The Beginner's Guide to the Film Financing Waterfall
In the film finance world, many words are used to define how money changes hands. For example, the term ‘waterfall’—also referred to as a recoupment schedule—references the flow of revenues to investors, producers and other parties with a financial interest in a production.
Below, I’ll provide an example of a typical waterfall structure and will explain how payment distributions impact each person who stands to profit from a project.
Why understanding the waterfall is important
The concept of a 'waterfall' represents a crucial component of film financing because it lays out the order of priority for the recoupment of production costs, repayment of investors and income payments for production, cast and crew members.
Like most businesses, productions take on debt before they become profitable, and profitability is not guaranteed. It’s not uncommon for productions to take several years to break even and start bringing in revenue. That being the case, it’s essential to understand how waterfalls work so you can set proper expectations on when individuals who supported your project can expect to see returns on their investment.
Film finance waterfall structure
Think of the waterfall as a math equation. The top is the sum—which changes frequently and can be a negative number until debts are repaid—and each line item beneath the sum represents a subtraction. The money source (in this case, a film) sits at the top of the waterfall, and the filmmaker, cast and crew sit at the bottom. Let’s look at the basic breakdown of a profit share waterfall to see how money flows through.
Paid first: Buyer licensing fee. This is money paid by a distributor or buyer to acquire the rights to distribute a film. A buyer’s license contains contingencies that grant the buyer rights to distribute the film for a specified period of time via a specific medium (theater release, DVD, digital sales) in a specific territory (domestic distribution, foreign pre-sale).
Generally paid up front as a one-time payment paid on the conclusion of a deal, the licensing fee can be a significant source of revenue to the Licensor (i.e., the production entity or LLC that licensed the film to the distributor). Though it can vary significantly, a typical buyer’s licensing fee generally ranges from 10% to 50% of the film’s total budget. The fee is determined based on the project details, including anticipated box office performance, distribution details and contract negotiation outcomes.
Paid second: Distributor fees. Distributor fees are calculated as a percentage of the film’s gross revenue, paid to the distribution company handling the marketing and release of a film. These fees are negotiated between the film producers and the distribution company. Though distributor fees can vary widely, they usually range from 10% to 30% and are meant to be an incentive for distribution companies to release and effectively market a film.
Paid third: Sales agent commissions. A sales agent commission is money paid to a sales agent who secures distribution deals for a film. This person represents a film and is responsible for negotiating distribution agreements with buyers or distributors. Sales agents are paid a percentage of the license fee negotiated with the film's distributor—typically 10 to 15% of the total license fee. The commission incentivizes the sales agent to secure the best distribution deal.
Paid fourth: Producer’s representative fee. Some producers opt to hire a production representative to help secure domestic distribution deals on behalf of a film. This representative works closely with the producer to negotiate deals with potential domestic distributors or buyers, and helps to package and promote the film. Just like a seller’s agent, a producer's representative collects a percentage fee—typically between 5% and 10%—of the total revenue generated by deal.
Paid fifth: Sales agent’s recoupable expenses. These are expenses incurred by a sales agent, producer’s representative, or the marketing agency that the agent or representative is associated with; these expenses are titled ‘recoupable’ because they’re reimbursed by the film's revenue before any profits are shared among investors and participants. Eligible expenses include but are not limited to: money spent on creating marketing materials, festival fees and costs associated with the creation of ad campaigns. Travel and accommodations for stars, directors and studio executives who are promoting the film can sometimes be expensed as well. As with most things, details on what qualifies as a recoupable expense can be negotiated. It's also possible to negotiate a cap on recoupable expenses.
Paid sixth: Production company fees. Once all the key dealmaking players recoup their fees and commissions are paid—meaning the production has reached a break-even point—it’s finally time for investors, cast and crew members, and producers to start reaping the rewards of their hard work. As is true with the rest of the waterfall, there’s a very specific ranking system that defines who gets paid first from the net-profit pot.
