## Monday, November 12, 2012

### Domestic Distribution Part III, Home Video Formulas

There are many formulas for home video deals, but most fall within three patterns. The first deal allows the distributor to retain a percentage of Gross Receipts as a distribution fee, and to recoup certain designated marketing expenses from film revenues, with the remaining balance, if any, paid to the filmmaker. I will call this formula a “standard distribution deal,” although there is nothing standard about it except for the fact that these deals calculate the distributor’s fee as a percentage of Gross Receipts. Another type of deal, sometimes referred to as a “50-50 net deal,” allows the distributor to first recoup its expenses from Gross Receipts off the top, and then share the remaining amount 50/50 with the filmmaker. A third type of deal is known as a “royalty deal,” where the filmmaker gets a percentage of the wholesale price of every DVD sold. The percentage is negotiable, but often is in the range of 20-25%. Here, all expenses incurred are irrelevant in calculating the filmmaker's share because they are borne by the distributor.

Which type of deal is best for a filmmaker? That depends on how much revenue is generated, the amount of expenses and whether they are capped, and the size of distribution fees. Let us consider three different scenarios.

First, suppose \$1,000,000 is generated in Gross Receipts from sales and rentals of DVDs. Gross Receipts for the home video media are  generally defined as the wholesale revenues received, less any returns. If the suggested retail price of a DVD is twenty dollars, the wholesale price would be about half or ten dollars. However, prices are negotiable and Wal-Mart is known to drive a hard bargain and pay substantially less for DVD’s.

Under a standard distribution deal with a 25% distribution fee and recoupment of \$100,000 in expenses, a filmmaker would receive \$650,000. Under a 50/50 net deal, with the same Gross Receipts and cap on recoupable expenses, the filmmaker would receive \$450,000. Under a royalty deal with a 20% royalty, the filmmaker receives \$200,000. Clearly the standard distribution deal appears to be the better choice.

But now suppose the film generated \$175,000 in Gross Receipts. With the same distribution fee and expenses, the filmmaker receives \$31,250 under the standard distribution deal, \$37,500 under a 50/50 net deal, and \$35,000 under a royalty deal. In this case, the 50/50 net deal delivers the most revenue to the filmmaker.

Now, consider a third scenario with only \$100,000 in Gross Receipts and the same distribution fee and expenses. Here, the filmmaker receives zero under either a standard distribution deal or the 50/50 net deal. However, under a royalty deal, the filmmaker receives \$20,000. The fact that distribution fees and expenses now outweigh Gross Receipts is irrelevant in a royalty deal, because the filmmaker gets 20% of the wholesale price, no matter the extent of fees and expenses incurred. Moreover, under a royalty deal, there is little room for a distributor to engage in creative accounting. Once you determine how many units have been sold, and determine their price, a simple calculation reveals what the producer is due.  Many creative accounting disputes concern the deduction of expenses which is irrelevant in a royalty deal, since expenses are not counted in calculating the producer’s share of revenue.

Consequently, the best choice for the filmmaker depends on a number of factors especially how much revenue is generated; which is unknown when the deal is negotiated. Since none of these types of deals is always best, it is important for the filmmaker to pencil out the numbers before deciding which formula they want.  Most deals are more complicated to assess because they cover multiple media, and the distributor’s fee varies by media (i.e., 35% for theatrical, 25% for broadcast television). Moreover, domestic distributors usually insist on cross-collateralizing expenses among media. Thus, if there is a loss on the theatrical release but a net gain on television, then the revenue and expenses are pooled. This enables the distributor to recoup its theatrical loss from television revenue. Particular care must be taken when the home video arrangement is a royalty deal that does not allow deduction of expenses. These royalties should not be offset against expenses incurred in other media.

DVD’s are sold on consignment, meaning the buyers can return any product for a 100% refund. Sometimes large numbers of DVD’s are returned. Therefore, most distributors insist on holding back some revenues as a reserve to make sure they do not pay the filmmaker a share of revenue based on sales that are returned.  DVD sales are dominated by mass merchants like Wal-Mart, Best Buy, and Target. However, only a few companies have a direct relationship with Wal-Mart, therefore the other distributors have to go through an intermediary such as Anderson Merchandisers.

One should also keep in mind that while home video sales have been declining VOD sales have grown. Some home video companies manufacture a limited number of DVD’s, or none at all, and focus on distributing the film digitally through NetFlix, Amazon, and other outlets. Without the cost of manufacturing, these deals can be quite profitable. However, one has to be careful in licensing rights to avoid conflicts and maximize revenues. The filmmaker may only want to grant VOD rights on a non-exclusive basis. Moreover, filmmakers can often negotiate with a home video company to retain the right to sell their film directly to the public from their own website.

Let me offer one final piece of advice. Filmmakers should never sign a short form deal memo to be followed by a long form contract. Once you sign a short form, you may have a binding contract with the distributor. When the long form arrives, if you do not like some of the provisions, you may have a big problem. If the distributor refuses to make the changes you want, you have an agreement but not on the terms you want.  Your options are not good. You cannot easily disavow the deal memo, yet you may not want to proceed without certain terms in the long form. A short form deal memo is short because many terms are left out. By agreeing to the short form, you are agreeing to a deal without knowing all its terms. Therefore, you should insist on going directly to a long form. If you are unable to work out all the terms to your satisfaction, you can walk away with all your rights unencumbered. Many distributors try to get filmmakers to commit to a short form deal memo because it is easier to negotiate. Nonetheless, if and when the long form arrives, the filmmaker cannot just walk away. The short form often does not include such provisions as a detailed audit and accounting clause. If there is a dispute between the filmmaker and a distributor, a judge will not insert terms that he/she thinks are fair. The contract is only those terms agreed upon by the parties.

About Mark Litwak: Mark Litwak is a veteran entertainment attorney and Producer’s Rep based in Beverly Hills, California. He is the author of six books including: Reel Power: The Struggle for Influence and Success in the New Hollywood, Dealmaking in the Film and Television Industry, Contracts for the Film and Television Industry, and Risky Business: Financing and Distributing Independent Film. He is the author of the CD-ROM program Movie Magic Contracts, and the creator of the Entertainment Law Resources website at www.marklitwak.com. He can be reached at law2@marklitwak.com

Mark will be speaking about distributing independent film at the SPADA (Screen Production and Development Association) annual conference November 22, 2012 in Wellington, New Zealand.