Fintech and Hollywood: a perfect match?

We just had the annual Oscar jamboree and congratulations to Anora for its five Oscars, and particular respect to Sean Baker who picked up four personally, something that’s never been achieved before. But Hollywood has an issue. No one knows where the money goes. I’ve just joined some friends to fix that.

It came around by accident, because I recently wanted to invest in a movie starring most of the British treasures you can imagine (Dame Judi and co). I floated the idea past a friend who is an expert in this area, and he said it would be stupid. What?

As the conversation progressed, it turns out that the whole movie industry is pretty opaque, with investor money wasted and only those at the trough of feeding profiting. It’s called The Waterfall Effect. This ‘effect’ means that those at the top get paid first and take the largest cut. Then there are the others who get paid next, most often the actors and producers; then there are those who get paid last.

A “Hollywood investing waterfall effect” refers to?the structured way in which profits from a film are distributed among different stakeholders, like investors, studios, talent, and distributors, where each party receives their share of the revenue in a cascading order, with the highest priority (like senior debt investors) getting paid first, followed by others in a tiered system, similar to how water flows down a waterfall.?Putting it more simply, Investopedia summarises this waterfall as a pyramid of buckets cascading where the water represents money, and the buckets represent investors, partners, or stakeholders. The water fills the first bucket first. The second bucket will fill only after the first is completely full and spills over. As water flows, more buckets are filled in the order in which they appear.

The problem is that no-one can work the accounting as to which bucket is filled first and last in a transparent way.

There are many examples from Bohemian Rhapsody to The King’s Speech – movies that were hugely successful but many lost their pants investing – and you can find out more in this beginner’s guide to film financing waterfalls.

I didn’t know anything about this and didn’t invest in the movie, but it led to some interesting conversations and lunches, so much so that I’m now the Chair of a company called Stelarator? that wants to bring transparency to this space and solve this problem.

You can find out more about Stelarator here https://stelarator.com/

and our aim is to bring light to the dark of film financing through fintech. Seed investors welcome!

Anyways, in the interests of diving deeper into this space my friend Vlad Hunter , CEO of Stelarator, introduced me to Thomas Kingston, publisher of the Media C-suite and an expert in everything to do with law and media. Here’s how the conversation went.

Thomas Kingston: One of the very first things I realised going back thirty years now is that people inside the media industry really don’t know how to speak to professional investors at all … venture capital, private equity investors … that communication skillset doesn’t exist. When a media executive or a media entrepreneur is in the room with a professional investor, they speak completely different languages.

They approach everything from a completely different way, and quite often they walk away from each other saying: I never want to meet another one like that again.

Having said that, the media and entertainment industry is robust and growing, and it’s highly lucrative. It’s more than three trillion a year in global revenues. It’s also in transition from a traditional business model, a traditional environment. It’s been all about the studio system and the creator economy, but growing into something different – a new business model – and that affects almost every aspect of content creation, distribution, and exhibition or delivery of the content.

So that makes this industry incredibly interesting to large investors, large asset management groups that have increasingly more and more liquidity.

They can’t invest fast enough and the war chest, if you will, the dry powder within the industry is accumulating, and it’s a problem for the most part.

Traditionally, if you wanted to invest in the media and entertainment industry, you either invested in a technology that provided infrastructure or you invested on the public markets into one of the conglomerates.

However, the transition that’s taking place – the disruption that technology has unleashed on this industry and the way in which the audience has embraced that technology – has changed the game completely.

So now, private equity investors, venture capital investors, the professional asset management class institutions are really able to reach into this industry. It’s been cracked open, if you will. The publicly listed media conglomerates are really in trouble. They’re still making money hand over fists. They’re still incredibly valuable. They have incredibly valuable balance sheets, with the IP that they’ve acquired and accumulated, but they have no strategy whatsoever. They have no vision of the future of this industry.

That is being taken up by media entrepreneurs and the audience themselves, and that’s why this creator economy has begun to take on a life of its own, and it’s a real challenge for the established traditional legacy media groups.

This has completely turned finance upside down.

