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Indie Producers Don’t Understand Tax Credits

by Jeff Steele

Producers don't get it.Over the past ten years most producers and financiers have been deriding the escalating cost of film production.  Indie producers have been on a relentless quest to find the elusive “final 20%” of their budgets.  They’ve raised the equity, made the presales, maxed the gap, and still they come up 20% short.  This shortfall is often due to the bank’s discounting of presale contracts, which wouldn’t be a problem if producers stopped trying to finance with gross numbers (see my rant on this.)

Meanwhile, over the same past ten years, producers and financiers have heralded film tax credits for saving the independent film industry in its darkest hour (where escalating budgets have collided with deminished access to capital.) 

South Africa and Puerto Rico were amoung the first to offer 10% to 15% tax credits for shooting in their respective countries.  Producers flew-in from all over the world to cash on this windfall.  Since then, incentives have shot-up from 15% to over 40% of local production spending.  It stands to reason that the proverbial 20% shortfall matched-up against a whopping 40% cash rebate should be a slamdunk for financing — these films should be financing themselves.  So why then are producers still stumbling around trying to fill that final 20% of their budgets?!  In short, its because producers can’t get out of their own way.  Rather than using the tax credits to plug a financing shortfall, they instead use the tax credits to subsidize bigger budgets.

The 2008 credit crunch, the dimise of over two-thirds of the entertainment lenders, the scarcity of equity, the exodus of hedge funds, and the increasingly conservative lending practices of the remaining banks have lead to a healthy contraction in film production.  Not only are fewer films being made, but they’re being made for less.  Many talent agents had a hard time coming to terms with this and as a result their clients didn’t work.  After two years of this, they’ve finally gotten the message.  Studio stars are now having to forage for work in the indie meadow and for once they’re being cooperative. 

With studios and indies making fewer films: gone are the days of fat upfront star salaries and gone are the mandatory rewriting fees for that script you just optioned.  Writers and actors are finally playing ball.  Post production houses and other vendors are so desperate for clients that they’re becoming investors just to get the business.  Producers haven’t had this much levererage since the 1930’s.  But yet, they still can’t find that final 20%.

Producers are sabotaging themselves by using the tax credits (and vendor investments) as layers in a film’s capital structure.  In other words, they make their movies by adding up all the money they have:

$3m in equity
+ $3m presales
+ $1m gap/mezz
+ $2m tax credits
+ $500k vendor investment
===========
$9.5m budget. 

However, after the bank discounts the presales and deducts their fees and interest, there’s going to be a 20%-25% shortfall (or more depending on who your sales agent is) that has to be plugged with additoinal equity or deferments, which is why most indie producers invariably end up working for free. 

Equity investors are already skeptical about the film business, let alone trying to convince one that your film will be the one that makes enough money to pay off all the debt and fees that they’re sitting beneath, as well as their own investment + premium + profit.  This is why it’s so hard to find equity. 

Wouldn’t the smarter play be to carve out the tax credit from the capital structure (finance plan) and pledge it to the equity?  In that scenario, the example above would now be: $7.5m budget that generates a $1.2m tax credit, or more.  In addition, if you don’t have somebody lend against the estimated value of the credit, but instead wait for the credit to be certified, then you won’t have to pay the 15%-20% vig that the lender will charge on the value of credit.  Within a few months, up to 30% of your equity’s investment will be covered.  If needed, you can also pledge the vendor investment to the equity to cover any remaining shortfalls (or use that to pay your producer fee.)

Bottom line: actors, directors, and writers all need to work and make money.  As such, producers have the opportunity right now to make movies for less, with marketable talent.  And using your tax credits to attract investors, who stand to recoup a third or more of their investment within the first year, will be a much easier sell.

27 Responses leave one →
  1. October 11, 2010

    ANOTHER excellent post, Jeff. Thank you.

    I hope my NEXT film (after whatever happens to A FATHER AND SON, and which will be either a Western or a gross-out comedy) will be of this scale, and we’ll apply this logic, which seems smart to me.

