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The GOOD, THE BAD, and the ugly

Should you invest in British film?

· film finance,film,Film Production,EIS,British Film

For knowledgeable investors, private investment in British film currently shares, with Collateralised Debt Obligations, a deep circle of hell. Anyone with only a superficial knowledge of the film industry, however, might find this surprising: it is boom time with £1.9bn invested in British film and high end TV in 2018 and now hitting a record £3.61Bn in 2019. In the same period HMRC has granted tax relief for the production of two hundred and forty-five British films, a healthy figure by any standard; British film luminaries seem to dominate every award ceremony from the Emmys to the Oscars; British studios are filled to capacity; and walking the streets of London one can hardly move two blocks without falling over a cable attached to a truck powering a film unit.

When you look under this industry’s bonnet though, it is about as British as a McDonalds franchise. Of those two hundred and forty-five films gaining tax relief, only fifty-eight so far have distribution deals, that is, the chance to make it to market and make money. Of those, the biggest twenty-five are entirely funded by US investment (which include ‘1917’ and James Bond ‘No Time to Die’), six more by other overseas investment, five by the BFI, the UK’s largest single producer funding film with public money, leaving only twenty-two either wholly or partially produced with UK private investment (and you won’t have heard of most of them).

So most of the vaunted £3.61bn spend on British film and TV is not British investment, which fell 45% in the same period to a paltry £175million. It is overseas money spent on making films in the UK and the profit will go overseas. An explanation here: a film or high-end TV qualifies as British and obtains producers’ tax relief based on criteria other than who funded the film, such as who wrote it, where it is set, or who are the cast and director are. Tax relief of 25% is a cash sum given to the, usually US, producer by HMRC against their spend in UK.

British private investment is now understandably shy in this arena because of the long running spat between HMRC and UK film companies obtaining EIS relief on behalf of their investors, schemes described as ‘scams for scumbags’ by the outgoing head of HMRC. This culminated in the Finance Act 2017 removing that relief and HMRC has aggressively pursued individuals who obtained such tax-breaks. The numbers are not small: in a recent appeal hearing, HMRC indicated that it is seeking to reclaim up to £1.6bn in tax relief. This accounts for British film investment falling off a £144 million cliff. And if anyone in Government is reading this, some alarm bells should be ringing. Amanda Neville (CEO of the BFI) stated this underlined ‘the importance of ensuring that the independent sector, the lifeblood for this growing success, is properly supported.’ The success is, of course, US, not UK.

Notwithstanding this unfortunate context, UK film production is booming and has been for some time; production increased 76% from £3.8 billion in 2014 to £6.7 billion in 2017[1], and year-on-year is currently growing at 30% per annum. This boom is being sustained by four things: UK talent; access to that 25% tax relief, weakness in the pound making the UK cheap, and finally, and most significantly, the Netflix wrecking ball that by 2014 had destroyed the film and TV distribution model, thus creating rampant growth in buyers, Amazon, Apple, Facebook, Google, Disney, and counting.

So what is currently on offer to British investors to exploit this boom? Here we still have to consider EIS. For despite HMRC having nailed this into its coffin, it has risen and is wandering round in rags in two guises that HMRC will accept: either a film production company making multiple films and high-end TV (the same thing from a UK tax perspective both for investment and relief) or a fund that invests in such film companies. Taking the second of these first, a fund of this type did recently receive the backing of the BFI and a nod from HMRC. Before you reach for your cheque-book though, there are two things to consider: firstly, the BFI’s remit is to ‘fund films that would not otherwise get made’[2] - a worthy sentiment, perhaps – but I’d personally rather invest in films and companies that make money. My second issue with this new type of fund is that it sounds too much like the old type, in that the investor has no visibility of how his or her money is being in invested. And as for the old type of fund, if having received your EIS3 form and claimed relief, HMRC later deems that company’s trades weren’t qualifying, you will need to give HMRC their money back.