For film-makers, borrowing against commercial paper has driven film finance for the last twenty years. If you were a lender or a bank or a specialist financial group that understood the film industry, understood distribution, understood some of the risks involved – and you had a promissory note or you had a distribution agreement or a negative pickup deal from a major studio – that piece of paper was worth every zero written in the right place. You lent against that – probably 90 cents on the dollar – and that’s how people got their pictures made, right?

That’s changed a lot, primarily in the last few years. It’s really hit almost rock bottom. I don’t want to say rock bottom because there’s still room to fall. It’s incredibly difficult to borrow money now. It’s incredibly difficult to get pre-sales agreements. It’s incredibly difficult to get a negative pickup deal.

The reason for that is the big media majors, the multinational distribution networks owned by the conglomerates that are listed on the exchanges.

It is their lack of vision, actually, it gives them a myopia. They don’t understand what’s going to happen five years from now. So they’re not spending money on anything other than what they own already.

This is why they do so many remakes and reboots of IP that they already own. That’s been happening for a long time now, and has become the primary policy in the C-suites of these big groups: do not rent somebody else’s IP. We’re not interested in anything that’s been written by anybody that we don’t already have a contract with, and where we don’t own the IP – the copyright – from inception. This is why the number of films that are getting picked up at the movie markets has fallen off a cliff.

Chris Skinner: As you’re talking it strikes me, because I’ve been watching the Oscars today, and an independent film made with $6 million picks up five Oscars, a record for the director and producer because he’s got four on his own. I’m wondering if that illustrates your point, because it’s an independent movie and now a lot of the voters on the Oscar nominations committee are no longer the former establishment. It’s been widened internationally. Does that change everything?

Thomas: Well, to a degree, yes. The Academy of Motion Picture Arts and Sciences, that’s the body behind the Oscars, have been around for a hundred years now. This is the 97th Oscar ceremony. It is an interesting concept. It was established by independent filmmakers who needed to develop new techniques, new technologies. They needed to bring in investors. They needed to showcase how this is advancing, and it was an immediately lucrative industry.

Technology was always the biggest driver in the development of new content, new storytelling methods, new delivery methods of communication of content and new delivery methods. So technology has always been a big part of this.

What you see in history of the academy is that it was taken over, if you will, by the studios and, for a long time, if it wasn’t a studio produced film it didn’t get an Oscar. It wasn’t even considered for an Oscar.

What the Academy is trying very hard to do right now is to internationalise the Oscars and internationalise film production. It will eventually start to embrace more and more independent films, more and more foreign independent films, and it started to do that some time ago. This is why Anora got five Oscars.

Chris: This is one of the questions I’ve asked before Thomas, because Anora raised $6 million to film and has made $41 million at the box office, apparently. You then have the costs of distribution and marketing and everything else that goes into it. How do you see the breakdown of the costs and the profit, because you can have a great movie that gets an Oscar, but nobody who invested makes any money.

Thomas: So there’s an infamous historical precedent within Hollywood, let’s call it Hollywood Accounting, and Hollywood Accounting results in lots of revenue to the studio but zero profits from the picture. So there is no obligation to distribute net profits.

The artists, the actors, the director, all negotiate an agreement to get a little bit of money to live on while they’re making the picture, but what they really want is if this thing goes to the Oscars and makes a couple of hundred million dollars in the box office, they want a piece of that. So they negotiate points or they negotiate a backend deal where they share in the profits.

Now, Hollywood Accounting is specifically designed to make sure that no picture ever hits a profit, and they do this through contracts with their own distribution companies that then take on the burden of marketing and other services. So, let’s say you have a $6 million picture. It’s distributed through one of the studios which takes on the obligation for all marketing. So the distributor says, “we spent $50 million on marketing” but without demonstrating exactly what money when to whom. The result? This $6 million picture makes $35 million at the box office, and theoretically it should be net profits of so much but, because $50 million went into marketing, and still has to be paid, the net gets reduced down to nothing and, sometimes, even a loss.

