Your own private equity

Indie bizzers debate the opportunities and implications of the latest wave of financing that's hit Hollywood

Private equity, some of it from hedge funds, is flowing in Hollywood — and now the indies can benefit.

Producer Michael London’s new shingle Groundswell raised $55 million earlier this year.

Even a newly studio-less Tom Cruise is getting a piece of the action.

Combined with tax incentives offered by various states, indies now have more access to U.S.-based financing. And new super-gap funds, like the ones repped by agency indie divisions at William Morris and ICM, serve to complement the fresh coin.

Daily Variety brought together a roundtable of the players in this arena to discuss the various issues involved. They include: London, Summit Entertainment COO Bob Hayward, ICM’s indie unit topper Hal Sadoff, William Morris Independent’s co-heads Cassian Elwes and Rena Ronson, and Relativity Media’s Ryan Kavanaugh, the man behind many of the hedge fund deals in Hollywood today. Daily Variety‘s Pamela McClintock and Sharon Swart asked the questions.

DAILY VARIETY: Let’s jump right in. What does the influx of all the hedge fund money mean for the indies?

Ryan Kavanaugh: For a hedge fund it’s almost irrelevant if it’s an independent or a studio movie. Today the word independent doesn’t mean a little $5 million arthouse movie — there’s a lot of studio-comparable material that gets made in the independent world. As long as hedge funds can find the appropriate models to follow their appropriate risk-reward ratios, they’re happy to participate.

DAILY VARIETY: Will the recent Warner Bros. pic failures (that had hedge fund backing) have an effect on the money rolling in?

RK: There’s been a lot of press about Warner Bros. losing money for some of its participants, but I don’t think, in a dramatic way, that it’s going to faze the market. Hedge funds are very smart institutional investors. They have done their due diligence on the industry, they know just like any industry it goes in cycles, and that’s why these deals — and even those hedge funds participating in the independent world — are following the slate mentality.

Hal Sadoff: But Ryan, on the independent side it’s harder to get a slate of movies, so how do they look at that?

RK: I agree. On all sides it’s important to have diversity. If you end up with three or four movies that you lose money on, you want to know that you have a consistent volume. At least the way we do our business, in the independent world, we have to get around that barrier, which is ensuring that we have enough volume to employ a slate mentality.

Michael London: But are you guys active in the independent world?

RK: Yeah, very active. We haven’t really come out of the closet. But we’re not hiding it. Our target is two independents a month, and I think we’ve committed, this year alone, $400 million in independents. I think six or seven are going into production in the end of the year.

ML: With and without studio distribution?

RK: It just depends on the model. We look at whether we’re going to take domestic risk or not, but we’re not going to take any domestic risk if there’s not studio distribution. We’re slowly bridging that gap on our own too. Obviously that’s why we did the Image deal. (Relativity Media signed a 10-year homevideo output deal and now has a 14% stake in Image.) It had nothing to do with our slate business. That was purely for our independents. We have our own homevideo now, and we’re working on bridging the other components.

Bob Hayward: I think the same is true from our end. We’ve seen no decrease in interest of hedge funds wanting to come into the space. And in some ways there is an interest in the independent sector now because foreign is a way of mitigating your risk.

RK: Yeah that’s a great point for us. From our models, doing the independents is less risky — less upside, but less risky than actually doing the slate deals.

DAILY VARIETY: What are the downsides of doing the slate deal?

BH: Exclusivity. On ‘Step Up’ we are in 100% of the movie ourselves. I think if you’re going into a legitimate slate deal with a financing company you’ve got to bring them in on everything.

DAILY VARIETY: How does this compare with what your situation at Groundswell looks like, Michael?