    But…

    I get the sense there’s some turmoil in the tax credit environment that might cause it tumble soon, just as the rest of the biz did. What do you think is the possibility that politics and economics might cause a shrinkage of the tax credit opportunties?

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    • Jeff Steele permalink
      October 12, 2010

      The tax credit turmoil has already begun in places like Iowa, Michigan, Hawaii, and Arizona. However, many other states are going strong and have great programs.

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      • October 12, 2010

        Hi Jeff, I heard that Relativity Media has a Model that allows them to recover 75% of their budget via presales? Because they work with A list cast and the top directors they can actually get that range of MG. Would that still be happening in today’s landscape?
        Thanks
        Anand

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        • Jeff Steele permalink
          October 14, 2010

          Yes, it is still happening in today’s landscape. However, it’s not just a matter of having top talent. It also has to do with being a consistant supplier. Buyers love predictabilty. If you can dependabily deliver 3-6 good films per year, then you’ll be a preselling machine.

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          • October 26, 2010

            Thanks Jeff. Thanks for the reply. I appreciate it.

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    • Curran Engel permalink
      October 12, 2010

      Tax credits and rebates will thrive in locations that have a viable infrastructure.

      Canada, New Mexico, Louisiana, New York and California have established infrastructure to support long term production activity. Over seas, China, and India are strong competitors for productions.

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      • Jeff Steele permalink
        October 14, 2010

        I disagree. The infrastructures created in Canada, Louisiana, and New Mexico were a direct result of the film tax credits as well as first mover advantage for being early adopters.

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  2. October 11, 2010

    ANOTHER excellent post, Jeff. Thank you.

    I hope my NEXT film (after whatever happens to A FATHER AND SON, and which will be either a Western or a gross-out comedy) will be of this scale, and we’ll apply this logic, which seems smart to me.

    But…

    I get the sense there’s some turmoil in the tax credit environment that might cause it tumble soon, just as the rest of the biz did. What do you think is the possibility that politics and economics might cause a shrinkage of the tax credit opportunities?

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  3. Michael Orchard permalink
    October 11, 2010

    Great site, just wanted to add a question in regards to indie producers: who hires the indie producer in a one investor model? Would it be the owner of the copyright before negotiations, say writer-director? Or does this sole equity investor call all the shots on hiring producers?

    From my understanding under the six tenth model, equity investors will not get 100% ownership but 50% or higher.

    With this said, could that other piece of the pie held by those other than the equity investor hire producers or give someone producer credit?

    If anyone could answer this for me, it’ll help in a potential circumstance.

    thxs
    M

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    • Jeff Steele permalink
      October 12, 2010

      Producers usually recruit investors; investors don’t usually hire the producer, unless the investor developed the material, in which case the investor would be the producer by default.
      If an investor, lender, or bond company have doubts about the producers or production, they may require that a qualified producer be hired.

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  4. BenL permalink
    October 11, 2010

    Great post. Thanks Jeff!

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  5. October 11, 2010

    Hi Jeff,

    Can you shed light on what are Vendor Investments?

    Thanks, Michael

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    • Jeff Steele permalink
      October 12, 2010

      Vendor investments can be from VFX or post houses, but any additional funding provided by a vendor could suffice.

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  6. October 11, 2010

    Jeff – great article! We all know that there is a real shortage of films being made and those who want to borrow against their tax incentives are finding that it is much more difficult to do so today.

    In my opinion, we are going to see a consolidation with the number of states offering tax incentives to filmmakers.
    The ones that are creating an infrastructure, ie. building studios and other facilities and creating jobs for their people are the ones that will survive.

    Having spent over 30 years insuring film and television productions, I’ve developed Tax Incentive Insurance so producers as well as their lenders can protect themselves in the event a state or country repudiates it’s obligation to pay the incentive earned, becomes insolvent, declares bankruptcy, or has a change in legislation reducing or doing away with its tax incentive program.

    In some states, producers can even insure in the event the state can’t pay the incentive when it becomes due. These are real exposures that producers and lenders should be concerned about.

