Introduction

How do independent producers without the financial resources of a major studio or streamer go about structuring and paying for their production? In the second article of our Media and Entertainment Law series, we’ll look at everything from setting up a dedicated production company to financing and distributing the production, along with some of the key legal issues independent producers should be aware of.

The first step for the producer is to set up a special-purpose vehicle or SPV. An SPV is simply a new limited company, which, in the UK, can be incorporated in a matter of minutes at Companies House. From a legal perspective, the SPV will hold all the rights and obligations relating to the production. It receives and distributes the money (both financing and in time, hopefully, revenue). It engages the talent. It is the hub into which the various spokes of the production attach.

Why use an SPV?

There are several reasons why it makes sense for all parties that a production is operated through an SPV.

Firstly, running the production through an SPV means all the assets and liabilities of the production are separated from the producer’s other assets and liabilities. If the production was operated through one of the producer’s existing companies, even with rigorous financial oversight and management, issues with accounting and reporting would undoubtedly arise in time. Such a scenario is as unattractive to the producer as it is to the production’s financiers.

Secondly, an SPV isolates the producer’s financial risk. Making films and TV shows is a risky business, so avoiding potential cross-contamination of the existing business if the production runs into trouble is generally a good idea. One sometimes hears SPVs described as “insolvency remote” for this reason. In legal terms, this means that if the SPV’s creditors call in their debts, their recourse will be to the assets of the production only (as held through the SPV) rather than to the producer’s assets more generally.

Producers should be wary of any request that another company within their group guarantees any of the SPV’s obligations. When guarantees are given, the financial risk is extended beyond the SPV thus defeating one of the main benefits of operating through the SPV in the first place.

Thirdly, the SPV structure allows a producer to carve up and allocate the ownership rights or “equity” in the production, perhaps to attract further investment to fund production expenses. As the rights to the production are held via the SPV, producers can grant ownership positions in the production without compromising the structure of their business as a whole. The SPV can also take on debt finance, using the assets of the production as collateral.

Fourthly, SPVs can be structured to qualify for tax credits or other production incentives. This could be by virtue of something as simple as having the SPV’s registered office in a particular location or it could derive from more complex matters such as the SPV’s shareholding structure. Requirements will vary from production to production and jurisdiction to jurisdiction, but the SPV provides the blank canvas from which to work.

Funding and structuring

There are myriad ways in which independent productions are financed and to look at them all in detail would require far more time and space than we have here. However, one common feature is the requirement to forecast the likely production budget at the outset. By nature, production budgets are fluid but by building up a funding portrait (with appropriate contingencies), the producer will at least know the size of the ask from its financiers.

A producer of an independent production may look to source the funds through a mixture of some or all of:

• licence fees paid by commissioning broadcasters
• selling the future right to distribute the production internationally
• selling the future broadcast rights in different territories
• pre-selling the music collection rights
• pre-selling the so-called “Audio Visual Secondary Rights”
• raising external debt and/or equity investment

Let’s look at each of these in a little more detail.

Commission licence fee

In simple terms, a commissioner is a party (e.g. a TV broadcaster such as the BBC) who agrees to pay a licence fee in exchange for preferential rights to exhibit a production on their channels, whether terrestrial channels, online channels or (more likely) both.

A commissioner will not fund the entire production budget, however, they may offer to pay a material percentage of it – perhaps up to 20%. The commissioner will invariably want to pay the fee in instalments on delivery of certain production milestones. If the production is episodic the milestones will be linked to delivery of an agreed number of episodes, often split into batches. A producer will usually want some funds provided earlier than the first batch delivery in order to pay the ongoing costs of production, so this will be a point for negotiation. When negotiating the funds flows, broadcasters will often hold the balance of the negotiating power, but producers shouldn’t underplay their hand – particularly if they hold rights to a popular or well-established underlying property.

Other matters for negotiation may include: the amount of the licence fee and length of the licence period; which channels the broadcaster may exhibit on (including video on-demand services); the scope of the “holdbacks” (i.e. the restrictions on other broadcasters exhibiting the production) and the broadcaster’s entitlement to a share of future revenues, including revenues generated through production related merchandising.

Sale of distribution rights

International distributors may be prepared to pay for the right to licence the production to broadcasters in various territories throughout the world. They will be expected to pay an advance in order to do so, with the payment amount sometimes called a “minimum guarantee”. Although paid in advance, the amount is normally paid in two instalments – on signature of the distribution agreement and on delivery of the production. In return, the distributor will be permitted to licence the right to exhibit the production in the designated territories.

