Twenty-Six Reasons to Avoid Foreign Pre-Sales

Twenty-Six Reasons to Avoid Foreign Pre-Sales
By Attorney John W. Cones

In my 30-year practice as a securities/entertainment attorney, working with independent
film producers seeking to obtain film finance from private investors, some of these producers
have from time to time raised the question (or possibility) of financing some or all of the
production costs of their film through foreign pre-sales. This method of film finance has been
around for many years and, in fact, is actively (and sometimes aggressively) promoted by certain
people in the film industry because it is financially beneficial for them. These people include (1)
individuals who work for the banks that make such loans (entertainment lenders), (2) individuals
who work for the completion bond companies (since all of the entertainment lenders require
completion bonds on films financed in this manner), (3) the foreign pre-sales agents who
represent the independent producer’s film package at the film markets (e.g., Cannes in the South
of France, the American Film Market in Santa Monica, the European Film Market in Berlin and
the Toronto Film Festival and Market, among others) and (4) the territorial distributors
themselves. Sometimes, entertainment attorneys and/or producer’s reps may also play a role in
helping a film producer put together the pre-sales package designed to attract the interest of these
territorial distributors.

All of these folks have a financial incentive to promote foreign pre-sales. They are
regularly and actively involved in writing articles and books, along with giving lectures or
appearing on film finance panels, promoting how wonderful the foreign pre-sale transaction is for
financing some or possibly all of your proposed film’s production budget. They tend to overlook
the disadvantages of this form of film finance. It is not in their interest to point that out. And
unfortunately, most independent producers are not sophisticated enough or willing to ask the
more difficult questions relating to foreign pre-sales. Thus, this article presents the other side of
the issue, in an effort to counter-balance this ongoing wave of information, and sometimes
misinformation, offered to filmmakers every year by the foreign pre-sale crowd (i.e., you don’t
hear much about the downsides of foreign pre-sale financing in film school, or even in
Hollywood for that matter, because most people with expertise in foreign pre-sales benefit from
such transactions and are interested in persuading filmmakers to pursue this approach to film
finance, even though the results do not necessarily benefit the producer, or any others who rely
on or participate in the producer’s share of a film’s revenues).

Financial Conflicts of Interest – One of the earliest problems to be encountered by the
independent film producer in seeking foreign pre-sales financing for their films is the fact that all
of these people want to be paid and, of course, should be paid, but they all get paid before the
producer, and anyone else relying on a share of the producer’s profit participation. In other
words, all of these people benefit financially from the foreign pre-sale transactions before the
film’s producer ever sees a dime in profit participations, so their financial interests are not
necessarily aligned with that of the producer. In many instances, they could care less whether the
actual release of the film generates any profits, since they’ve already made their money. Thus, all
of these people have a financial reason for promoting foreign pre-sales that is quite independent
of whether the film deserves to be produced in the first place, or whether the film will result in a
profit for the producer.

Development Costs – Secondly, putting together a film package that will attract the
interest of territorial distributors typically requires a significant expenditure of money. There may
be costs associated with acquiring the underlying rights to a story, or rights to a script. In order to
get a professionally-prepared and reliable production budget, a fee may need to be paid to an
experienced line producer.

Attachments – The most expensive item of all, however, is the cost associated with
attaching elements to the project. It is extremely difficult to attract the interest of territorial
distributors in a film project without recognizable names attached, either for the lead roles and/or
the film’s director. If these individuals have enough name recognition to add value to the film
project, they are also most likely to be at a point in their careers to demand at least a nonrefundable deposit in exchange for the commitment of their time. In other words, if they are
actually committed to appear in or work on your film, they have to contractually block out a
specific time period on their own calendars, and turn down any other work opportunities that
conflict with that time commitment. They and their agents want to be compensated for that
commitment. And typically, if there is no money at risk (i.e., the producer is subject to losing the
non-refundable deposit if the production costs of the film are not ultimately raised) then there is
no attachment – no firm commitment), and it is horribly inappropriate to run around Hollywood
saying you have some name actor attached, when you really do not.

