Understanding contract accounting practices for films

February 19, 2014
posted by sheric

Recently, I was introduced to a podcast series on the business of film from the folks over at Craft Truck. While perusing the episodes, I found one covering the creative accounting practices of studios and distributors and thought I would share some of the material here. You may be surprised at what is lurking in your distribution contracts regarding royalties and how payments are reported to you, probably unpleasantly surprised. Steven Sills, co author of Movie Money: Understanding Hollywood’s (Creative) Accounting Practices, reminds us repeatedly in his interview, “Get as much money up front as you can.”

Sills also explains that even though he is a CPA, his work in the industry has nothing to do with the generally accepted accounting principles (GAAP) found in financial statements prepared for companies in other industries. In film, accounting is done according to the language of the contract that was signed and the ones drawing up the contracts are the studios and distributors. Obviously, they are drafting contracts that benefit themselves and their only requirement after the contract is signed is to report to the participant in exactly the way the contract says. Sills simply ensures that reporting and payments are being made in accordance with the signed contract. If you are about  to sign a contract that you expect to see revenues from, you better understand exactly what you are signing!

contract accounting practices for film

If I am a producer about to finalize my distribution contract from a distributor, what are the 2 or 3 things I should do to help insure I am treated fairly as a profit participant?

SS: “Everyone has different reasons for engaging in contracts. If you are a successful producer, you may be looking to make money. If you are a new producer, you may simply be looking for credits for your resume. A lot has to do with what you want to accomplish, but let’s assume you want to get your fair share.

First, get a very good entertainment lawyer and have that lawyer negotiate on your behalf. It is going to cost you money upfront, but it could save you a fortune on the backend. Next, get as much money upfront as you possibly can because you don’t control how you will be reported to in the future. The distributor controls that whole process, how they record information, how they report information, how they interpret the contract. The more money you can get upfront, the better off you will be financially. Then, keep an eye on what happens in the reporting. Review your statements, get good consultation on reading the statements to see if anything inaccurate jumps out. Your lawyer may want to consult with an auditor before any contract is signed to see if any changes could be made that could benefit you in the future.

Certain things can be negotiated if you have good representation. When we sit down for an audit, first we read the contract and see if it differs from what we would normally see from that studio. If the lawyer was able to get certain provisions changed, chances are the studio will screw it up because they are huge multinational corporations who have certain ways of doing things, accounting systems that do the same thing over and over. If you change the language in your contract, chances are it won’t be changed in their system. This is why we audit.”

Do you find there is a habitual practice to misinterpret the contract on the part of studios or distributors? What is the state of practice when it comes to contract accounting?

SS: “Studios and distributors write the contracts to be beneficial for themselves. They interpret things for their own best interests. Unless a participant has a lot of leverage, he has very little ability to negotiate significant changes within those contracts. People in business expect that if you are writing an agreement, you will write it in such a way that it will benefit you. These agreements are written with a certain end result in mind. That result is to give a reasonable amount of money to the profit participant, but also to cover the studio’s or distributor’s own costs and that includes the whole business. However, to a profit participant who believes they are a contributor to the success of a movie, they want their fair share of that success.

There is a very famous litigation out there about the Buchwald case. It has to do with the movie Coming to America, the Eddie Murphy film. In that case, there is testimony from a former studio executive that shed a light on how this process works. He said the reason we [studios] do the practices we do is because the winners have to pay for the losers. For every successful film we make, we have 9 unsuccessful ones and we have to cover the cost of those unsuccessful movies. If we give away all the profits for the successful ones, then we lose money on the unsuccessful ones so we need everyone to participate in that. Well, a profit participant doesn’t feel that way. If they contributed to the successful movie, they want their share of that success and that’s where the tension is. So in your contract, you will need to determine if you are involved in the business of the studio, or whether you are a participant only in the profit of the film in which you were an actor/writer/director/producer.”

Do you see a major shift in where money is coming from in terms of revenues and how that impacts contract terms?

SS: “There’s definitely a major shift. The DVD market is diminishing very rapidly and the VOD market is increasing, but not at the same rate as the decline in DVD sales so there is a definite decline in overall revenue and that has to do with how people get their content.

But to understand this, it requires a little history. Go back to the early 1980s when the home video business first started. It started with the Sony Betamax machine in Japan.

