FILM FINANCING: WALL STREET INVADES HOLLYWOOD

INFLUX OF TRADITIONAL INSTITUTIONS MAY BE AT ODDS WITH NOTORIOUS ACCOUNTING PRACTICES

Back in the day, the ways in which movies were financed called to mind the adage about never wanting to see how sausages are made. Producers using credit cards and borrowing money from friends and family to get their movies to the silver screen were legend. Others tell of the wealthy spending millions of dollars on films to satisfy a desire to mingle with the stars or see their names on the screen.

Times have changed.

Today, the trades report virtually every day about financing transactions involving traditional banks and investment institutions – i.e. “Wall Street.” Staid institutions seem to appear daily in the pages of Daily Variety or The Hollywood Reporter – Goldman Sachs ($210 million deal with Lionsgate Films, Variety Jan 17, 2007), Morgan Stanley ($200 million deal with Focus Pictures and $150 million deal with Paramount Vantage, THR, Jan 26, 2007) and Royal Bank of Scotland ($350 million deal with New Line Cinema, THR Feb 1, 2007) are just the latest of these reported financing deals in the hundreds of millions of dollars.

These institutions are investing not just in studios and their slate of blockbusters. Wall Street institutions now partner directly with individual producers to back those with successful track records on their future projects. According to the New York Times (“Wall Street Woos Film Producers, Skirting Studios” October 15, 2006), producer Joel Silver (“Lethal Weapon” and “Matrix”) reportedly inked a deal with investment firm, CIT Group, for $220 million to produce 15 motion pictures. Ivan Reitman (“Animal House” and “Ghostbusters”) reportedly has a deal worth $200 million for 10 pictures with Merrill Lynch.

HOLLYWOOD ACCOUNTING

The influx of traditional financial institutions accustomed to standardized accounting practices and returns on their investment could have an impact on how Hollywood conducts its business in the future.

“Hollywood accounting” has long been the subject of jokes and (more ominously) lawsuits. Gary Wolf, author of the book on the film “Who Framed Roger Rabbit” was based, sued Disney when Disney claimed that the picture failed to turn a profit. Art Buchwald sued Paramount Pictures over the film “Coming to America” when the studio claimed that movie never made a dime. More recently, Peter Jackson, director of the picture “Lord of the Rings,” sued New Line Cinema over certain “accounting practices.” That these profit participants in such significant movies would need litigation to sort out their participation in the movie’s “profits” speaks volumes over the way studios accounted for “profits” on motion pictures.

Wikipedia describes it this way:

Hollywood accounting is the practice of distributing the profit earned by a large project to corporate entities which, though distinct from the one responsible for the project itself, are typically owned by the same people. This has the net result of reducing the project’s reported profit by a substantial margin, sometimes even eliminating it altogether.

In other words, Hollywood accounting practices do not always comport with “generally accepted accounting principles” – GAAP – which traditional investment institutions take for granted.

WHAT DOES THIS TREND MEAN FOR PROFIT PARTICIPANTS

The optimist in me says that the influx of venerable financial institutions could only help the individual profit participant. These institutions will demand that studios and distributors make only arms length transactions involving the properties in which they invest and that any expenses charged to the movies be above-board. Moreover, the institutions will have the resources to challenge the studios on any questionable transactions or charges – all of which you could expect to deter any “funny business” from taking place.

However, the cynic in me says that nothing will change and that only those with sufficient “clout” in the industry will benefit – same as it ever was. So while these institutions investing hundreds of millions of dollars will have the resources and the power to negotiate favorable profit definitions and contractual rights for reports and accounting, the “regular” profit player will still be subjected to profit definitions which favor the studios.

In addition, the consolidation under one corporate umbrella of studios, television and cable networks and new media outlets continues unabated. Thus, transactions among corporate affiliates are more prevalent than ever. Whether the “sale” of rights to exploit a motion picture to a studio’s network affiliate is consistent with what a sale in the open market would bring for those rights will continue to be a concern for most profit participants.

Accordingly, profit participants must continue to be vigilant in negotiating their deals and definitions as well as in monitoring the transactions transferring the rights to those pictures. In other words, just because these institutions might be able to “clean up” some of Hollywood’s most notorious practices for their own deals doesn’t mean that the individual profit participant is going to reap much benefit. Lawyers and auditors who are tasked to keep studios and production companies in check will still be needed.

That’s my opinion, based on almost twenty years in litigating these kinds of disputes. Wall Street’s participation in the industry is certainly a trend worth watching since this is likely to affect the industry for years to come.