What this meant is that, through contracts or through practice, creatives never fully participated in the revenue streams from the distribution and delivery of their content. Now, those revenue streams are really important when you look at this industry today. We are talking about $3 trillion in global revenues every year. It gives you an idea of the size of this industry.

Chris: I was just going to ask, because gaming is massively bigger than Hollywood these days, is that covered by the same rules and disciplines, or is that different?

Thomas: No, it is different. But the creative element within gaming has also been exploited to a certain degree by the publishers. They’re the people that are in there writing script all day, writing code all day. They get paid a salary, but not necessarily a piece of the profits. And gaming is hugely profitable.

You also need to think that it’s sometimes a shared IP. So that IP aspect is where there’s a lot of convergence with Hollywood.

Chris: Well, that’s what I was wondering. If you’ve got Lord of the Rings, the Hobbit or something, and then you’ve got the gaming version, then isn’t that the same thing?

Thomas: No, there’s a licensing aspect to the intellectual property behind the Hobbit or behind the game. If it mirrors the film, then it has to take a license from the owners of the IP for that film, and it’s not necessarily the writer or the director or the producer. Coding is also different. It’s treated differently in terms of intellectual property, and so the gaming industry has always been a little bit different than the Hollywood industry in terms of films versus games.

There are a lot more opportunities for a group of really talented coders and creatives within the gaming industry to leave an oppressive publisher and set up their own title, and that happens. That’s a lot easier to do in gaming than it is in films.

Chris: So, now you’ve got streaming, gaming and so many other digital distribution structures and it sounds like, from what you’ve described, there’s not one all encompassing legal structure. They’re all different targeted to the different media and distributions.

Thomas: They all belong within the same industry. They’re all segments of the same industry. But there are differences in the way business practices, corporate structures, legal structures, and distribution work.?

For all intents and purposes, the commonality across it all is that there are two primary revenue streams. One of them is consumer spending on access to content. The other one is advertising spend on access to the consumers.

Think of the consumers spending money on tickets. That’s the audience, right? Those are the people that are putting the money in and, until now, consumer spending has been the deepest, widest, most lucrative revenue stream to the industry. Film, games, you name it. That’s just changed.

Now, to tie this all back to what you see in the Oscars and the film industry and the history and all of this, the big studios control distribution and delivery to audiences. Therefore, they control receipt of revenues from consumer spending, and it is a monopolistic type of control. It is a cabal. They do have arrangements; they do have agreements; they understand how this works.

Whether it’s receipts from the box office or whether it’s subscriptions from streaming customers, those receipts come in to the media majors. They make their money from consumer spending on access to content.

What’s changed is the advertising spend. It’s now going to hit a trillion dollars a year.

Chris: How would that trillion dollars break breakdown, Thomas? Is it mainly through Amazon and YouTube and direct to consumer?

Thomas: So, that’s the really valuable question. The answer to that is, until recently, most advertising spend went to the big broadcast networks as commercials and to social media platforms as programmatic advertising,

Now, brands have started to realize that, on these social media platforms, there were individuals that were gaining millions of views of their content. They were gathering followers, numbering in the tens and even hundreds of millions. In some cases, these influencers began to be approached directly by the brands and they said: rather than us spending money to the platform, we want to give some money to you. It’s much more cost effective for the brand. It’s much more welcomed by the influencer.

So, they begin to build campaigns around sponsorship of influencers.

It then expanded into other areas like podcasting. You began to see the likes of Joe Rogan, who has several hundred million followers with millions of views for each of his episodes. Sponsors were running to him. Compare the viewership numbers for the top-rated television show today against Joe Rogan’s average viewers per episode.

Chris: I want to get back to that point about film finance really quickly and how it’s changing.

Thomas: So we talked about film financing, financing a picture by an independent film producer. It’s all being turned on its head right now for one thing. There’s more money out there than there has ever been, and there’s more money out there searching for a good investment opportunity. Despite this, an independent film project standing on its own is rarely going to catch the interest of a professional investor. Unless that producer has acquired commercial paper valuable enough to lend against, nobody’s going to put money into it. Even if it’s Francis Ford Coppola. Even Francis Ford Coppola struggled. He had to sell his own assets to fund his latest picture Megalopolis.