The Sony equipment allowed Japanese businessmen and women to record onto tape TV shows during the day and watch a tape of the programs at night. And then a company called Magnetic Video worked with Sony to market that machine in the United States. At the same time, Magnetic Video negotiated a deal with 20th Century Fox to license their films and put them on tapes and sell them in boxes to consumers, the VHS tape. It was the beginning of the home video industry.

In negotiating with Fox, all parties figured out how much they should get out of this product. They figured that the cost to revenue ratio back in the early 80s was about 60%; 60 cents of every dollar went to buy the tape, design and make the case, market the VHS copy, market the machine just to get this product out to the public. So the 40% that was left over was split. Magnetic got 20% royalty for creating the concept and Fox got a 20% royalty for licensing their films. So that is where the 20% royalty rate comes from and persists to this day. It was the basis for this entire home video industry.

Now the cost to revenue ratio for DVDs is more like 25-30% range for cost, but making a 65% profit, but still only paying a 20% revenue share to the profit participant. That takes us into the VOD realm, which will soon become the dominant source of revenue for distribution. Most studios have decided to classify VOD as home video revenue subject to the 20% royalty even though they don’t have the same cost structure involved as in DVD. In a digital file, there is no cost to manufacture a disc and ship it anywhere, no packaging to make, marketing costs are reduced because much is done by the entity that is selling the product, but they still only pay 20% royalty to the profit participant. Why they are keeping royalties the same? Their response is they need more profits to offset the losses they incur from the decline in DVD sales. They need to maintain their profit margins.

Let’s say the distributor charged the consumer $10 for a download copy of a movie, one the consumer can keep, not just rent. Let’s say the download came from iTunes, so they keep 30% of the transaction or $3 and pass $7 back to the distributor. The distributor will report 20% of that $7 on your statement. That’s $1.40 and if you get a 10% profit participation, you get $.14.

Certain types of downloads will only receive a 20% royalty on the revenues received. When negotiating your deal, you need to find out how they treat downloads; as home video purchases subject to the 20% royalty or as rentals because those are more like the licensing fees received from broadcast deals.

We’re dealing with an oligopoly here. 90% of the films are being distributed by a handful of major distributors and they set the terms. If you don’t like their deal, they will tell you to go down the street, but often you will find the exact same terms everywhere else. You have to hope to get your movie made, it becomes a huge success and you will get something out of it.”

 

To listen to the whole podcast, jump on over to the Craft Truck site HERE  I will be recording a podcast for their Business of Film show next week. I’ll post the link to it here when it is available.

Sheri Candler
 

Minimum marketing spend for an indie film

April 15, 2013
posted by sheric

This is a question I hear often “About how much should I set aside for marketing and distribution of my film?” It is a tough question to answer precisely because even Hollywood professionals have a difficult time balancing  how much marketing spend is just enough to make the film appear successful, but not so much that it results in taking a loss. I’m looking at you John Carter, Battleship and Dark Shadows. One could argue that those films were not good and that’s why they “failed,” but the pressure placed on a studio marketing department to open big the first weekend in order to appear successful necessitates a large marketing spend (usually minimum $50mil).

In this video with Film Courage, I talk about the bare minimum marketing spend one should budget for an indie film when planning out the overall film budget:

 

But that doesn’t mean you should think “Right, 10% is the amount I should set aside” because you really do need to formulate your entire marketing plan. You need to pinpoint the exact audience you are going to try to attract with your film, figure out how best to communicate with them and work through all of the elements you are going to create or need to buy in order to reach the audience or reach the goal of the production successfully. Remember, the goal for every production is NOT the same. For some filmmakers, just getting industry attention in hopes of a better career will be a success (see David Lowery and Behn Zeitlin as examples). For others, “changing the world” or raising awareness behind an issue in hopes of the audience taking a more active role in solving the problem is a success (see The Invisible War as an example). For others, gathering the support of a core audience that will continue into other work will be the mark of success (see Ava Duvernay and Tiffany Shlain.). Outside of Hollywood, success is not always marked by huge profit numbers.

During the course of your audience identification investigation, you may find that without marketable elements such as star actor names or major festival wins or stellar critical reviews, it will be nearly impossible to reach the broad audience your story will need to reach. This is especially true for dramas (coming of age, tragedy, period etc.) and comedies. Most documentaries inherently have an audience to tap into because there is a cause or a personality being profiled that organizations/clubs form around. There is no quirky comedy or coming of age drama organization to tap. Understand?