    Over the past couple of years I’ve insured in excess of $250 Million in tax incentives ranging from $1 Million to $30 Million and lenders are more readily to consider loaning money if they can reduce their ultimate risks. The cost of the insurance is nominal and in some states, insurance premiums are considered a “qualified spend.”

    Bob Jellen
    Arthur J. Gallagher Insurance Brokers of California, Inc.

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    • Jeff Steele permalink
      October 12, 2010

      Thanks Bob. My understanding is that the cost is about 3% of the gross credit/rebate.

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  7. Justin permalink
    October 11, 2010

    Jeff,
    Thanks as always. Is your strategy on rebates (as opposed to credits) the same? As in, pledge them to equity as well?

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    • Jeff Steele permalink
      October 12, 2010

      I used the term tax credits in the general sense to describe transferable and refundable tax credits, cash rebates, grants, and any other government subsidy.

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  8. October 12, 2010

    Jeff,

    In your example, ‘$1M gap/mezz’ is the mezz the bridge loan? Something else?

    Thanks, Michael

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    • Jeff Steele permalink
      October 12, 2010

      Generally speaking (and for this scenario):
      Gap is a loan against unsold foreign territories;
      Mezz is a loan against the amount that a senior bank deducts from a presale contract (e.g. if a bank lends 80% of the value of a presale contract, then the mezz lender would lend against the other 20%.)

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  9. Jack Binder permalink
    October 12, 2010

    Extremely insightful article Jeff! I’d be happy to help yourself, clients or readers create or crunch their budgets intelligently for tax credit applications as well as generate finance and camera ready film budgets in order to head your valuable advice regarding equity recoupment.

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  10. Scott Hillman permalink
    October 13, 2010

    I guess my question is: Why Don’t you cut foriegn sales instead?

    Since foriegn presales are increasingly hard to get, and have a signficant discount factor, while state tax credits are reasonably simple to finance agianst why not simply cut your foriegn sales-the equity producers actually get the foriegn sales when they come in.

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    • Jeff Steele permalink
      October 14, 2010

      Investors need to know that there is a market for your film, and foreign presales are the key indicator of that international marketability.
      In addition, tax credits can only reasonably cover up to 25% net to the budget. Presales can generally cover up to 40% (or more).

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  11. October 14, 2010

    Would have been nice to know about tax incentive insurance. We were financed and green lit to go in Iowa when they froze the program in Sept. 2009. Now there was a real can of worms.

    Steve Lustgarten
    leofilms.com

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  12. Paul Rosenblum permalink
    October 15, 2010

    Great post, Jeff. But I don’t understand this statement:

    “If needed, you can also pledge the vendor investment to the equity to cover any remaining shortfalls (or use that to pay your producer fee.)

    Vendor investments, in my experience, are never made in cash, but rather in goods and services, i.e., a post house or sound house will work on a deferral basis. This reduces the initial cash burn during production/post-production, but it doesn’t pay producer fees.

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  13. October 15, 2010

    Hi Jeff – I understand that UK producers have been angling to have the tax credits be recoupable form of equity from overages/profits the film might generate; arguement being that without the UK qualified producer there wouldn’t be any tax credits – thoughts?

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  14. October 18, 2010

    Jeff,

    You are getting OH so warm!

    This is great information. I would like to see more analysis on these specific issues you bring up, in future posts.

    I like your take on, “…because producers can’t get out of their own way.”

    VERY good point.

    Stan

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  15. John Thompson permalink
    October 18, 2010

    I wonder if the reason “producers can’t get out of their own way” is snowballing opportunities re better talent and locations once the realization of actual financing hits newbies. They’re like, hey man. I’m really making the movie. Now I got to make it better-er. :-/

    Great site Jeff.

    My range is in the quarter million range. I own the script and have shot one of the 39 sequences and am now in financing limbo. My plan is to get with a family friend producer and figure this foreign territories pre-sales thing. But can’t decide which comes first, the chicken or the lasagne.

    If the other pages are any indication, talent comes in at number three priority for foreign presales. Which is good? Lol.

    I have great un-known talent for the sequence I shot and haven’t cast the rest yet in hopes of attaching a name before finance was complete.

    I love any suggestions on this site. It’s fantastic!

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