Potentially Disastrous Misunderstandings

If I had to choose what I think is the single biggest obstacle to films getting made, it is financing, or rather, the lack of it. Don’t get me wrong, lack of dramatic talent or technical cinematic skills would kill the venture also. But even if you had the most brilliant person for every role and crew position, there’d still be no movie without the money with which to make it.

I recently came across an article about financing. I shuddered at some of the things written in that particular article although to be fair, it wasn’t the first one I’ve ever read that wrote something along these lines: “equity is an investment….get an interest rate…”

Folks, take my word on this. As a former professor of finance and a veteran Chartered Financial Analyst, I’m telling you that this is wrong. If you are fortunate enough to ever be pitching for capital from professional investors, get your terms right. Don’t get taken to the cleaners.

Loans receive interest and the return of the amount of money that was lent. Equity investments receive dividends (although equity investments in artistic projects never pay dividends) plus, very significantly, a portion of gains in the underlying investment. It’s a matter of risk. (I refer to financial risk, not the risk of the art itself.)

Breaking it down one step further, loans, such as student loans and mortgages, require the full repayment of the amount borrowed, called the principal, as well as periodic payment of additional amounts until the loan is repaid in full. These additional amounts are the interest payments. Interest payments are all that those who lend money “earn” for making conventional loans. That’s it.

Notice what’s missing? A WHOLE LOTTA DOUGH! What would lenders get if they had had a chance to lend money for the making of “Avatar,” the highest grossing movie of all time with worldwide receipts of over $2.7 billion? Only their original amount of money back plus interest. That’s it! Obviously that’s better than not getting anything back but like people who invest in tech companies, movie investors are typically aiming for the moon with their money. And a loan isn’t the weapon with which to shoot the moon.

That’s what equity is for. Equity is ownership. Equity is also another term for stocks which is ownership in companies. And what do investors in stocks want? A WHOLE LOTTA DOUGH! And it is definitely possible, although admittedly without certainty, that equity investments can earn such dough, while loans cannot.

Let’s go back to James Cameron’s “Avatar,” which cost $237 million to make and market. What would the lucky investor who had had the chance to invest, say, $23.7 million to purchase 10% of the film get? You know this. A WHOLE LOTTA DOUGH! (The ratio would never actually be 10% investment for 10% equity but it makes the calculation easy.)

But there’s a downside to equity and it’s a biggie. If “Avatar” had grossed only what it cost to make and market, what do you think equity investors would get? Answer: zilch. But in this scenario, what would those who lent money to make the movie get? First dibs on getting back the amount of money lent!

Thus, the advantage on a successful movie goes to the equity investor. The smaller disadvantage (can’t really call it an advantage though) on an unsuccessful movie goes to the lender.

However, as I can attest from personal experience, when filmmakers pitch for money, it isn’t uncommon for potential investors to ask how much they would make on some hypothetical (usually preposterous) amount of revenue for the movie. But then at some point they would also ask when they’d get their money back if the movie bombs. See the problem?

You may wonder why this isn’t made more clear in the industry. Simple. Because film investors can have their cake and eat it too if filmmakers do NOT understand this.

How to address this is a topic for a future article, but understanding anything else about finance, in movies or anything else, requires first this basic understanding.

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