This week offered up yet another reminder of why the film industry can seem such a perilous place for outsiders to do business in. Under the headline Yellow Brick Mess: How A Failed ‘Wizard of Oz’ Movie Became a $100 Million Investor Nightmare’, online trade publication TheWrap examined how a computer animated sequel with a smattering of A-list voice actors could have lost its collective investors up to $100 million – while the producers and fundraisers appear to have pocketed tens of millions of dollars.

In so many ways, Legends of Oz: Dorothy’s Return is a movie we've all seen before. In its PowerPoint presentation to those investors, the fundraisers projected anywhere from $720 million to $2.04 billion gross revenue on film content. Even at the low-end, these are Disney-scale numbers that no independently released animation has come close to matching. Court documents show that at least one investor received profit projections forecasting a minimum return on investment of 162 percent, and “also received materials featuring the covers of DVDs of highly successful animated films such as Toy Story, Finding Nemo and The Incredibles.” According to SEC filings, as much as $103 million was raised from solicitations and roadshow presentations for the proposed franchise. Six weeks into its theatrical run, the film is showing a worldwide gross of less than $9 million. Whatever's over the rainbow for Dorothy’s Return, it's certainly not a pot of gold.

Much like the Scarecrow, those investors must be now wishing they had more of a film business brain. They would not be alone. Judging by our monthly FILMONOMICS TALKS in both New York and West Hollywood, which are invariably packed out, there is widespread recognition across the independent filmmaking community that the business needs far greater illumination and more rigorous examination. This goes beyond just questions of business ethics. Structural changes are also needed in order for us to transition out of financing models that made sense during the flush days of the videocassette and foreign pre-sales but now look dangerously antiquated and hopelessly opaque in the face of current market realities.

The complexity of indie film funding - typified by smoke-and-mirror accounting and “waterfall” recoupment schedules that seem to punish those taking the greatest risks – means that film remains a haven for bad behavior and bare-knuckle negotiating tactics. Not surprisingly, issues of transparency, due diligence and the ideal capital structures to mitigate against such disasters keep coming up during those FILMONOMICS TALKS.

For the benefit of those unable to participate in our events, we have curated a series of roundtable discussions organized around many of those recurring themes. These are essentially edited highlights that we will run as a three-part blog series over the coming weeks. Full transcripts of each 90-minute discussion, with all their nuggets of inside information, will also be made available later to all film financiers and investors who are fully signed up members of Slated with completed profiles. The hope is that by peeling back the curtain on the film industry’s mechanics, we can help pave that way to an Emerald City of returning investors, risk-taking storytellers, equitable deals – and fewer wicked winds.

As a ready reference tool, the 14 participants quoted extensively in this roundtable series of blogs are listed here in alphabetical order, together with their Slated affiliations:

SETTING THE SCENE: INDUSTRY FAULT-LINES

Stephan Paternot: I always look at everything through the lens of Internet business models. I see how incredibly opaque and inefficient and fragmented the film industry is. It’s impossible to navigate. The fact that you need an expert, and an attorney, to help you start every deal is ridiculous. Now, that’s where they make money, and they do it well. The harder it is for the business to be deconstructed, and understood, the more they're needed.The film industry is successful despite itself because everyone is always looking for money. Everyone is always actively networking, trying to get their film package, trying to get their film finance, trying to get their film sold, trying to get their film seen. Yet there's nothing out there that gives them an efficiency or scalability to get it done.

Dan Cogan: I think the more transparency there is in the industry, the easier it is to come into it as an outsider. But I think there's actually less transparency today than there used to be. When you watch something on VOD [video-on-demand], nobody knows how well that film is doing unless the distributor tells you.

I also think that there is a problem in this industry where essentially the folks who guide investors into the business, people like us, have for most of the history of the business been charlatans. They've always been about a fast buck. For whatever reason, film has always been that way. It's never seemed to me efficient because the truth is that if you hustle an investor and you cheat them, then you have to do that all over again for the next movie because they're not going to come back. Whereas if you treat investors well and you develop a relationship with them, they are going to want to come back.

In fact, even if the film you make isn't successful, they might want to come back because they enjoy the experience. I think increasingly producers and financiers are learning that. I think that the more there are folks guiding filmmakers who actually are looking out for investors as oppose to preying on them, the more investors can enter film and feel comfortable.