Most independent film producers do not have the cash on hand to cover these preliminary
(i.e., development costs). That’s one of the reasons why we often see wealthy individuals get
involved in helping to finance this stage of a film project. They have the money and are willing to
assume the risk – at least somebody was able to talk them into assuming this risk. In the
alternative, an independent producer could conduct what we refer to as a “development offering”
to investors, where the money needed for the development costs, script, budget, attachments and
other expenses are raised from passive investors. This allows the producer to avoid having to pay
out of pocket for these development costs and tends to spread the risk amongst a larger group of
passive investors. Such offerings typically however, involve the sale of a security, and the
producer will need to associate with a securities attorney in order to properly conduct such an
offering. That’s another article.

Foreign Pre-Sales Agent Expenses – So, let’s say you are able to assemble an attractive
film package, with a commercial script (and you have a clean and demonstrable chain of title), a
professionally-prepared production budget and a legitimately attached recognizable name
director and lead actors (the basics), along with a one-sheet, poster, trailer and/or pitch deck (the
additional bells and whistles that may be helpful in marketing your film package to prospective
territorial distributors), and you want an experienced and reputable foreign sales agent to
represent your film package at one or more of the film markets. That will also cost money. There
are fees to be paid to the film market to both attend, and for the right to set up shop at the market
and promote your film package, in addition to the expenses to be incurred by the foreign sales
agent (travel, hotel, meals, entertainment, etc.) that need to be covered.

Another Conflict of Interest – This is a tricky area. Is it possible that some foreign sales
agents who agree to represent the film packages of more than one independent film producer at
the same market, will inflate their estimated expenses, or worse, ask each producer to cover
100% of the foreign sales agents expenses, thus creating a situation in which the foreign sales
agent is making money by double or triple-dipping into several producers’ pockets for the same
expenses? How does a producer prevent either of these problems from happening? And, how
does a producer know that the foreign sales agent is making his or her best effort in representing
the producer’s film package as opposed to the other film projects the foreign sales agent is also
representing, at the same market? Again, we have a conflict of interest – not uncommon in the
film industry. I don’t know whether you’ve noticed or not, but the film industry has long been a
haven for a lot of sleazy people – scam artists of all sorts and every background (see my book
Hollywood Wars – How Insiders Gained and Maintain Illegitimate Control over the Film
Industry). So, your best judgment is under great pressure in these circumstances, when you are
trying to select a reputable foreign sales agent, and trying to monitor whether he or she is acting
in good faith on your behalf. Here’s a tip! Contractual language won’t prevent an unscrupulous
foreign sales agent from engaging in such behavior, and your after-the-fact remedies are quite
limited.

Ok but let’s assume that you have somehow come up with the money to pay for the
development of your film package, you have the script, budget and attachments, and you have
avoided the potential problems associated with the foreign sales agent and their representation of
your film project at one or more film markets, and your film package is actually getting interest
from some of the territorial film distributors in the top ten foreign film markets (i.e., countries).
Now, you may be confronted by a whole new set of problems.

Market Fluctuations — First, we have to consider that the market for pre-sales comes and
goes as the economies of various foreign territories weaken or strengthen, and as the number of
available films in the marketplace in any given year increases or decreases. You cannot rely on
what happened last year or the year before in any given territory.

Buyer’s Market — So long as there such a great disparity between the number of films
produced and the number and capacity for distributors to distribute, the market will be a so-called
buyer’s market for distributors. That tends to give more leverage in pre-sale negotiations to the
territorial distributors, and they typically do not hesitate to take advantage of that disparity in
negotiating power.

Increased Distribution Costs Make Pre-sales Less Practical — Fractionalized and splitrights agreements have become less practical in recent years because of the increasing relative
cost of U.S. theatrical distribution. You might want to check out the list of distribution expenses
attached to a distribution deal (see sample film industry agreements at
www.filmfinanceattorney.com).

Cost-Value Trends do not Favor Fractionalized Pre-sales – As film production and
distribution costs have increased, the percentage of revenue generated through a film’s domestic
theatrical release has been reduced in relation to other media or territories. In addition, as the
value of ancillary rights has increased, domestic theatrical distributors have been more likely to
insist on requiring the domestic ancillary rights as part of any domestic theatrical distribution
deal.