ML: Well, I definitely noticed in the last few months, with the problems in performance of some of the movies that we’re talking about, that the hedge funds started to sniff around a little bit more on producer-driven models, as opposed to studio-driven slate deals. And the problem as an indie producer or as an independent production company is that our slates are just so much smaller. I mean, we’re making three movies this fall, but that’ll probably be all we do for a year. …but, right now in New York there’s a whole lot more producers trolling around for money than there were six months ago. I have a lot of peers who are spending a lot of time in New York … I would say 90% or so of those efforts are going to be unsuccessful.

Cassian Elwes: Everyone I ask, they’re always saying, ‘Well, I’ve got part of it…’ (laughter)

HS: And they’re all going around to the same people.

DAILY VARIETY: Who are “the same people”?

CE: Well there are hundreds of hedge funds. Probably 30 huge ones, right?

RK: There are probably 50 funds that are big enough to really play in this business in any meaningful way.

CE: Of which maybe two of them are only slightly interested.

RK: I think there are 10 people who are always there, as long as the deal works, and probably another 10 to 15 that play more passively. In our general deals we’ve had up top 20 funds participate. But I think that the reason the producer deals are coming alive is because there’s only so many deals you can do in Hollywood — there’s six or seven entry points into the studios, and they’re all gone. The next place to go is to producers, and the deals are by nature smaller. I think some of them will close. (But) it’s not a great model for a hedge fund because you put very little money to work compared to these other deals, and you take a lot more risk because the volumes are nowhere near what you could get with a studio.

HS: But on producer deals, a key to it is distribution. Those hedge funds aren’t going to last if there’s no distribution.

RK: In my opinion, you need distribution, you need a co-finance party. I don’t think hedge funds will participate where they’re writing a check for 100% of all your movies.

HS: I think over the next two years, we’re going to see new independent distribution companies. That’s the next step for the hedge funds.

CE: Yeah, except they love the fact that MGM has this pay deal that they can click into, and whatever new companies come up are not necessarily going to have those deals.

RK: It’s no secret to people in town that we’re doing something with distribution. We just did our own homevideo. And I can tell you, at least from our experience, that I don’t think the pay deals are going to be the same anymore, when they expire. I think that new people, hopefully like ourselves, will be able to get new deals, maybe not quite as strong but similar deals to what the new pay deals will look like.

DAILY VARIETY: Cassian, tell us about your plans to leverage the state rebates, like in Louisiana.

CE: All these states are bringing money to the table. It could be a way to make up for the German tax money that went away in the last two years. And, in fact, it could be a better situation for an independent producer — this is purely incentive money that you never have to pay back. … We basically went to the state of Louisiana and said, “Let us come and bring a lot of films to you, and will you give us a nice deal.” We have the Pelican Film Fund, which we’re just starting up now, to bring $300 million worth of films through.

Rena Ronson: And that, in combination with working with Blue Ryder, which is another venture that we’re involved in, monetizing tax deals has kind of put us at a level where we can fill a couple of holes in a production financing deal.

ML: What’s amazing is how full all those state programs are.

BH: I know, on “Step Up” we were the first film in the Baltimore program. We went back to Baltimore recently and told them we’re looking at filming our next picture here, but the problem is they’ve become so busy they can only allocate so much. In New York, you’ve sort of got to go to the queue and wait until you get your money back.

ML: That’s true in Pennsylvania, it’s true in Connecticut …

RR: Yeah, but the good news is we have how many states?

BH: If you’re using it for financing, unless you’re going to pay an intermediary or something, you have to have money to bridge it for however long it’s going to take. We said to Baltimore, going in, “Make it refundable during post and make it bankable.” That’s got tremendous value to us, because you use it as collateral and it’ll really help draw productions to you.

CE: I’m sure where the hedge funds can come in and really make a play is in the independent sector is to do super-gap financing because that’s a portion of the financing, and it’s slightly more risky than the gap financing the banks have been doing, but it’s not that risky in our opinion. Because why would we be making the movie if it ultimately is not going to generate 45% of its budget? So that’s an area that I think hedge funds can get into.

