THE REVENUE WATERFALL

It’s a known fact that most movies lose money, which means that the investors will not see a full return on their investment – nor any profit. However, most movies do not lose 100% of what’s invested, some revenues are in most cases generated – and paid out. In these cases it’s crucial in what order the monies are paid out – and to whom. This is what’s usually referred to as the ”the revenue water fall”. That is to say; who gets how big piece of the cake, when it’s not big enough to feed all parties?

Risk mitigation

Raising funding and securing distribution for a movie is hard. A common way to easy up the process is to minimize the venture for the investors, by changing the order in which the investment is recouped – so their investment is prioritized and recouped before others. E. g. when a distributor or sales agent invests an advance and/or minimum guarantee – and their investment is the first to be recouped – before any of the producer (and his/hers investors) – can take part of any revenue. Or when so called “senior financing” or “top financing” (usually used instead of an MG), financing that are prioritized before “mezzanine debt” (which is a debt/equity hybrid usually tied to a tax scheme, like the UK EIS-fonds) – and pure equity (which is last in line of “cash investments”).

Short term limited profit deals

When “senior financing”-partner invest in the movie, he or she is not interested in a long term equity/profit sharing agreement, but instead are looking for a short term limited profit deal (and limited risk) – as a sort of interest (but without security). The producer and the investor might then agree upon terms where all revenues the producer receives are paid out to the investors, until the investor has recouped e.g. 120% of the investment. That is to say, the investors will see a 20% profit before any other investor or lender sees any return. But on the other hand, if the movie is a hit that’s all the investor/lender are going to see.

A “mezzanine debt” is a hybrid between loan and equity and is, as said, usually tied to a tax-scheme where the investor for tax purposes can’t exit the engagement in the investment until the years has passed (or something similar). The “mezzanine debt” is recouped before pure equity, but after “senior financing”- and usually also have an option to convert the loan to equity (should the movie exceed expectation). The “mezzanine debt” is then collected in an escrow until recouped or converted into equity. When recouped the investor exits the engagement (unless they need to be kept in escrow for tax purposes).

Equity can also have different recoupment arrangements, depending on if it’s pure venture capital from a private investor, some sort of government supported equity – or maybe equity in form of services or equipment provided to the production.

When you take all this different types of possible different prioritizing of financing sources (and deduction of fees) – where the distributor recoup his money before the investor, and the investor then recoups with a great profit before anything is paid out to the producer – you start to understand the importance of structuring a good ”revenue waterfall” to minimize the risk. Since no one wants to be at the bottom of the “waterfall”, this always becomes a big issue during negotiation. Many times a ”corridor” is then used so that only a portion of the revenues are prioritized, while the rest is not (like a distributor giving the producer a 20% corridor, and then using 80% to recoup the MG and/or marketing fee).

Structuring the revenue waterfall

It’s important to understand that this process of structuring the revenue waterfall is done when you negotiate the agreements between the parties. The legal documents is what controls how the revenues will be distributed. It’s very, very important not to negotiate any contracts that comes into conflict with one another, such as negotiating with the financiers that they will recoup from first dollar if the distribution agreement states something different. It’s also important to be aware that all terms used in legal agreements are defined terms. That is to say, they may not mean what you think the mean, but rather the have a different – defined meaning. Words like gross- and net profit, marketing expenses and so on – often have a very different meaning. Another important thing to keep in mind is that many distributor and financiers is of the opinion that the producers don’t really count on any profits from sales, but rather have their main source of income from ”producers fees” (and in many European art-house movies, this is very true). So, if a producer chose to invest or defer his/her fee in the movie, they should be very aware of how this effects their position in the revenue waterfall. From very prioritized to “not so much – with all of what that means in terms financial endangerment.

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