And reproduced here for posterity…
MINIMIZING INVESTOR RISK THROUGH FILM SUBSIDIES (copyright Justin Evans)
I’ve written about how independent filmmakers can raise money for their films in a previous New Breed post. And, while ethical accounting practices and professional business plans are important they are only part of the equation.
THE MIND OF THE INVESTOR:
Investors invest for a variety of reasons, but the unifying concept for all investors is simple. Investors are fearful of losing their money. This fear overrides their desire for profits. Let me repeat that. The fear of losing money is a stronger motivator than the desire for profits.
Most entrepreneurs assume an investor wants to hear about a massive ROI(return on investment). They start talking about exit strategy (the method in which investors extract their capital from a successful venture). This is putting the cart before the horse. The first thing an investor wants to know is how an entrepreneur will protect their money. Once that issue is addressed then they want to hear about profits and exits.
If you reverse this, you’ve probably lost the investor. Why? Because they know that projected profits is merely speculation. You may have done your best and you may truly believe you can achieve a high rate of return for the investor…but it is still speculation, not fact. And, what’s the value in an exit strategy for a project that lost all it’s money? That’s not an investment…that’s a tax write-off.
Therefore, the first thing an investor wants to hear is how you can concretely protect their money.
TOOL #1: SECTION 181
You’ve heard of farming subsidies. A few years back savvy film lobbyists created subsidies for the film industry. As they outlined the dangers of runaway production to Canada, Eastern Europe and Australia, Congress passed legislation that resulted in Section 181 of the IRS Code. Put simply, Section 181 states that investment in a motion picture shot in the US is 100% tax deductable for the investor.
100%. I wish I could write that in neon.
By including a chapter in your business plan about how an investor can use Section 181 to reduce their tax burden you can illustrate to the investor how you are reducing their risk. Section 181 guarantees that they cannot lose all their money in your film.
Now, Section 181 should have been easy to understand. It hasn’t been and that’s why few people understand it and even fewer use it. In 2007 the IRS finally released a pamphlet explaining how they interpret the code. Some members of Congress believe the IRS’ interpretation contradicts elements of their original legislation. Because of the contradictory interpretations and the IRS’ reluctance to clearly outline how to use Section 181 for your motion picture you need a Section 181 consultant to help set up your film properly.
Google the term. You’ll be able to read the code and you’ll find a few individuals who claim they can help you with Section 181. I’ll happily consult with you as well. But, here are some of the broad strokes:
– 75% of the motion picture must be shot in the US to qualify for Section 181.
– There is a 15 to 20 million dollar budget cap (although, this needs further explanation).
– There is no minimum.
– TV pilots, TV episodes (up to 44), short films, music videos and feature films all qualify for Section 181.
– Section 181 can be applied to regular income or capital gains, depending on your corporate structure and how your investors are involved with the company. If this is done wrong your investors can end up with a helluva surprise when they turn in their taxes.
– Section 181 is retroactive. If you finished a project in the past couple years you and your investors may be able to redo your taxes and recapture some of your expenses as a tax rebate from Uncle Sam. This will require hiring an accountant who understands Section 181. If you created a $2,000.00 short film I doubt it is worth your time, money and effort. If you self-financed a $60,000.00 feature film then it is definitely worth your time.
– The motion picture’s corporation will need to issue Schedule K-1’s to the investors so they can take advantage of Section 181. Consult with an accountant on how to do this.
– And, yes, there is more to it than this simple list. This is only an overview. As with any element of the IRS code, you can’t leap to conclusions nor make bold assumptions about how you can take advantage of this law. It is nuanced. In its current form it is paradoxically interpreted. Hire an expert to assist you with implementing this into your venture. Hire an accountant with Section 181 experience before you redo previous taxes.
Right now, your ears may be bleeding and your eyes glossed over. If you struggle with the differences between passive and regular income, if you don’t understand how to incorporate a business, if taxes make your skin crawl…don’t give up. Just hire a consultant. It’s worth every penny. Because, if you implement a Section 181 plan in your business model you’ve made it much easier for an investor to write you a check.