Zak Kadison: There's a lack of understanding of the cost that it takes to be a film studio or a film financer. It’s great to seek that transparency. At the same time it's really frustrating being on the other side, doing very transparent deals but having talent that doesn't recognize the risk. We as the money take the opportunity to tell your story. I can't make a living investing on a movie-by-movie basis and giving you a fifty-fifty split because I'm going to go belly-up in a year. I think talent, historically, is very dismissive of the studio and the producer's effort. And simultaneously I think the studios are very egregious with their back-end profit-sharing definitions.

Mynette Louie: It’s funny: for the longest time people have used this stat that only one in every 10 films makes its money back. I think it’s more like one in 20, maybe one in 50 now, since there’s such a glut of films out there because of technology.

DON'T GO CHASING WATERFALLS

Bill Grantham: It’s always good to step back and ask yourself the question ‘Why do we do it this way?’ The debt-equity model that we have for so much film financing really dates back to a time when the business was swimming in money. There's always a great thing about a debt model from the point of view of somebody who shares the profits of a movie. And that is that the lender doesn’t get any profits. If you want to produce another movie, and there is so much money swashing about for you to pay back your debt, then you end up with 100% of the value of the movie.

The rise of the debt model for independent film production goes back to the explosion of the video business that you were talking about in the 1980’s. The real rationale was that you could borrow money, pay it back easily, and then you had this fantastic aftermarket of video, television, pay television, and so on, and you could just make huge profits out of it. We’re still using that model, although the fundamentals of the business have completely changed.

So what would a model look like that wasn’t driven by debt? It would be a pure equity model. It would be a pie rather than a waterfall. Now, in reality, we’re probably looking at hybrids here, but if you’ll try to imagine what a pie model means, you really have to go to your sources of revenue. You touched on lower budget more niche types of production, You may well be looking at something that is viable using monetized web platforms like Yahoo! and Google, and flat fee operations like Netflix, or Amazon, which don’t give you a lot of money, but give you a lot of exposure. So it is, at least, feasible at lower budget end that you could look at a pie model. What you do have on a pie model is - apart from the soft money, which you can get on any model you use - have to assemble all of that money from equity, and you have to go out, and sell it.

Stephan Paternot: Film, as an investment asset class, is always struggling because the investors you need most are the first to get screwed. There's a fundamental structural problem, which is that everything's sitting underneath a mountain of debt. Each of those financing pieces has different terms. Every single deal is a custom piece of work that needs to be analyzed to death. So until you move to a model where it’s a pie, and everyone can simply understand what piece they have of that overall box office - or VOD - number, until we get to that level of simplicity, investors will keep coming in first position and will be the last to get out every time. Everybody who’s in the business, all the experts, they know to get their fees the hell out before there's ever going to be a profit. The reality is that everyone on the inside, they get out when this thing’s getting made. They really don’t want the equity investors really knowing that so clearly.

WHAT NEEDS CHANGING

Arvind Ethan David: The reason the independent film business is broken is really about distribution. The thing that needs to change - and this isn't a short-term thing – are the fundamental distribution assumptions. The reason that Netflix is a good thing for the independent film industry, and the reason that pay-per-view platforms are a good thing, is that lower budget films are going to have to debut more and more in rooms like the ones we live in.

The interesting thing about live theater, as an investor or as a producer, is that there's no one sitting between. There's no one other than the theater, the physical venue, sitting between you and the audience. Every ticket they sell for a West End or Broadway show goes to the stars, the director, the writers, the rights-holders. The producer and the investors are getting paid back gross. No one is taking from us. In an independent film, how many people sit between you and the money?

I just closed the financing on a musical in London. The subscription agreement I used for is two-and-a-half pages long. That's it and people just write checks. And there's a reason for that. It's standard. There's zero negotiation. This is how the deal works with angel investing - which is where the phrase come from, by the way ‘theater angels’. If you pay this, you get this and they are paid from the first dollar. The shortness of the contract is because the deal is simple. There's transparency. There's nothing to audit. Or if there is, there is only one place to audit, and it’s the box office. There is no one sitting between you. There's no sales agency and there's no interparty.

Stephan Paternot: The reason that tech has exploded is that it’s so incredibly easy to figure out how to get in - and what you're going to get out. It’s so simple. There's a very standardized contract. With most companies, when you invest, there's enterprise value that grows over time. If you invest early, you're going to get a disproportionally large piece of equity. As the enterprise grows in value over time, the next investor will pay more money to get the same piece of equity. Eventually, one day when you all get out, you're all getting your pro rata, pari passu piece and everybody’s happy.