Also, you may realize you need the help of a producer of note who can help position your project to a whole set of constituencies (managers, agents. attorneys, the media, distributors, and exhibitors) within their sphere of influence. Being able to tap those resources for help can catalyze the process of getting the film seen to a wider audience or catapulting your career in the industry because they are all gatekeepers for a reason. Can you go around the gatekeepers? YES, but it can be much easier to achieve success with their validation. Producers of that stature like to be paid and, well, they should be. Another expense that could make a difference to your film’s ROI.

Some indie  producers have seen this video and told me they are now going to set aside 10% (only) from their production budget. If that overall budget is only $50K, that means they are going to try to achieve an awful lot with only $5k to spend on movie marketing and distribution. You can spend $5K just getting a good website built or having a first rate trailer edited or hiring a publicist for your big festival debut. You’re going to need more than a good website, a trailer or a good publicist to promote your film during one event in order to execute the formidable work of getting audience attention on your project and selling it directly if no distribution deals are presented. I am all about NOT being dependent on the good distribution deal to come and save your film. Too many times that either doesn’t happen, or the distributor drops the ball and doesn’t give the film a meaningful release. You can only know that the film will have a meaningful release if YOU have planned for it.

A few line items that will be on your marketing and distribution budget are professional graphic designer, website designer, copywriter, web hosting, email service provider, search engine optimization service, ecommerce shopping cart and fulfillment, merchandise manufacturing (aside from DVDs), trailer and short video clip editor, advertising/media buys, publicist, on set photographer, DVD authoring/replication. digital encoding for iTunes/other online outlets and possibly VOD services,  DCP drive preparation, Vimeo Pro account if appropriate, online measurement tools, printing services (for posters/postcards), theatrical booker, festival consultant (a well connected one), festival submissions and travel expenses, premiere parties or other live event components. This is taking into consideration that the producer or someone on the production will be doing this considerable work for free or for backend. If you want to hire someone to do this work (who will also handle any opportunity/problem that comes up during the course of marketing and distribution and will be a full time community manager for your audience base), that’s another expense. Personally, I don’t work for backend, but you may be able to strike that agreement with someone. Point being, it will be really difficult to obtain all of this for only $5K and I have been as realistic as I can in this listing of needed marketing and distribution expenses. I really can’t see this being done for less than $40K excluding labor cost for a PMD or calling in a lot of favors. The high end can go as high as your ambitions for the film. *AMENDED BELOW*

While it is possible to find marketing budget templates on the internet that are not specific to film or to look at guidelines that some film commissions provide for marketing grants, most are not geared for the indie film world we live in now. They mostly speak to marketing plans that rely on big advertising spends and posters because they are still stuck in the mindset that the goal is to drive cinema attendance. Yep, Hollywood is still relying on that route, but as an indie, you can’t do that. A theatrical release may not be realistic or appropriate for your film’s resources. While these templates/guidelines are useful to look at,  you really need to assess what audience your film is specifically trying to reach in order to plan out the expenses that are appropriate. I write these kinds of plans, very tailored to your film. The plans include reading the scripte/watching the film, audience research, best positioning angle to take for the core audience, ideas for content creation and release to online channels, email best practices, publications to pitch for stories with contact details, and a preliminary marketing and distribution budget that includes the resources you will need to implement the plan.

As a producer, it is imperative that you have marketing and distribution expenses included in your overall production budget and you can’t know those expenses if you don’t have a marketing and distribution plan based on the core audience of your film. Otherwise, you are putting your production, your investors and those who agreed to defer their pay in extreme risk of not achieving the production goals.

Amended: In speaking with my colleague, Jeffrey Winter from The Film Collaborative, his advice is budget a minimum of $50K just for the theatrical campaign.  This breaks down into about $7K for organizational/online outreach, $20K in theatrical 4 wall fees needed for major markets such as NYC, San Francisco, LA, DC, Chicago (places where you will want major publication reviews, but whose policy stipulates a film must have a week long theatrical and in more than one city so it can be seen as a national release), $7K for a prominent publicist (needed to contact outlets such as NYT, LAT etc who probably won’t review if you called yourself), $500 for Blu Rays, $1000 for DCP, $1500 for poster design and printing (I think he’s giving you a break on this! You’ll probably need to spend more), $500 for shipping, $10K for a reputable booker to help you get screenings in more cities so you won’t have to 4 wall, $3K for a kick ass trailer,  the rest you can spend on ads.