Generally, the production company fee recoupment schedule goes something like this:
- Top priority: Senior debt investors. These investors provide loans at lower interest rates than other types of lenders. Rates typically fall in the 8% to 12% range but vary drastically based on the size and scope of the project and the production company’s creditworthiness. Senior debt investors can offer lower rates because they’re entitled to receive the principal amount plus interest before anyone else gets paid. Many films use bank financing for their senior debt, but some secure senior debt from individual contributors.
- Second in line: Gap finance investors. When senior debt doesn’t cover the full cost of a production, gap financing is pursued to raise additional funds. Gap finance investors typically take a higher return, often in the 12% to 20% range, in exchange for investments made in a production that’s already secured senior debt. Interest rates are higher because the likelihood of the debt being repaid decreases the further down the ‘waterfall’ you are. Banks provide this type of financing, too, and typically take unsold territories as collateral.
- Third in line: Equity investors. Though these investors stand to take home bigger profit shares when a project is successful, they put themselves at higher risk because all debt must be repaid before equity investors see a dime. Equity investors typically look toward breaking even plus making anywhere from 10% to 30% on top of that.
- Last in line: Participants. This category of payees includes talent, directors, producers, and any other key players who are owed a share of net profits. Details on how much they receive are defined in their contract and will differ from project to project. However, participants—including the producer—only get paid when and if all other investors with priority status have been paid.
Now that you understand the basic structure of a film finance waterfall, let's talk about key factors that can shift payment priorities.
Waterfall variance: What to expect
The film finance waterfall structure can shift based on whether the producer opts to be paid a minimum guarantee or flat license fee. In the case of a minimum guarantee, a distributor or sales agent pays a production company an agreed-upon amount, generally up front as a cash advance, then later recoups the payment from revenues, whereas the license fee structure follows the pattern we defined above. With a minimum guarantee, there is the potential for the production company to receive more money down the line once the distributor recoups all of its expenses, whereas a license fee is typically a “one and done” payment.
Productions may also incur additional costs that need to fall into priority order for recoupment. These include but are not limited to guild residuals, additional off-the-top payments, box office bonuses and distributor electronic payment wire transfer fees charged by the bank. These ancillary fees can add up fast, so it’s important to keep them in mind as you structure financial agreements and make sure you adequately pad your budget. With a theatrical release, there are even more costs to consider.
Theaters recoup their overhead, typically as a pre-set amount defined in the buyer’s agreement, and the amount is recouped before the theater splits any net profits with the distributor. It’s also important to note that theatrical release deals are subject to change based on a film’s opening performance; this is because theater buyers want to rotate in films that will keep seats full to recoup costs. As a result, it’s common to end up haggling over terms after opening week.
How to secure a fair distribution deal
Building fair distribution agreements has become more complex because many productions skip a theatrical release and go straight to streaming. Without streaming performance data, it’s harder to effectively put a value on a project. We anticipate that the industry will develop better systems to help producers define value over time—but for now, we’re navigating murky waters as we work together to define a ‘new normal’ in the world of distribution. In the meantime, here are some tips on how to build a solid distribution deal.
Before you enter a binding contract, make sure you have clarity on how distribution fees, gross proceeds, and net profits are defined in your distribution agreement. We recommend seeking out the expertise of an entertainment attorney who can fully analyze the nuances of the agreement to help you make sure you’re striking a balanced deal.
For more information on how an entertainment attorney can help you navigate structuring a deal, check out my recent Master Series webinar with special guest Maria C. Miles.
The main things you want to look for are vague or open-ended responses that can be exploited after an agreement is already in place. It’s also important to understand what windows will exist between platforms, if any, and to understand your usage and territory rights. Having a firm grasp on the details of your timelines will allow you to manage and set proper expectations with your investors.
Film finance is complex, and understanding the ins and outs—so you’re able to build distribution deals that are fair and balanced—requires careful vetting and planning. The fact that you’re here, educating yourself on how film finance waterfalls work, and what and who is involved, means you’re taking a great first step towards protecting your production.