The Next Wave Of Film Financing: German Tax Shelter Funds.Film financing is analogous analogous /anal·o·gous/ (ah-nal´ah-gus) resembling or similar in some respects, as in function or appearance, but not in origin or development. a·nal·o·gous adj. to surfing surfing, sport of gliding toward the shore on a breaking wave. Surfers originally used long, cumbersome wooden boards but now ride lightweight synthetic boards that allow a greater degree of maneuverability. . The goal is to keep your eye out for, and catch, the next big wave. Each ride is different and exhilarating ex·hil·a·rat·ing adj. Causing exhilaration; invigorating. ex·hil  a·rat , but sooner or later the ride ends when the wave breaks
upon the shore.
Prior Waves I have had the pleasure of "surfing" these financing waves for the last twenty years TWENTY YEARS. The lapse of twenty years raises a presumption of certain facts, and after such a time, the party against whom the presumption has been raised, will be required to prove a negative to establish his rights. 2. , during which time we have experienced: * The U.S. public equity wave (witness Cannon and Carolco). * The foreign bank wave (e.g., Credit Lyonnais). * The Japanese financing wave (culminating in Matsushta acquiring Universal and Sony acquiring Columbia). * The insurance-backed financing wave, which crashed eighteen months ago. * The German public equity wave, which crashed six months ago. The Next Wave So what's next? I had initially thought the next wave would be the Italian or Spanish public stock markets, but they have petered out. Instead, the next wave is clearly building again in Germany, which would seem to defy de·fy tr.v. de·fied, de·fy·ing, de·fies 1. a. To oppose or resist with boldness and assurance: defied the blockade by sailing straight through it. b. gravity (they must have way too much money in Germany), but this time the funding is coming from the German tax shelter tax shelter: see tax exemption. funds. This wave is being driven by a number of factors, including the following: Germany has closed down most other tax shelters (such as for ships), so films remain one of the last viable tax shelters. The impetus behind all film financing waves is that the film industry is sexy, and investors would rather have a prospectus on their coffee table that has sexy pictures from films than pictures of widgets. Investors believe it is better to invest "directly" in films than in once high-flying publicly traded German film companies. Tax Benefits The tax benefits available in Germany are astonishing a·ston·ish tr.v. as·ton·ished, as·ton·ish·ing, as·ton·ish·es To fill with sudden wonder or amazement. See Synonyms at surprise. . German tax law permits the immediate deduction deduction, in logic, form of inference such that the conclusion must be true if the premises are true. For example, if we know that all men have two legs and that John is a man, it is then logical to deduce that John has two legs. of the cost of creating "intangible" assets, including films. Thus, investors are able to immediately write off the entire cost of producing a film. This is in stark contrast to almost all other tax systems, which require the cost of creating a film to be amortized either over a number of years or as a percentage of revenues received (in order to match deductions and income). Under the German tax system, investors get deductions now and income later, which is the stuff tax dreams are made of. With tax rates in excess of 50%, the up-front deduction is a substantial benefit, which is magnified if the investment is leveraged with debt. For example, if the debt/equity ratio Debt/Equity Ratio A measure of a company's financial leverage calculated by dividing long-term debt by shareholders equity. It indicates what proportion of equity and debt the company is using to finance its assets. is 1:1, the investor immediately gets back more in tax savings than the amount of the investor's actual cash investment (although the investor will be liable for repayment of the debt later on). Most importantly Adv. 1. most importantly - above and beyond all other consideration; "above all, you must be independent" above all, most especially , the films do not have to be produced at all in Germany. Most countries that have film tax shelters require production in the home country, and the tax shelters serve as an indirect, but intended, subsidy subsidy, financial assistance granted by a government or philanthropic foundation to a person or association for the purpose of promoting an enterprise considered beneficial to the public welfare. for local production. In contrast, Germany's system results in an unintentional subsidy for worldwide production. This fact has not escaped the German government's attention, and overtime, Germany has passed increasingly restrictive requirements on German tax shelters. These restrictions have changed the business model (discussed below), but they have not - by any means - changed the fundamental benefits of film tax shelters outlined above. Structures German tax funds come in two basic flavors: (a) net-benefit funds and (b) equity funds. Historically, most funds have been net-benefit funds, which are typically structured similar to the classic sale-leaseback model; a film company sells underlying film rights to a German fund, which finances the film's production budget by borrowing funds that are directly or indirectly lent by, or guaranteed by, the film company. The German fund then licenses the film rights back to the film company (or its affiliate) for essentially fixed payments overtime. The film company defeases its obligation to pay these fixed payments by depositing a fixed amount with a bank up front. The amount deposited with the bank is less than the total investment by the German fund, so the net result is that the film company gets to pocket the net benefit. In most transactions, when the dust settles (net of commissions, transaction costs Transaction Costs Costs incurred when buying or selling securities. These include brokers' commissions and spreads (the difference between the price the dealer paid for a security and the price they can sell it). , etc.), the film company pockets about 10% of the budget of the film. In some cases, the film company als o owes some theoretical back-end participation to the German fund, but these are typically structured in such a way as to rarely kick in. Since the bottom line with a net-benefit fund is that the film company pockets about 10% of the budget, and this is often paid after production, the film company must have the financing for the budget itself or from another source (such as a bank loan). In other words Adv. 1. in other words - otherwise stated; "in other words, we are broke" put differently , net-benefit funds do not really provide the funds to fund the budget itself. On the other hand, film companies do not owe much, if anything, on the back end to net-benefit funds. Based on this combination of factors, studios typically prefer net-benefit funds. In contrast to net-benefit funds, German equity funds actually cash flow all or a substantial part of the film's budget and take a true equity position in the success or failure of the film. While these funds absolutely care about the economics of the deal, the German tax benefits take some of the edge out of the negotiations. Thus, these equity funds can typically accept more risk (and the possibility for a lower return) than other equity investors that do not have the German tax benefits. German equity funds are not willing to be completely at risk. Typically, they insist on minimum guaranties of at least 50% of the budget, with estimates from a reputable rep·u·ta·ble adj. Having a good reputation; honorable. rep  u·ta·bil sales agent of sales in excess
of the total budget. For marketing purposes, the equity funds also like
to have a guarantee of repayment of at least a substantial part of the
investment, even if this guarantee is payable after a number of years
without interest. Also, the fund managers definitely want the funds to
earn a decent return; their hope is to raise the next fund and the
next... and this won't happen if the first fund is a bust.
Many independent film companies relish German equity funds because they can cash flow production and demand less in return than a normal equity investor. Life doesn't get better (unless you think the film will be a blockbuster block·bust·er n. 1. Something, such as a film or book, that sustains widespread popularity and achieves enormous sales. 2. A high-explosive bomb used for demolition purposes. 3. , which would result in the payment of a share of profits to the equity fund, and you have a cheaper alternative to fund production). As a result of increasing restrictions under German law, including the requirement that investors be at-risk, net benefit funds are waning and equity funds are gaining favor. What was once a nice financing structure for generating approximately 10% of the budget has thus blossomed into the next full-fledged equity wave of film financing. The conclusion? Surf's up! It is good to know that just as the last film financing wave (the German stock market) is receding, the next wave is coming in, and this rhythm will remain for so long as the film industry needs money and sex sells. Schuyler Moore is with Stroock & Stroock & Lavan LLP LLP - Lower Layer Protocol in Los Angeles Los Angeles (lôs ăn`jələs, lŏs, ăn`jəlēz'), city (1990 pop. 3,485,398), seat of Los Angeles co., S Calif.; inc. 1850. . |
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