RK: That’s a piece of what we do, because we finance the entire film. But the difference is we do gap, super-gap, all the financing of all the pieces of the capital structure, so we will only do a whole movie. But we are looking at every piece of the structure including the super-gap.

HS: I think we’re seeing a lot more of those players out there today, trying to do gap, super-gap, more than I’ve ever seen before. And, as Cassian said, I think these state incentives combined with the gap, super-gap, along with the people willing to bank the tax credits, a couple of pre-sales, and you can cover a lot of your budget. You have between 60% and 80% just with that. So we’re seeing a lot of that and it’s becoming more complicated …

RR: We sit at meetings sometimes with a chalkboard and we go, “If we get this percentage here…” and then we piece it together.

BH: But is it really any more complicated? I mean, the basic principles of the sources have always existed. You’ve always had foreign pre-sales; you’ve always had foreign subsidies, someone who’s discounted the foreign subsidies. You’ve always had your super-gap, and your domestic deal… You’re just changing who’s providing the financing.

HS: I think we’re changing a lot of the players. If you’ve been involved in a lot of the European-based financing, you know…I was a banker for all those years, and we’ve seen all these kinds of deals, very highly-structured. But it’s just different players now — the states, the hedge funds…

RK: I think it’s two things. Up until the last five years the independent world was nowhere near as alive as it is now. It was, if you were doing big movies, basically you were doing them at studios. Now, I think as many if not more pictures are getting done independently than at the studios. So there’s just a lot more need for that capital. And because all this money’s coming in, it’s just much more active. You have people getting more creative with super-gap and tax incentives, and more creative with how to subsidize sales. And that’s why we set our business up in the way we did, being that, in the independent world everybody has to go to nine places — you go get your gap here, and your super-gap here, and this there and your tax credit here — our goal is to provide 100% of that.

CE: But you have to caution the producers who are going to be reading this article thinking that this is just now going to be a bonanza for them with every single project that they have, because you still have to analyze your movie and you still have to figure out what the revenue streams are eventually going to be for that film, both from domestic and foreign. Everyone’s estimating all the time, but if it doesn’t make sense on a financial level it doesn’t matter how many financing plans there are out there.

HS: You have to show that, eventually, the money will come in to repay all of these sources. That’s the worst thing that could happen with all of this hedge fund money around, is if they put money into all these movies, and they lose money, they’ll be gone. So I think it’s our job to protect them as much as possible.

ML: It’s funny listening to all this, because I came just from the purely creative side, and I’ve spent the last year just trying to learn the stuff that you guys take for granted. As a producer, it’s just such a different universe from the kind of binary world where either a studio wants your movie or a studio doesn’t want your movie. And I just noticed a lot of jerry-rigged production plans. I think the thing you were just talking about, where there are so many different pieces and so many different players, and they’re all transient — there are pieces coming in while other pieces are going out, and they’re all looking for validation from each other. So it becomes this jigsaw puzzle where there may or may not be a piece missing. And holding talent is the hardest piece of it… As a production company, that’s a nightmare, because with all of these contracts that have to be signed, no one really commits their money until the very last moment. And so you’re constantly running the risk of things blowing up in your face.

CE: This is why we decided to get into the bridge financing business, because we saw all these films in this situation where there were so many multiple financers involved and there wasn’t any money to get the whole thing started. We raised some money on it, and we’re now on fourth movie.

RR: But our job also is to evaluate the deals. To say, “Is this guy real? Will this come together in time?”

RK: Going through the process, for us, first we have to find product that we think has good commercial value. That’s not always the easiest thing in the world. Then you’ve got to find product that fits the model — and the model is not an easy “I think it’ll make money” — it goes through a very rigorous process to “We’re really confident we’ll get our money back, and we really think we’re going to make money on it.” And going from that first level to the second, it filters maybe 20% of the material you actually like, even that potentially fits into that model. And then once you actually say “Go,” you have all the stuff Michael was talking about, which is, probably 50% of those never get done because there’s all these pieces that need to be put in place.