From a legal perspective, it’s important for a producer to ensure that any rights granted to a distributor don’t conflict with those granted to a commissioning broadcaster or to other distributors or international pre-sales partners (for which see further below). The same rights cannot be granted twice. In a production with multiple financing sources, an interparty agreement between the various financing parties is often a good idea so that everyone is clear on who holds which rights and in which territories. However, care must be taken not to disclose sensitive commercial information. The reality is usually that some financiers are paying comparatively more money than others and sometimes for lesser rights.

Pre-sale of international licences

Pro-active and well-connected producers may be able to secure additional advance revenues from pre-selling licences to broadcasters directly, both domestically (if there is no commissioning broadcaster on board) and internationally. They may or may not use a sales agent to assist them, but if they do the sales agent will expect a commission.

In return for these pre-buy licences, the broadcasters will be asked to make a signature payment upfront which will be used to help fund the production. Pre-selling licenses has the obvious benefit of generating cash for the production, however producers need to be careful not to alienate potential distributors. After all, if a distributor realises they won’t be able to grant licences to the production in their key territories, their interest might start to wane, putting a potentially substantial minimum guarantee in jeopardy.

Music management rights

If the production is to include original musical compositions, such as a soundtrack, the producer can appoint a rights management company to administer the rights to those compositions. This is of course on the proviso that the producer has been assigned the copyright in the compositions in the first place – we’ll look at this topic in more detail in a separate article.

The rights management company will be appointed as the agent of the Producer, empowered to administer the compositions and master recordings in specified territories. This means they have the right to issue licences to perform the compositions and to collect and share in the income derived from such performances. In return, the music rights management company will pay an advance, which will contribute to the production budget.

Producers should be alive to the fact that audio-visual secondary rights (AVSR) can be carved out and monetised separately from primary music rights. Therefore, unless agreed otherwise, the agreement with the music rights management company should expressly exclude so-called AVSRs from the scope of the right being granted to them.

AVSR

Audio-visual secondary rights work in a similar way to music rights. They arise from rights such as cable/satellite retransmission rights (this is typically the most valuable AVSR right) through to rental and lending rights. They will seldom generate as much revenue as music rights but they do provide an additional revenue stream, vital in these days of ever tighter production budgets. As with primary music management rights, a collection agent will pay an advance upfront in return for the right to collect and retain a portion of the AVSR rights. The music rights management agent and the AVSR rights management agent can of course be the same party, however, they don’t have to be and savvy producers can often get a better commercial outcome by splitting these roles up.

Debt and equity finance

Finally, a producer can also choose to raise finance from traditional sources, such as bank loans or selling ownership stakes in the SPV in return for an equity position. The SPV will have certain assets that can be used as collateral for loans, such as the estimated value of rights still to be sold.

Debt, mezzanine and equity finance may all play a part and each has a different risk/return profile. If a traditional bank loan is taken out, this debt is usually repayable first. It will carry the lowest risk for the lender and their return is limited to the interest which accrues on the debt. Equity is the highest risk in that it carries the greatest likelihood of no return to the equity holder if the production fails or performs badly. However, if the production is successful the equity holder will share in the financial upside, which will be attractive to financiers with greater risk appetite. Mezzanine debt sits somewhere in the middle, with a higher interest rate than senior bank debt but subordinate in repayment priority. It would however be payable before any returns on equity. Bridge financing can also be considered where funds are required short term to fill a final funding gap. Note though that interest rates on bridging loans will be high.

Completion guarantors are often (but not always) used to provide comfort to financiers that the production will be delivered by a certain date and to an agreed specification. If the production runs into difficulties, the completion guarantor is at risk for the funds advanced by the production’s debt financiers. They also take on the risk if the production goes over budget. Where used, the completion guarantee will form an important part of the production financier’s collateral package.

Conclusion

This is no more than a high-level overview of some of the issues involved in getting an independent production made. There will be lots of moving parts for a producer to manage, not all of which mesh neatly together. Notwithstanding this, each of these elements will need to be locked down in a legally binding contract and there are numerous pitfalls for the unwary.

It often takes incredible skill and tenacity on the part of a producer (not to mention a slice of good fortune) to secure the funding to meet the budget for an independent production. Having someone to support with structuring the production and financing is vital. An experienced lawyer can help. If you would like to discuss any of the issues covered in this article in more detail, please contact Peter Ward.