Francis Ford Coppola wins Razzie for 'worst director,' slams Hollywood - Los Angeles Times

So, the days of being able to leverage and build a single independent film project, in my opinion, is done. They’re not dead, and there are exceptions that tend to be touted as the rule, but the rule is these days, no professional investors are going to touch an equity portion of any single film project. It’s not a smart move, right?

However, a film producer who’s got five or six really good scripts as a catalogue, has assets. If he’s produced one or two of those into income producing product, he has a track record and he can begin to build up his production company in the same way that a tech company has to build itself up. It’s got a product, he can make more product. There’s an audience out there for it. He’s got a management team that knows what it’s doing. It’s got all the fundamental characteristics of a business, with balance sheet assets in the form of intellectual property rights.

So, any company that’s able to build that proposition up, there is money ready to pour into it.

Chris: Could you talk around the capital stack and what that looks like and who’s got the risk capital? Who’s got the, let’s say, non-risk capital in that??

Thomas: A traditional independent film project has a capital stack. If you look at its total budget – from acquisition of copyright through to delivery of the picture to the distributor – there’s a budget there. That budget is filled by a capital stack. The development portion of that project’s life cycle is almost always equity capital. So that person has to go out, just like any other founder, and through friends and family, through mortgaging their house, they come up with the equity to develop this picture into what’s called a package. A package is what they go around to sell to distributors and streamers, right? It’s the package that includes who the actors are, who the directors are. It’s all set. It’s the pitch deck and the business plan with everybody locked in, right? That’s the package. So the development is everything up to that point.

That’s almost always equity. Equity is usually about 30% of the total budget. You then have the costs of production; the cost of principal photography; hiring the actors; post-production and editing: the production costs. Those are almost always funded through finance, through debt, and that debt is almost always backed by commercial paper. So it’s an asset backed finance deal.

If it is a good size film with a $30 million budget and the film has a negative pickup deal, which is basically you deliver this picture the way we want it to be delivered, we’ll pay you the full budget plus 30%.

That’s the classic negative pickup deal, right?

So, then you get a completion bond. If you’re a lender, you’re not taking any risk on this whatsoever. It’s an eighteen month lend, and you’re guaranteed with a completion bond to get paid.

That’s the capital stack on a traditional classic film project.

Chris: So, who gets paid first and who gets paid last, because there’s a cascade?

Thomas: You’re talking about waterfalls, and that’s another one hour discussion, but waterfalls are important to understand. There’s a lot written on it. You can find a lot of material to educate yourself on waterfalls, and then it’s worth having another conversation about. But basically, a capital stack is divided up like that.

What’s changed is who’s delivering the content to whom?

So you’ve gone from a studio system where the studios or the middleman controlling distribution and delivery to today, thanks to the internet and computers and AI, where anyone can create any content and deliver it to 5.6 billion active users on the internet. 5.6 billion people.

So if you’re a content creator and you go out there and you market yourself; you build up an audience yourself; you can deliver content to that audience with a value attached to it; and, through technology, we have data on who’s watching your stuff. We can collect that data.

So if you’ve got a content creator out there; they’ve built an audience; they don’t need the studios anymore at all. They’ve got their audience. That audience will pay in either time or they’ll pay for access. They’ll subscribe. The advertisers will pay for access to that audience. If you can show them the data, you can raise the money.

It used to be that you would get a distribution deal if you had Brad Pitt in your film. Brad Pitt, a known quantity. People will go to see a Brad Pitt movie just because he’s in it. That’s what their agents will say. What Brad Pitt has is his own audience.

Nowadays, what Brad Pitt is doing, and what a lot of these guys are doing, is they’re saying: I don’t want to be the talent. I’ll still be the talent, but I bring the audience. If I bring the audience, I can go to these sponsors and brands that I love, and I can tell them whatever picture I want to attach myself to, you need to be there. I want you to put $X million bucks into it. As sponsors, you do that. We’ll figure out how to make it good for you in terms of your marketing, your promotion, but then Brad Pitt brings the money. He’s an executive producer.

