Front Money – what it is, how it works
Front Money – what it is, how it works.
What is Front Money?
Front money, or Seed money, as it is often called, is a common first round of capital for a start-up businesses, including many independent films and theatrical projects. It gets its name from the idea that early stage financing plants the seed that enables a small business to grow.
Obtaining funding is one of the most critical aspects of getting your project on the track to production. In fact, many projects fail or are prevented from even starting due to a lack of capital. Although obtaining financing can be difficult for any small business, it is particularly hard for new entertainment ventures. Since these ventures lack a track record, potential lenders and investors are often skeptical about their prospects for success. Nonetheless, the persistent would-be producer, if armed with a sound business plan and the necessary skills, can usually obtain funding for his/her project eventually.
Who invests front money?
Family, friends, and colleagues are the most common source of front money producers look to after after using their own finances. Folks like this already know the entrepreneur, and are therefore more likely to take a chance on funding a film, play, musical or what-have-you. Because it is almost impossible to predict how successful the project may eventually be, the only outsiders likely to invest in the venture are those who respect the producer’s judgment and abilities, and believe/share his or her vision. Contributors of front money hope to participate in the project’s success and realize a healthy return on investment.
Front money is frequently used to obtain initial options on literary material, pay writers and other creatives to adapt the material into a film or stage script; and to pay lawyers and other professionals for their services in setting up the producing company, documenting the chain of title, drawing up the offering materials for the full financing package, and filing the necessary governmental paperwork to comply with regulations.
High Risk Capital
Front money carries the highest risk of any type of investment. In addition to the usual risks inherent in any business investment, and particularly entertainment projects, there is always the distinct possibility that after using up the front money, the producer of the project will not be able to raise the full financing for the project.
Because the front-money is being spent before the full investment is accumulated, if the funding isn’t obtained, the front-money investors will not receive refund of their contributions.
Nature of the investment
Front money usually takes the form of equity financing, with the investors having partial ownership of the company. For this reason, producers should weigh carefully potential investors' personalities and business reputations before taking front money. Since these people will be part owners of the company-and may insist upon having some control over decision making-it is vital to ascertain whether their interests and personalities are compatible.
Extra consideration for early risk
Because of the high degree of risk associated with front-money investment, investors are justified in expecting a greater return on their investment than later, “ordinary” investors. Typically, this involves the producer giving front money investors “points” from the producer’s side of the profit equation, in addition to those allocated directly in proportion to the invested capital.
For example, suppose an investor’s contribution of $50,000 would (if ordinary investment funds) entitle the investor to 1% of net profits. That same $50,000 invested as front money might entitle the investor to 1-½%. With the additional ½% drawn from the producer’s share of profits.
While it may seem easy and simple to round up front money from a large number of investors, doing so is unwise, and in some jurisdictions, illegal. (New York, for example, places strict limitations on the number of front money investors and the amount of front money relative to the overall project). From a more practical standpoint, however, taking money from more than one or two investors is a recipe for headaches. Administering the investments will be challenging, and the producer will have given up more of the precious profit pie with each front money deal.
Front money deals are typically not very complicated. They are often documented in a short-form letter agreement detailing the terms of the investment. An experienced theatrical or film finance lawyer should be able to prepare a suitable front money agreement very quickly and at modest cost.
As with all complex entertainment transactions, it is imperative that a lawyer be consulted when considering seeking front money.
Great article Gordon! Insightful and practical as usual.
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Thanks for the excellent and concise 2/14/2013 release, “Front Money —
what it is, how it works”.