or more of ticket sales), distributor and sales agents fees. Again, referring to the BFI’s Statistical Yearbook 2019 for confirmation, the average advertising spend for an independent UK film in 2018 was £200,000. This figure rose to £2.1 million for studio-backed films.

In the same year, the top three global distributors (Walt Disney, Universal and 20th Century Fox) took between 14.5% and 23.6% of the share of box office takings. For smaller distributors outside the global top 10, the average was 4.5%. Industry anecdotes suggest a film must make ‘twice its budget’ in order to see any profit.

Production is a long and uncertain game

Film production is a long process. As an investment strategy, it’s usually even longer – taking anywhere between three to ten years to generate any financial returns. It’s also difficult to predict the size of those returns.

There is also no guarantee that the project you invest funds into will be a success; the size of a project, the level of investment or the names attached to the production are not mitigating factors in and of themselves.

Other risks to investors in the film industry

• Failure to deliver the film to the distributor within the contractual period, thereby granting the distributor the potential to cancel the contract;
• Production costs running over budget;
• The completed film not being in line with the agreed script, resulting in a breach of the contract with the distributor.

In any of these scenarios, the investment and potential returns are at risk of being lost in part or in their entirety.

These risks are compounded by the fact that, once the investment goes into the production process, the producers can use the money as they see fit. Investors generally have little or no control over how the funds are spent and lack the ability to intervene should things start to go wrong.

A film completion bond agreement can minimise or eliminate much of this risk.

Effective due diligence for investors and producers

Investors without any film industry experience should exercise caution. A high level of due diligence is always essential, regardless of experience. Risk analysis and due diligence in the film sector is a complex area, but one of the most effective ways to ensure this is done to the highest possible standard is by having a film completion bond in place.

Completion bonds offer protection for investors

A completion bond is a form of insurance which covers the lifecycle of a film project. It makes provisions for a third party to oversee the production and delivery of the project on behalf of the investor.

A completion bond is normally paid by way of a percentage fee based on the budget. Despite the protection it can offer, completion bond providers are still relatively few and far between.

The completion guarantor team will usually consist of a producer, a risk manager and claims manager, as well as legal and insurance partners. Completion bonds are usually available for feature films and feature television series. It’s possible for a bond to combined with other insurances, such as Film Producers Indemnity (FPI), Errors and Omissions (E&O) and Credit Risk Insurance.

How a completion bond provides protection over funds

With a completion bond in place, the completion bond guarantor will oversee the financial aspects of the project. They are responsible for carrying out a full audit and risk assessment, which includes pre-production, post-production and delivery. The guarantor also monitors production and delivery throughout.

A completion bond can also include take-over rights, which give the bond guarantor the legal power to finish and deliver the film. This can include the right to ‘hire and fire’ key personnel, such as the director.

In short, a completion bond provides a guarantee that the producer will finish and deliver the film in accordance with the agreed script, thereby ensuring the payment of minimum distribution guarantees to the producer and investors.

In the worst-case scenario, if the bond guarantor deems the project to be financially unviable, they will repay the investor. However, continuous auditing and risk management should make this an unlikely scenario.

A completion bond provides a three-tier level of protection for investors:

• An experienced and independent audit of the entire production, on which a decision to invest can be made;
• Ongoing input relating to the progress of the production, and scrutiny of production finances, with the option to take control of spending – particularly important should things start to go wrong;
• A guarantee that if the film isn’t delivered, the investment will be repaid.

Endorsement and protection for producers

If a completion bond is in place, it can be a powerful endorsement; it shows that the project is sound and has withstood close scrutiny. For producers, it offers a stamp of approval from an experienced and independent third party, which in turn can act as a powerful incentive for potential investors.

The scope of due diligence

Risk assessment for film investment

Effective risk assessment requires analysis of three separate areas: creative risk, production risk and performance risk.

Creative risk analysis

An analysis of the individuals involved in the project, such as directors and actors, as well as their respective track records and the script itself. This can be helpful in estimating whether this production team will be able to attract strong sales.

Production risk analysis

As described above, this includes the potential for delay, things going wrong and budgets running out of control. Legal issues over rights, bad weather and other unforeseen events can all throw a production off schedule.

Performance risk analysis

This is an opportunity to look at the production’s chances of success, both at the box office and with subsequent rights sales.

Completion bond due diligence pre-checks

The completion bond guarantor will scrutinise key personnel and paperwork. It will be essential to have the following in place:

• An agreed and accepted script;
• An accepted budget;
• Accepted contracts for cast and crew;
• Requisite insurance;
• 100% finance agreed.

Ongoing due diligence and risk management

During the production process itself, the completion bond guarantor will continue to be actively involved, by way of:

• Regular reviews of production paperwork, including daily production reports, weekly cost reports, cashflow reports, release of escrow payments and constant financial overview;
• Ongoing monitoring to ensure the product being delivered continues to be in line with the script and budget, both above the line (with director, cast and crew) and below the line (with day to day costs) and in line with the schedule for delivery;
• Monitoring of pre-production and post-production expenditure leading up to delivery, as well as actual production expenditure.

Completion bonds offer an additional and significant level of protection, over and above the usual and more limited protections offered by an FPI policy.

Additional film insurance

While completion bonds offer protection for the investor, FPI insurance should also be in place to cover incidental damages or loss. An FPI policy will normally cover death or sickness of the cast; damage to or faults with hard drives, negatives and equipment; loss of set items; theft and other losses.

Film investment doesn’t have to carry a high level of risk

Need expert advice on how to secure your investment in film and television projects? Kerry London provide comprehensive film completion bonds to cover a range of potential project risks. We insure the life cycle of a production: fully auditing the project, monitoring spending and reducing the chances of investor losses as a consequence of mismanagement or unforeseen obstacles.

For more information, visit our site or get in touch today.

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