This sort of work makes most creatives run for the hills. We’re not built for math. But, when you’re pitching an investor, which sounds better?
“As you can see, investing in my movie is going to be a huge risk. You’ll be risking 100% of the capital you put into my movie. But, I’m a good filmmaker. Trust me. I’m going to make a great movie that will make you a profit.”
“Investing in our project includes a level of safety investors haven’t experienced before in the entertainment industry. We’ve taken the time to research recent tax legislation, and we’ve hired a consultant who can explain how your investment is 100% tax deductable. We’ve gone through the steps to make sure the IRS will recognize your deduction. Therefore, you’re risking approximately 60 cents on the dollar. How many investments, in this market and in this economy, can promise that a significant portion of your money is completely protected? Now, let me explain how we’re going to make an exceptionally good movie with tremendous profit potential…”
The first remark is like every independent filmmaker in the world. They’re begging. The second isn’t a beggar. The second is an entrepreneur.
TOOL #2: GOVERNMENT SPONSORSHIP
Shoot your movie in a state with rebates or transferrable tax credits and pass this subsidy onto your investors at the completion of production. As an example, if a $100,000.00 movie shoots in New Mexico and spends every penny in the state (or, through a pass through corporation that pays state taxes) the state of New Mexico will cut a $25,000.00 check for that motion picture.
You can pass that check onto your investor. Like the educated statement provided in Tool #1, adding adding a state subsidy to your business plan allows you to speak about risk minimization. You can now claim that the investor is only risking 75 cents on the dollar if the project is produced in New Mexico…or 62 cents on the dollar if produced in Michigan. Iowa now has a 50% rebate (although with some unusual provisions that complicate the matter). In essence, they’re buying 100K investment in your movie for only 75 cents and the government is picking up the rest of the tab, on a delayed time table.
Are there nuances, details and stumbling blocks to this process? Absolutely. So, yet again, it is best to hire a consultant to help you with this. Considering over 30 states in the US now have some type of tax credit or rebate plan it is foolish to not take advantage of these incentive programs. If Michigan wants to help filmmakers make movies, then why not take advantage of that?
You’ll be tempted to dismiss this and make your movie in your hometown. This is convenient. You might be lucky…with 30 states now competing for motion pictures with rebates, transferrable tax credits shooting local might still enable you to take advantage of one of these programs.
But, which do you want? To make a movie in your neighborhood with no investment or to make a properly financed motion picture with a decent amount of capital? If you’re serious about this as a business, then start thinking like a business owner and put your investors before your comfort zone.
TOOL #3: MARRIAGE
Combine Section 181 with a tax rebate. By coupling the two together you can reduce an investor’s risk by 65-100%. Think about that. It depends on how much the investor earns annually, how much they’ve invested in your movie and where your movie will be produced…but, it is possible that an investor could invest in your motion picture…and risk nothing. Conservatively, they’re risk will be 50% of what they’ve given you. That means if they invest $100,000.00 they are guaranteed to recoup $50,000.00 in tax deductions and rebates. Depending on the math, they may be able to write off 100%.
A WORD OF CAUTION
There are nuances to Section 181 as well as every state rebate or transferrable tax credit. Spend a couple thousand dollars to hire someone who understands these incentive programs. Make sure a lawyer familiar with these programs has vetted your business plan. Practice your pitch for that lawyer so they can vet the language you’ll be using to pitch investors. And, for God’s sake, please get the math right. Don’t walk in and say they’ll risk nothing unless you know that is actually true.
Here is an example. Your movie needs 200K. Investor X wants to invest 200K into your film. Their annual income is 200K and they have 1M in assets (making them an accredited investor). Their annual taxes are approximately 50K and they have absolutely no tax write-offs to take advantage of. If they invest 200K into your film they’ll be risking 150K…because they only owe 50K in taxes. The IRS isn’t cutting them a check. They’ll be happy to let the balance go to zero, but they aren’t draining the Federal coffers to cover anything beyond what the investor would have owed.
So, that means they’re risking 75 cents on the dollar.