The British film production company with EIS (30% relief up front, no capital gains tax) sounds more attractive, until you look at what HMRC requires that company to do in order to qualify. They want to see growth metrics such as employment of increasing numbers of staff, capital investment, and keeping investor capital at risk i.e. not pre-selling films, all of which are contrary to good practice in running a film company. A competent film company (the UK’s most successful is Working Title with an output deal with Universal) is light on its feet, with minimum staff, spending most of its money on developing projects and that means salaries and developing IP. The last thing it wants to do is unnecessarily build staff or infrastructure. In summary, EIS qualification could mean that film company has little chance of becoming profitable.

Investors can of course invest directly in an individual film, which will definitely not qualify for EIS. Films are expensive: low budget means £3million, and with a film budget the sky is the limit. The investor needs to be coming in with substantial cash or be part of a larger fund to match the other people investing. This is because returns are governed by something called the ‘recoupment waterfall’ which is how a film pays back its investors. This is less like a waterfall and more like a tower of champagne glasses in an old movie; debt is top glass, equity lower down; the bigger the chunk of equity the higher the glass. The problem with the old EIS funds, and probably the new, non-EIS funds, is when the champagne pours it often runs out before it reaches your equity. But say you have funds that place you near the top glass, you still need to be able to look at the project and assess both the risk and your likely return. A challenge when investing in film is jargon and lack of transparency.

So a few pointers here for the wary investor: you need to know what, if any, distribution deals the film has. If this is with an online provider these are fairly straightforward in that the film is going to borrow money then get paid back on a cost-plus basis (and they probably won’t be looking for equity). But most films are a mix of online and other distributors so you need to see the sales estimates. These estimates are drawn up by independent sales agents and, while often inflated, give you high and low figures and when you compare that to the film’s budget should show how much gross profit that film might make. Finally, a film’s value is largely a product of who is in it (cast) and what it is about (genre). And don’t be afraid to go with your gut: famous scriptwriter William Goldman’s maxim is in film ‘nobody knows anything’ and if the film don’t sound like the sort of thing you would sit down to watch on Netflix or pay to view on Amazon then you are probably not alone.

A film company without EIS could be a good place to put your money; it offers lower entry level, and the risk is spread over a number of films. The return will be lower than that of a successful individual film but so will the downside, and if you had invested in Working Title around the time of ‘My Beautiful Laundrette’ you’d be sitting very pretty even with no tax relief. They went on to produce ‘Mr Bean’, ‘The Big Lebowski’, ‘Notting Hill’, ‘Billy Elliot’, ‘Love Actually’, and ‘The Theory of Everything’ to name a few. Of course, picking a winner is hard, but so is picking the latest tech start up, and similarly, common sense is the most useful analytical skill. You need to know the film company owns several IPs in terms of high-end TV or film which it has a realistic chance of turning into product and selling (finding distribution, in film language). Ideally, some of these should be advanced enough for the company to show you some evidence of any deals they have with distributors and film sales estimates. The company should be able to show you their business plan and their financial model and you can apply the same metrics as with individual film with the advantage you are now spreading the risk over several projects. I’d want to know if they have skin in the game, and if they do, is my money in the same place as their money. If it is a Ltd Company (rather than LLP) then this would mean the same type of shares. I would want to know how much of the company they are planning to sell now and in the future so as not to dilute my holding. And last but not least, what is their exit strategy? (HMRC hates this so if it is in the plan, they certainly won’t qualify for EIS). When is that exit and where are those funds coming from?

Foreign investment is pouring into Britain and film and high-end TV is experiencing a gold rush that is set to continue as the new providers clamour for film content. Like all rushes some will strike gold, some not. So notwithstanding the burned fingers of the past, I predict UK investors will be looking again at film investment - and there are no other investments that allow you the chance to point to the TV at Christmas in front of the family and say ‘I made that’!

[1] BFI statics, 2019

[2] Ben Roberts, BFI

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