Domestic Theatrical Release Creates Value in Other Markets and Media – Also, the
domestic theatrical distributors point out that their expenditures on advertising and publicity
helps to create value for a film in the other markets; thus, in all fairness, they should be allowed
to participate in those markets.

More Offers Means Less Reason to Pre-sell – Theoretically, the more value a film is
presumed to have, the higher the offers distributors and ancillary buyers are willing to make to
keep their competition from buying the same rights. But the more offers the producer gets for
ancillary rights, the more confident the producer can be that the film actually has value and that
all rights can subsequently be sold to an important distributor.

Foreign or Fractionalized Pre-sales May Eliminate Domestic Distributors – U.S.
theatrical distributors often insist upon all or substantially all rights to help cover recoupment not
only of advances to the producer, but also their increased distribution costs. That is, any ancillary
right that has significant value will be demanded by the domestic theatrical distributor as a
prerequisite of distribution. Thus, the producer who pre-sells any of the rights (e.g., territorial or
specific media) to a film runs the risk of pre-selling the film out of a domestic theatrical release.
And since these other rights will probably require a domestic theatrical release at a specified
level (e.g., number of theatres), if there is no domestic theatrical release, then these pre-sell
agreements are likely to be voided.

Pre-sales Bring Lower Prices — We have to recognize that territorial distributors know
their market better than the independent producer, or the foreign sales agent. They have a much
better idea how much money they could possibly make by distributing your film in their country,
but to hedge their bets, they are not going to offer you (the film’s producer) top dollar for those
rights. They are going to low-ball you. The reality is that such distributors are considering several
films to fill their distribution slots for the year and on the whole, we’re producing way too many
films each year. As a result, the price that a buyer is willing to pay before seeing a prospective
film will generally be less than that which the same buyer would pay for the same film as a
completed motion picture. These territorial distributors want to be assured that they will make a
profit off of your film.

Giving Away Your Film’s Upside Potential — Film production companies relying on presale strategies may succeed in reducing but not eliminating their downside risk, while giving
away much of a film’s upside potential. Why do we say that? (see Collection Difficulties below)

Collection Difficulties — Pre-sales are based on contingencies, for example, the actual
collection of moneys due from the providers of pre-sale contracts have turned out to be difficult
in many instances – often more difficult than collecting from domestic distributors. In other
words, by agreeing to a minimal distributor advance (payable upon delivery of the completed
film to each territorial distributor) that is likely to be all of the money you’ll ever receive from
that territorial distributor for that country. So, in effect, by engaging in a foreign pre-sale
transaction, you have effectively given away your upside potential for being paid any profit
participation for the exploitation of your film in that country – one of the top ten film markets in
the world). If you combine that with half a dozen other such territories, you’ve given away a
significant part of your potential profit. If you’d like to see many of the reasons why it is difficult
to collect profit participations from any film distributor, take a look at the monograph “337
Business Practices of the Major Studio/Distributors”. So, when you are talking to foreign sales
agent, ask the question: “Can you refer me to some of your former producer clients who have
actually collected profit participations from that particular territorial distributor or in that
territory?”

The “A”Picture Dilemma — Many industry observers today suggest that it is difficult to
pre-sell rights in major markets around the world without an extremely strong film package, the
so-called “A” picture. On the other hand, if a producer has an “A” picture, why should it be
necessary to seek pre-sales? Furthermore, the stronger motion picture package will generally
require more money to produce; therefore, more pre-sales will have to be made. In addition, the
stronger the pre-sale package is, the more money it will take to obtain the firm commitments
from talent.

Takes too Much Time — Since it generally takes much more time to contact and negotiate
with multiple interested buyers of pre-sold rights in the various media and territories, producers
using pre-sales may encounter a lengthier time lag between the start of their pursuit of pre-sales
and the start of production than some other forms of film finance. Of course, this further
complicates the attachment problem, since you’ve had to commit in advance to a specified start
date in order to obtain the firm commitments from talent.