Chris: Effectively, you build up all the network of the people who have to be involved in the movie, and particularly when you get to a Brad Pitt or someone of that ilk, they become a producer. So the cascade, the waterfall, is that they all get in the dip first, and I get there last. Is that right?

Thomas: Well, yeah. I mean, there’s gross participation, there’s net participation. Waterfalls can get complicated.

The definition of producer has widened and diluted tremendously. It used to be that just to get Brad Pitt to act in your film, there was no other contribution beyond being paid to act. He’ll say, look, you’ve agreed to pay me this much. That’s great. And he might even be able to say, I want gross, not nets. I want a percentage of the gross, which is everything that the studios don’t want. They want everybody to get a piece of the net.

Only things change, because you can now go direct to consumer. The direct to consumer distribution model is gaining so much traction that people are now able to make a feature length film and put it on YouTube and make a profit on that film.

Chris: Is this the whole reason why artists, whether it’s music or movies, media, are really worried about artificial intelligence?

Thomas: Yes and no. This is a longer conversation but, as concise as I can do it, artificial intelligence challenges things in several ways. Recently there was a court case. It was one of the first court cases against an AI company for scraping data for training purposes. Last month, it reached its conclusion, and the conclusion was that this was a violation of copyright law, which everybody knew, but it took the courts to make that settled piece of law right.

The further back you go, before that decision, the more AI companies were just saying, we don’t care. We’re going to scrape anyway. They’ve gotten to the point now where it’s recognised as copyright theft and they have to pay.

So, what are AI companies doing instead of paying? They are striking license deals with publishers, licensing deals with other IP owners, and they are becoming – instead of a drain on revenue streams to the industry – they’re becoming a source of revenue streams to the industry, and this is going to eventually be a significant source of revenue to the industry.

What artists fear from AI, and what was behind the actors strike in Hollywood, was that a lot of the studios were saying: we’re going to scan your image and we’re going to create artificial characters, artificial voices. You never have to show up to the sets, and yet you are a main character in this film. That’s the future that they’re terrified of because then you are an actor with no power, with a bad agent, having to sign away the right to their image in the context of this character.

By way of example, you have a film being produced today with just a bunch of TV screens behind the actor, with the background generated by computer; and they will be using just a bunch of AI generated images of people in that background running around; and a lot of those images were captured through auditions across the industry. This means that these actors aren’t being paid a penny for their appearance as extras. They aren’t paid anything. That is why they went on strike.

So there was a lot to be afraid of with AI.

An actor owns the copyright to their performance, unless they’ve signed it away. This is becoming more and more of an issue. As the creator economy starts to rejig the way the economics of the industry work, that’s going to change. That power is going to come back to the creator of the works, the creator of whoever owns that copyright, the creator who created it in the first place.

Chris: This means our biggest argument going forward is going to be about intellectual property and copyright?

Thomas: Of course. Intellectual property is the fundamental core of this industry that allows people to make money. You can’t make money unless there’s a copyright and a chain of title from that copyright. Without that, you’re not legally allowed to make money.

About Stelarator

Stelarator is a new middleman providing the due diligence framework, credit risk management and packaging of deals. The problem we solve is that there is no clear financial accounting in movies. There is no one route forward. There is no A follows B follows C. There’s just a start and an end product and, how you get there, is completely free formed in between. Stelarator solves this by applying distributed ledger technology to track and trace the flows of finance across the industry.

Find out more here: https://stelarator.com/ and?seed investors welcome!

About Thomas Kingston

Dr. Kingston is an American lawyer & private equity professional with 30 years of international experience in investment strategy. He is the founder of Cyprus Capital Partners, the first private equity firm in Cyprus and Coherent Media Group a corporate holding company dedicated to media and entertainment businesses globally.

He is a corporate and political speech-writer and has ghost-written numerous Op-Eds, political/espionage thrillers and science fiction novels. He has lived and worked in London, Dubai, Abu Dhabi and Nicosia as both advisor and executive to several of the world’s largest family offices, institutional investors and State-owned investment companies.