As an entertainment executive, I think a lot about break-even analysis, not only for my own company but for the investors whom I serve.
First, let’s talk about break-even analysis for a company. An entity should always be aware of its fixed costs, variable costs, sales volume (current and predicted), sales price, and how these factors and changes to these factors influence each other. If you know what your fixed costs are and add to that your variable costs at a predicted volume, you can easily figure out how many units you need to sell in order to cover your costs and break even. You can also determine how many additional units are needed to reach a specific profit.
This is important data, but is often not enough to make a final decision. What assumptions are being made? What are the opportunity costs? Are there alternative media that have lower variable costs where you might have to sell less product to make the same profit? Do you ever really know how many items you will sell of a music CD or DVD or Blu Ray? Are consumer buying trends moving toward one’s medium or away from it?
My father, a one time Yale professor, now retired, often talks to me about the difference between facts and opinion in investing. While it is always preferable to invest on the basis of facts, it is rare that one has many real facts in most investments. If I get three calls a week from people who want me to invest in oil and gas wells in Texas, Kentucky, and Oklahoma, do I even know that the people on the other end of the line are legitimate without a trip to visit the well?
Investors who I speak to are interested in two things, return of their investment and return on their investment, and how that return and risk compares to other opportunities that come to them each day. In some cases, they are also actually passionate about the project itself or the filmmakers themselves, but that passion should take a back seat in investment analysis.
So how can an investor, couple or investment company predict how much money he or she will make from a film, let alone whether that film will break even? Here are six ways investors I know figure out whether a film will be profitable for them or not.
1. They value and properly weight my opinion. If you were a real estate investor who invested in the first project that came your way, would you make a profit? Smart investors look at many projects. I look at up to 700 projects a year and pick the top ones based on specific criteria. That research, expertise, and expense on my part does not substitute for due diligence by an investor, but it’s a big head start over doing it all yourself!
2. They get educated. Most investors prosper in areas where they know something about the process. Few people with money are experts in film, but the industry parallels a number of other investment types, such as oil wells, and the filmmaking process is extremely predictable compared to other entrepreneurial endeavors. Pre-production, production, post-production, distribution, exhibition, ancillary sales and licensing, etc. are pretty consistent in every film made by professionals. If an investor loves learning and asking questions about new industries, they are likely to do better in film than someone who invests with a passive understanding of the industry. Knowing that G, PG, and PG-13 movies make substantially more money than R films may also help an investor safeguard his or her money. If a filmmaker is presenting you with an R script (two or more F-words), it’s a hint that they have more artistic ego than business sense or loyalty to you as an investor. To succeed in the entertainment business, one needs to be both artist and businessman or woman.
3. Smart investors work with people who have made films before. A funny thing happens when you make your first film. You discover what in your budget was a fact and what was just opinion! You also find out how disciplined you are as a Producer or Director, because a good Producer is able to negotiate to keep costs down that are constantly trying to rise. Did those $266,000 lenses get returned on time? If not, you may end up paying thousands extra if you can’t talk the rental company into sticking with the original contracted price. If some of your equipment is coming from out of state, did FedEx charge you an unexpected $1,600 as a “stated value fee?” Did the production go over one day, and addendums suddenly need to be prepared for all cast and crew agreements? Did you factor in payroll company expenses, and if not, is the filmmaker going to spend weeks doing paperwork that should be spent in post-production or marketing the film for profits and waiting for the SAG deposit back? These are realities in film that a first time Producer is unlikely to recognize and factor in. A smart investor recognizes a first time Producer’s naivete and at least makes sure they are working with people who have experience on the business end of film. Better yet, don’t work with beginners who may be passionate about making a film, but forget they have to sell it afterward! This happened to a friend of mine who blew $10,000 on below B-rated film Vampire Biker Babes, the first film that came his way. Work with those who have successfully produced and marketed a film, who have their feet on the ground, and you’ll be much better off. Hint: People who have made films before can also show you the quality of work they have done before. Is it marketable? Can it compete with movies in theaters? On DVD? On TV? On Pay Per View? Other downloadable, paid and advertising supported content like Hulu or Netflix?
4. Smart investors require completion bonds and production insurance on every film they make. (With proven directors who stay within budget, you can sacrifice completion bonds, but at your own risk.) In most cases you can’t get location permits and vehicles, let alone rent those $266,000 lenses, if you don’t have production insurance. Smart investors make sure there is enough insurance in place to cover the cost of major damages to the set and equipment so the production is not on the hook with insufficient funds to complete the film because a Production Assistant knocked over four Red cameras. Completion bonds are also useful, as they guarantee a film will be done on budget. Completion bonds are only available for so-called “bondable” Directors who have shown the ability to get things done under budget. If the film has already been shot and you are being approached about completion funds, one should still make sure insurance was in place when the film was made, as also someone who makes sure releases have been signed for featured brands, artwork, crew work, actors, and extras.
5. Take your investment amount and figure out exactly where the sales are going to come from to recover your investment. These days about two-thirds of profits come from DVD sales and International sales and pre-sales. Of course, these could also be your only profits. Find out what the distribution strategy is for the film. Is it realistic, or do the filmmakers claim they are releasing at Sundance, where at best 1 in 100 films are accepted? (Usually far less!) How do these estimates compare with past films by these filmmakers? Can any revenues be expected before the film is even released, as with pre-sales? In reaching a break-even figure, you might also discuss tax benefits of film investing with your accountant. We have two CPA’s you can talk to about advanced tax strategies, particularly if you own a company that pays high tax bills each year.
6. Communicate! Establish a communication plan up front so you always have an idea of where the production stands. You need to give the filmmakers room to do their jobs, but regular updates should be expected and pre-planned. Volunteering to be an extra on the film you help finance gives you another way to keep an eye on how things are going while also contributing to the production and learning the process. Try not to spend too much time with the Director while on set, if invited, as you are paying for not only his or her time, but the crew’s as well. Find filmmakers who are good communicators and you will have a far more pleasant time. If you are on the same page up front when it comes to expectations, they can work for you as much as you believe in them. Finally, don’t neglect written communications, including the PPM or Private Placement Memorandum that is common in film finance. This tells you what the risks are, if you read it, and the Subscription Documents you sign should also accurately let them know this project is a good fit for you, even though it is not as liquid as publicly traded stock. Don’t invest in a film without proper documentation and a comfort level with those making the film. You don’t have to invest on your first meeting, but don’t waste their time either. You are probably not the only investor in the project, and the sooner production can start the better.
Investing in film can be very rewarding, both intrinsically and when the film does well. Plan for success, do your due diligence, and you could see returns far higher than what your mutual fund advisors can offer you. In the end, are you willing to help sell the film if it helps you make money, or if necessary to get your money back? That’s another thing to consider, especially if you have connections. The business acumen that made you successful enough to invest in film may also help the filmmakers maximize the profits of the film.
In the end, break-even analysis numbers help you make an informed guess about the profitability of your film investment, but you have to make the executive decision, and it may be just as much about gut feeling about the team making the movie as the comfort of numbers. Filmmaking is a team sport. Find a team to play on that needs the capital and expertise you can offer, but that also meets your goals as an investor and contributor to the success of that team!
Unlike Wall Street, film investing is anything but a zero sum game. You are “producing” something of value that will hopefully entertain and inspire people worldwide. That alone is a reason to invest with pride in film over many traditional investments. If you are just starting, get your feet wet, but don’t go in so deep you have to worry about drowning!
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