Higher Cost of Capital — Companies relying on pre-sales will inevitably have a relatively
high cost of capital compared to some other forms of film finance. For example, in a foreign
territory pre-sale, the entertainment lender’s principal, interest and fees are collected out of the
distributor advances upon delivery of the completed film. Some completion guarantors charge an
up-front fee (based on a variable percentage of all production costs other than the contingency,
interest and finance costs) and agree to rebate a portion of it to the producer if no claims are
made after the film is delivered. This is sometimes referred to as a “no claims rebate.” Also, as
noted earlier, the sales agent’s expenses may have to be advanced prior to his or her attendance at
markets and the sales agent’s fee will typically be recouped out of the film’s revenue stream, in
addition to the costs and fees of the foreign distributor, before the producer will receive
payments, if any, beyond the producer’s advance.

Only Part of the Financing Needed – Generally, foreign pre-sales can only provide a part
of the total financing of a film’s budget. Thus, in addition to spending the time and effort
developing some expertise in and pursuing this form of film finance, a producer will also have to
spend time and effort developing some level of expertise in and pursuing other forms of film
finance to cover the entire budget.

Contractual Quagmire — From a contractual point of view, it is difficult to coordinate the
various contractual concerns of the bank, the completion bond company, the producer and the
various media and territories when negotiating and drafting multiple pre-sale agreements. If you
are paying your attorney on an hourly fee basis, this could get expensive.

Default Disaster — If a licensee (i.e., the pre-sales purchasing entity or buyer) sees a
rough cut of the film and decides it is so much worse than expected (or otherwise unsatisfactory),
the buyer may notify the producer that it will not be paying the balance of the minimum
guarantee and will forfeit its deposit, if any. In that event, the bank may demand that the
producer repay the loan, and the producer may have to seek payment from the distributor. If the
producer fails to repay the loan, the bank might foreclose on the negative if it took a lien as
further collateral, or attach the film and its proceeds even if it did not have an original lien.

Simply not Available — As noted earlier, the availability of foreign pre-sales varies from
year to year depending on larger economic issues in each of the countries that traditionally offer
such pre-sales. As an example, as the marketplace generally is flooded with more and more
feature films, it becomes less necessary for distributors in foreign territories to pre-buy the rights.
They may opt to simply wait until the films are completed.

Survival of the Weakest — Pre-sales often support projects that perhaps could not and
should not otherwise have been made; thus, producers seeking pre-sale commitments may be
looked upon with disfavor in some segments of the industry.

Reversion Rights and Library Values — When pre-selling rights to a film in various
markets and media, the production company or its attorney must be careful to coordinate
provisions relating to the reversion of such rights to the producer following exploitation of the
film in such markets and media. If not, the film is likely to have less value as a library asset, and
confusion over the status of such rights may make it difficult to include such film in the sale of a
production company’s film library.

Macroeconomics — Feature films financed in this manner increase the number of films
produced in a given year and thereby increase the demand for, and thus the cost of, various film
elements that are theoretically in limited supply (e.g., screenplays, directors, actors, sound stages,
etc.). Also, since there are more films produced each year than there are capable and willing
distributors available to distribute, the oversupply of films contributes to a significant imbalance
in the bargaining strength between producers and distributors.

Losing in the Long Term — Over the long term, the relatively few films that are highly
profitable for a producer using pre-sale strategies are likely to be insufficient in number or in
degree of success to recoup the losses of the firm’s many non-profitable projects. In other words,
the thinner potential profit margins of pre-sold films make it less likely that such a production
company will financially succeed in the long run (see the study by David Royal, “Making
Millions and Going Broke, How Production Companies Make Fortunes and Bankrupt
Themselves”, American Premiere, November/December 1991).

Conclusion – So, what sort of conclusion can we possibly draw from these counter-points
to the constant promotion of foreign pre-sales as a film finance method? One friend, in his peer
review, suggested that he was relieved to learn that there are only 26 reasons to avoid foreign
pre-sales, when there are 43 ways to finance his feature film. In effect, however, this article is
written as a response to the suggestions made from time to time by some of the people involved
with foreign pre-sales, that there are a lot of problems with investor financing of independent
films. As my book points out, there are advantages and disadvantages to every form of film
finance and none are easy. But, if you are bound and determined to pursue the foreign pre-sales,
at least, this article may serve as a checklist of problem areas that need to be addressed and
hopefully resolved. Good luck!

* This article is partly based on a section in my book 43 Ways to Finance Your Feature Film,
Third Edition (Southern Illinois University Press).

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