Avoiding Equity Financing Pitfalls — Show Me the Money

Through the years we have considerable experience in advising clients as to how to not waste their time and legal fees running after financing which appears enticing on the surface, but when closely analyzed, has no chance of happening.

Recently, for example, a client of ours who was searching for equity financing for a motion picture was approached by a broker who claimed that our client had been "pre-qualified" for equity production financing. It's kind of like receiving a pre-approved credit card in the mail -- they are hard to resist, but there is usually a catch (like 22% annual interest). The client provided us with the documents from the broker (which had the buzz words "specialized financing" on their letterhead). On the face of these documents, this broker was prepared to provide an equity line of credit (essentially a loan) repayable at the end of five years. Of course, there were a plethora of conditions, some of them so elastic (like "prudent budget") as to be virtually meaningless. But here's the real kicker. In order to proceed, this company required a retainer exceeding $5,000, with no promise that the line of credit would ever happen.

Thankfully, the letterhead on the proposal letter included a website, and we investigated what kind of businesses this broker had provided financing to. The closest thing to an entertainment project was the financing of a drive-through restaurant in Peoria. In addition, when we spoke to the broker and asked him to provide some evidence that he had the money and he could not do so.

This is a common example. We estimate that the percentage of proposed equity financings that ultimately close and provide production financing is 1%, at best. Not exactly a Hall of Fame batting average. However, based on our experience, if you follow the following strategies that you will substantially limit wasted time and money and even increase the likelihood that you will actually get your project financed.

The first rule is deal with principals, not brokers. Hollywood is infested with all sorts of brokers, finders, "producers" and other self-appointed money-finders, most of whom jeopardize your pocketbook and your soul. You may not need a broker to find what we call presale financing (money put up by companies in exchange for distribution rights). Just open the Hollywood Creative Directory ("HCD"), which lists every studio and production company. There is also the International Film Buyers Directory which lists the foreign sales agents and many of the international territorial distributors, television networks and video companies by country. Many of these companies know how to play the game, and as we will discuss, they can be the key to getting presale financing. However, we know of no person or company of any repute in Hollywood who makes a living from finding equity financing for independent films. To put it bluntly, it is just not a viable business.

The second rule is find out all you can about the money source. Let's say you meet a guy at a cocktail party who brags that he has $300,000,000 in an "insurance equity fund" from some nebulous off-shore company. You pitch him your project, and, guess what, it's just what he had in mind (brokers and finders tend to like everything). You might try these questions on the guy:

1. Are you a broker or a principal of the company?

2. Who is your lawyer?

3. Who are your accountants?

4. How many pictures have been actually produced and released with the funds from your "insurance equity fund"?

5. Who at your bank can I talk to in order to verify available funds?

It's best to get the bad news early. We had a bizarre experience a few years ago on a financing we were negotiating. Mark met with the purported financier and immediately was suspicious. He asked for the gentleman's business card and a few other details, and immediately got authorization from the client to spend a relatively modest amount to check out the guy through a private investigator. In the meanwhile, the documentation from the financier's lawyer mutated from our client receiving money to our client giving the financier money.

The next day the private investigator called Mark, and reported that the financier had eight different aliases, and was wanted on both state and federal charges, including securities and computer fraud. Suffice it to say that our client backed out of the transaction. Unfortunately, this is not a rare occurrence and we could give a dozen more examples.

How do you find out if the money is real? From our experience, it tends to be more real if the company has invested it in the past. Companies who invest in the movie business and manage to stay in business either have some sort of business savvy, strong financial backing or are lucky. Also, the film business is quite a small community. A well connected lawyer can probably check out a potential investor very easily if the investor has been involved in other film deals in the past. Entertainment insiders protect each other from being involved with people who are untrustworthy, unsavory, or simply difficult by trading very candid private assessments.

If an investor you don't know is talking about providing money to your project, don't invest too much time with them before asking for a copy of a bank statement or other hard evidence that they have the money. Once you receive the bank statement or other documentation, follow-up to make sure that it's real by speaking with the bank officer in charge of the account. Please keep in mind that especially in our computer age, it is very easy for crooks to doctor documents. A client of ours once sent us a letter of credit drawn on a Swiss bank to be used as collateral for a bank loan for production financing. Since we were not familiar with Swiss banks, we decided to check on the bank. It didn't exist. The letter of credit was a complete forgery.

Here's another one of our favorite tests to separate the men from the boys -- ask the potential investor for some up-front cash to cover costs. Our client used this in a recent transaction and had a $20,000 wire transfer the next day to cover our legal fees, without any paper whatsoever. That investor was real, and that financing came through. Sophisticated investors will understand that they need to pass the "show me the money" test.