But, wait! You’re going to shoot this movie in Michigan. Michigan will give you a 40% rebate. They’ll kick in an extra 2% if you shoot it in one of the numerous Special Economic Zones they have throughout the state. So, you shoot in Detroit and spend EVERY PENNY in Michigan. That means they’ll cut you a check for 42% of your 200K budget. That’s $84,000.00. You agree that this rebate belongs to your investor. Investor X will now be getting $134,000.00 in tax deductions and rebates from the Federal Government and the State of Michigan for their 200K investment in your motion picture. They’re actual risk is less than 45 cents on the dollar.
Any savvy investor will take such massive reduction in risk very seriously.
But, there’s no such thing as a free lunch. If you’re going to get Uncle Sam and The Land Of Enchantment to blindly subsidize your filmmaking career then it’s going to require research, due diligence and some expert advise (that more than likely won’t come free).
But, don’t dismiss this either. Ask yourself a simple question. Which is a tougher path…convincing a Hollywood studio to buy your screenplay and let you direct it…or, spending a month researching these incentive programs so you have a secret weapon in raising money?
More importantly, asking friends and family to invest in your movie is no longer an exercise in begging. Take the time to factor how much your family members will spend in taxes this year and ask them to invest a good chunk of their tax dollars in your movie instead.
My greatest fear in explaining these tools is that a slew of crappy movies will get made at the expense of tax payers. The law of unintended consequences pretty much guarantees this will happen.
I delayed writing this article for nearly two months for this very reason. I truly mean this…my fear is that every half-baked script in America will suddenly find money it doesn’t deserve and we’ll be drowning in second-rate content. This will only make it more difficult for good filmmakers to cut through the noise and have their projects taken seriously. It will make the market tremendously overcrowded. And, it will inevitably result in massive investor losses….which, will eventually lead to the repeal of these very laws.
We’ll be back to square one, people.
So, remember this. You still have to make a great film. Most of Western Europe had massive film subsidies throughout the 1970’s and 1980’s. The goal was to enable individuals to make movies that could be distributed commercially and build a viable local film economy to compete with Hollywood. Ironically, the more their citizens used these subsidies the more market share Hollywood gained. Why? Because most of the filmmakers made crappy movies far worse than what Hollywood had to offer. The general public is still our collective employer and if they don’t like our movies they’ll tell their friends and our movies won’t have legs. No matter how much you spend on your film, it must be great. The script must be amazing. The acting must be astounding. You still need a celebrity actor to convince traditional distributors to consider releasing your movie. You must still be excellent at this craft. If not…you’ll be one of those forgotten French filmmakers from the 1980’s who made an artsy stinker of a movie that has disappeared into the ether.
Australia has subsidies. Canada has subsidies. Great Britain has subsidies. How many great directors come out of those three countries every year? Let that give you pause. Subsidies will help you get any movie made…even a bad one. I know a filmmaker who recently began work on his first feature film. I offered to help him with casting. But, he gave me great pause when he said “The script is crap. I mean it. It’s awful. I just want to get going on a feature film like you.”
How selfish. How short sighted. How self-sabotaging. How miopic. How…stupid. He might as well take a .45 caliber pistol and unload it into his foot.
Because of my concern regarding the law of unintended consequences I’ve deliberately left out a lot of details. I know far too many amateur filmmakers who would easily jump to the conclusion that with 100K they’re ready to make a feature film…and neglect pre-production, careful planning and the time it takes to write a great script. Their lack of patience terrifies me because all they’ll achieve is making expensive amateur films.
In short, you’re going to have to jump through many hoops to make these incentive programs work for you. I did. It helped hone me as a filmmaker and entrepreneur. Nothing good will ever come from something being too easy. We all have word processors on our computers. How many of us have ever written The Great American Novel?
In fact, as I write this, I hope most people realize that access to capital is not their primary obstacle. Lack of skill has and always will be the real hurdle.
For the experienced independent filmmaker these tools can change everything. Combine these three tools with a solid business plan and transparent bookkeeping and you’ll find raising money is relatively straight forward.
For the amateur who has no patience…you’ll be ruining it for the rest of us if you don’t slow down and craft a project worthy of an audience.