The Film’s Production Shell Company – How It Works

I wrote the following as a reply to a comment sent to me by someone doing pro bono work for an independent film producer. The question was about how the production’s shell company worked. here’s my answer:

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Hi, Nancy. Thx for commenting.
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Development

During development the independent film company sets up any development costs as Inventory on their balance sheet. This could include proportional allocation of general costs like trips to Cannes, to AFM, to film festivals, etc., as well as direct costs like options paid for exclusive rights paid to a writer, etc. It’s wise to put some, or all, of the development cost for each project in the Film Budget for the project you’re in the midst of raising finances for. That way, if the project gets financed, you can get those development costs paid back. If the project never gets financed, a common problem for independent producers, then the inventory of costs can be written off. As you can imagine, the write-offs are big in times of net revenues and very little in times of net loss. It’s also wise to put a fair salary for the independent film producer in the film budget, because it’s always a long-shot if the independent producer, as an equity investor, will ever actually get to see any cash after release.

The Prod Co

At about the same time that the project is getting financed – that is, the investors for a particular project have committed and the cash to do the film/tv production is finalized, a shell company is formed with the single purpose of producing that particular project. The shell company concept is common with film and television productions. It’s often referred to as the “Prod Co”, i.e. Production Company. It doesn’t have revenues, only funding (equity or loans) and costs. Any assets bought or built during the production (wardrobe, cars, etc.) are not booked to a Balance Sheet account, but rather are booked as a cost and then in post the assets are sold and the proceeds are credited towards the costs. At the end of the post-production period there should only be an empty bank account, the funding and the cost of the film/tv production.

A Clean Statement of the Cost of the “Negative”

This makes the Prod Co a clean statement of what used to be called the “Negative Cost” – so many productions are shot in digital now that it’s a fading term, but the concept is still the same. The costs are easily audited for any State Tax Incentive, as well as for any investor’s audit purposes. This statement of costs is universally referred to as “THE Cost Report”. (I often wish we had an industry specific term for it, because the term “Cost Report” is synonymous with just about any business.)

Legal Rights and Ownership

The Prod Co as a separate entity keeps things clean from a legal “Rights” standpoint. The Prod Co owns the rights to the creative work – i.e. has had the rights assigned to it – provided, of course, that the writer, director, cast. site locations, all signed the proper release and transfer of rights documents – this is not as big a deal as the lawyers would like you to believe, but it’s still important and you need to have those doc’s signed and to hand when selling the final product.

The Prod Co also helps to keep things straight from a legal “Organization” standpoint. The various ownership structures, and various positions of loans to be repaid, can all get pretty confusing, but having it under one Prod Co entity at least narrows the confusion to one entity. (As a note, I see that many of the Prod Co’s now are LLC’s, which probably means that the taxable gains/losses can go straight back to the individual investor for the US Federal Tax Credit under section 181 – it may also help foreign investors – anybody who has a comment, or can enlighten further, please ‘pitch-in’.)

Way down the road, after the film/tv project has been sold (and re-sold, dvd, etc) there may be, hopefully, something left for the Prod Co’s equity shareholders – after distribution costs, salesman’s commissions, SAG/WGA/DGA residuals, bank loans, etc. The Prod Co should be in receipt of those cash revenues, and the equity participants can finally get their hands on that cash. This is where the infamous “Back End Points” comes in so handy.

In Summary

In summary, the Prod Co is created when the financing is in place to make a particular production. It’s the Prod Co that makes the deals with the bank for loans, with the bonding company, with the WGA/ DGA/ SAG, with the investors, etc. It’s also the Prod Co which makes the sales deals, distribution, broadcast, dvd, etc. So, it needs to be designed with the best tax advantages in mind for the equity participants, in the hope that some cash will actually be arriving in the Prod Co’s bank account sometime in the future.

I hope that helps. It’s a pretty decent rundown, so i think I’ll post it as a blog as well.

Best
John