In the film space, there is no growth in enterprise value. As the first person coming in, maybe you put up some development money, a couple hundred thousand dollars buying a book right, working on a script. Maybe you didn’t get that director you needed, so you're burning more overhead just trying to keep the project alive to find the talent. And what happens is you need to go find more investors, but the valuation of your film hasn’t increased. You desperately try to get on board whomever you can. You're just Frankensteining this piece of financing together to get the next person inwho might be equity that’s sit senior to your equity, or debt that’s senior to all or you. By the time you finished production, you got all these layers. Of course, since you’ve spent 100% of your money on production, you're completely beholden now to the distributor. This would be like Apple developing the iPhone, pouring in billions of dollars, and then begging Best Buy to put it on their shelf. They would never do that. They’ve their own distribution channel. They put their own marking dollars, and get it out there.

Now, I'm not here to try and say Slated is going to solve this part. This is going to take a lot of time to get worked out. But as a first investor, you're investing in a system that is set up to protect the house, and that’s the industry. Until there's a fundamental reform - and that may happen because of crowdfunding, which is starting to flatten things, or that might happen in part because of Slated - but until all that happens, you have to keep playing this game. Keep burning all those initial investors.. and eventually the whole game falls apart.

PARADIGM SHIFT

James Belfer: There are two things that need to change in order for the film industry, and particularly the independent film industry, to begin taking on a lot of the entrepreneurial practices that we see in the tech start-up world. The investors have to change their expectations and the filmmakers have to change their expectations. Everyone needs to just say, ‘this was the way that we were doing things and there has to be a new way to go about doing it. There needs to be a change.’ This is something that has happened in the film industry like clockwork every 15, 20 years and so we’re about due and technology is expediting that.

Whether it has been the arrival of talkies or color films or VHS or DVD and now digital, technology always changed the way the industry works. And, now, because of the available software for filmmakers to market and distribute their content, that’s going to ultimately have to change what it means to be a producer.

I don’t think it needs to change what it means to be a filmmaker. They need to go out and make films and I think that there needs to be a producer - or as I like to call him/her, an executive producer - who is in charge of the business of that project. And from there what you need to really look at is the film as a piece of IP [intellectual property]. Film is always more than just a film. It’s its characters, its setting, its universe. The idea of developing a film property beyond just a film creates all this extra value. It allows for additional rounds of financing. It allows for you to retain a majority of your rights and exploit them in a way that you could very well go off and exit this thing three, five years down the line all because made it work as a graphic novel and then when the graphic novel became popular, the film became popular, so then you spun out a merchandising line.

When film producers start treating their films as this IP, that will attract a different type of investor. Not just the angel investors, because they are all over film and they love it. Angels are always are looking for diversity in their portfolio or consider it an alternative investment form. Even institutional wealth management companies put money into independent films because it’s an alternative investment for them. But if we want to get VCs [venture capital firms], and we want to get the big institutional investors saying, ‘Yes, I am going to give money to an independent film,’ then you need to create really strong IP. Because that’s what they’re investing into for a software company to begin with: it’s the IP. And if your IP is extremely valuable because it can hit multiple different platforms and multiple mediums, then all of a sudden now we can start getting that type of institutional money and those types of firms into the industry.

APPLYING THE TECH START-UP MODEL

Mynette Louie: I always feel uncomfortable when people call films IP or content, because they’re unique, artistic things.

I think the main difference between tech and film is that tech has more sophisticated investors than film overall and I think that with start-ups there are particular business models that you can fit into. You can be ad revenue supported, you could get subscribers, or you can sell a product etc. Film is a little weirder. Films are art. They’re not widgets. So they’re a lot harder to assess because of the fuzzy emotional and creative elements that you have to deal with. You have to have to have your finger on the pulse of how tastes change, how audience behavior changes, what the zeitgeist is right now. There’s all this subjective stuff that’s very hard to quantify and very hard to pin down that I think is easy to do in the tech world than it is in the film/art world.

Paul Bernon: In the tech world, there’s a lot more buyers for product whereasin the independent film world, there’s only a small finite amount of distributors that you’re selling to, that you can monetize out of. There’s plenty of companies that get incubated in a VC environment that sell to mid-sized companies that you’ve never heard of and that’s still a great return. Whereas in the independent film world, we only have a certain amount of studios that are going to buy that film and get us out on an MG [minimum guarantee] plus return basis.

Audience Comment: when you’re looking at VCs, they are investing in a team that they’re committing to for five years, right? It seems like it makes more sense for VC money to apply itself to a company like Gamechanger. They surely don’t want to invest in one film. They’re interested in buying the horse that is going to win many races, not one race. And if they can do that, I bet it would be valuable to investors if they get first refusals when the team embarks on their next project.

Colin Brown
Editorial Director