Canada: Debt, Equity And Tax Credits: How Films Are Financed

The other day I cued up a new release movie that I had been eagerly anticipating. As the opening credits rolled, I couldn't believe how many entities were being credited. The list kept going and going, with a range of what appeared to be both governmental and private organizations. What could these organizations all have to do with making this movie? We have all seen the opening credits and title sequences to our favourite films, although if you're like me, you probably don't pay much attention to the cleverly named companies and funds that have earned a credit in the film. The answer, of course, requires us to follow the money. Most of these entities have contributed to the financing to the film, either by way of investment or tax incentive, and as a term of their contribution are entitled to a screen credit. In this post, we'll look at three of the primary methods by which film producers obtain their financing.

Debt financing

Historically, film producers funded their pictures with their existing capital which was usually by way of retained earnings from other films or with funds from other public or private sources or a combination of both. Many Hollywood films are produced purely using existing capital from the studios involved in the production, which of course negates the need for third party financing.

On the other hand, in the event funding is required (which is the case with many productions, big-budget Hollywood films being no exception) films can be debt-financed by way of loan, typically obtained from institutional or private lenders. Of the big six banks in Canada, a handful of them offer dedicated film finance departments which have either been grown in-house over the years or kick-started by the acquisition of private funds which have become the media financing arm of the bank.

A film credit facility from one of these banks does not differ substantially from a credit facility in favour of any other business, although there are some important nuances which distinguish film financing from a regular financing deal. The lender will typically take security over the borrower's present and after-acquired personal property which, importantly in this context, includes the intellectual property rights in the content. Lenders want to ensure that the borrower possesses the underlying rights required to create the content and as such a chain of title opinion is usually required. A chain of title opinion involves reviewing the various agreements and assignments between the original creator of the content all the way down to the production company to track the ownership of the underlying rights and ensure that it has been properly transferred, and is given by the borrower's counsel.

As producers typically establish new production companies for each new venture, the borrower will likely not have any material assets other than the underlying rights to produce the content. As such, the lender will want security and guarantees from certain of the producer's subsidiary companies.

The closing process of a bank financed film is often more fluid than a standard facility where all deliverables are required to be in place prior to the lender's advance. A bank may actually advance funds even before the transaction has closed, although in my experience this depends on the relationship between the production company and the lender. An example of this is where errors and omissions insurance (or E&O insurance) is required. E&O insurance is a type of producers insurance which covers legal liability and defense for the production company against, among other things, lawsuits alleging unauthorized use of titles, formats, ideas, characters, plots, plagiarism, and defamation. The timing of when a producer is required to have E&O insurance in place depends on the complexities of the project but is usually required before a film can be released.

Another important piece of the funding process which is crucial to the bank offering the credit is to have a completion bond (sometimes called a completion guarantee) in place. This is a special form of insurance that essentially guarantees that a production will be finished and delivered on schedule and within budget in the event the producer is unable to complete the project. The use of completion insurance is hilariously depicted in the film Lost in La Mancha, the documentary about Terry Gilliam's attempt to make The Man Who Killed Don Quixote in 1998, a film where the producers famously encountered a series of unfortunate events which did not enable the film to be completed. While Quixote has not yet graced our screens, I recently came across an article that suggests Gilliam has not yet given up on ensuring his film sees the light of day.

Lastly, the typical deliveries such as resolutions, officer's certificates and opinions will be required by the lender as a condition of closing the deal.

Equity funding

Where debt is not the preferred method of funding the film, sometimes equity financing is used by way of private placements or offerings. The formalities of this process can vary from full lawyer-driven equity deals to informal cash-for-shares structures. A good example of the latter is the Coen Brothers' first film entitled Blood Simple (despite considering myself a big Coen Brothers fan, I admit I have not seen their 1985 debut) where Joel and Ethan corralled a group of private investors by taking their film trailer and going door to door to come up with the US $1,500,000 or so that was needed to make the film – they succeeded and the film was made, and the rest is history. To date, the domestic gross revenue of Blood Simple is just shy of US $4,000,000. It may not be a windfall, but it's a decent return for the people who took a punt on a couple of unknowns. The Coen Brothers' true grit, pound-the-pavement ethos is tried and true, and is still used by indies and big studios alike as a way to generate funds to produce their films.

Tax credits

Another significant source of funding is from the use of tax credit incentives. Most Canadian jurisdictions, including the federal level, offer a tax incentive to encourage the use of local personnel and/or local filming locations. The incentives are offered for projects which offer Canadian content or use Canadian production services. The Ontario Media Development Corporation, an agency of the Ontario Ministry of Tourism, Culture and Sport, offers three different film tax credits, which provide refundable tax credits to qualifying entities of up to 35% for certain production expenses. At the federal level, the Canadian Audio-Visual Certification Office (CAVCO) co-administers two federal tax credit programs with the Canada Revenue Agency under the Income Tax Act.

The US also historically offered tax-related incentives to filmmakers, although due to the abuse of tax shelters and tax legislation reforms in the 1980s, producers started to look elsewhere for funding. Cue foreign countries with tax-credit programs to begin marketing to Hollywood to bring their funds overseas to attract investment. In addition to Canada, the United Kingdom, Australia and several other European countries including France, Holland and Germany offer significant tax breaks to attract Hollywood's money. Germany has among the most attractive incentives for studios, as the German tax code permits a film's investors to make an immediate tax deduction notwithstanding that a film has not even begun production. The film need not be shot in Germany or use German crew (a condition of many other local tax programs) but so long as the copyright is owned by a German entity the tax incentive applies. Studios get around the copyright ownership hurdle by sale transactions which include immediate lease-back with an option to repurchase at a later date.

The merits of tax credits and the value they add (or the amount they cost) to the taxpayer continue to be debated and in recent years provincial and state tax credit programs have been slowly drying up. That notwithstanding, it is probably fair to say that hit productions such as Breaking Bad or Deadpool probably wouldn't exist if it were not for tax credits.

To conclude, there are various ways a producer can obtain financing for its project. The fact is that many producers employ all three methods described above to generate the level of funding they require to express their idea (or the idea of someone else for which they have obtained the underlying rights). Each method comes with its own unique challenges and requirements.


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