When most people think about investing in films, they imagine backing the next blockbuster. However, the smartest money in Hollywood isn’t betting on hits, but providing secured loans against solid collateral.

A Brief History of Hollywood Financing

The evolution of film financing reflects this shift from speculation to collateralized lending. In the industry’s early days, major studios controlled everything from production to distribution. The 1948 Supreme Court decision in United States v. Paramount Pictures forced studios to divest their theater chains, leading to the rise of independent producers and more complex financing structures. 

In the wake of the 2008 financial crisis, the rise of streaming platforms, and the post-2020 shift in media consumption habits, studios have pivoted to focus on distribution. Now, they finance only a select number of high-budget films, often through partnerships with independent producers. This transformation has opened space for institutional investors to enter the market. 

Specifically, while technology-driven platforms like Seed & Spark, Film.io, and others have played a role in expanding access to financing, the industry’s core shift towards collaboration and external financing offers an attractive private credit opportunity. While equity investors wait years hoping for profitable box office returns, lenders receive priority repayment through a carefully structured waterfall system.

The Waterfall Defined

The waterfall structure determines how money flows through a production. Lenders sit at the top of the waterfall, providing crucial short-term production loans ranging from 2-15 months with gross annual yields of 15-30%. Unlike equity investors, these lenders begin recouping their investment as soon as production meets specific milestones. 

The system works by carefully aligning funding with key production phases, beginning with script development funded by producers. As projects enter pre-production, two vital forms of collateral emerge: location-based tax rebates and pre-sold distribution rights. These assets secure the short-term loans needed for filming and post-production work, with each completed milestone unlocking new funding while simultaneously securing previous loans. 

By financing specific stages of production and securing returns when key milestones occur, private credit investments can offer more predictable, risk-adjusted returns compared to traditional equity-based approaches. 

From Setback to Success 

A recent case study highlights how careful loan structuring can power Hollywood productions while protecting investors. In 2023, Xtellus provided $3 million in mezzanine financing for a promising comedy blockbuster. This specialized funding sits behind senior lenders but ahead of equity positions in the capital structure, maintaining a claim to a portion of net profits of the film. While mezzanine deals typically hold secondary positions on collateral, and are typically secured by the unsold foreign territory rights, we successfully negotiated with the senior lender to secure first-position on domestic territory sales — an unusual advantage. The 18-month mezzanine agreement targeted a 20% annual return with a 12% guaranteed minimum, plus 5% of the film’s net profits.

The project was expected to be completed by Q3 2024, but the production faced delays of 3-6 months with theatrical release pushed to Q2 2025. Importantly, the mezzanine investment remains well-protected. Despite stretching beyond the initial agreed term, our penalty interest structure ensured we are compensated for the delay with an additional 1% accrued per month and an anticipated total gross return of 46%.

Navigating Risk and Returns

Film production lenders must assess their appetite for risk and capacity to provide operational oversight beyond simple capital deployment. Each lending product has a collateral base and risk profile related to its stage of the production process. For example, Foreign Sales Loans sit at the lower end of the risk spectrum, whereas more traditional loans like Guaranteed Asset Protection (GAP) Financing, are higher risk. 

Production complications can quickly cascade into significant financial exposure. Lenders’ success hinges on understanding the complex web of contracts and relationships that secure repayment, from completion guarantors to distribution agreements, while maintaining the flexibility to address inevitable challenges during production. 

Nonetheless, for investors seeking uncorrelated returns in today’s volatile financial markets, film finance’s waterfall structure offers a compelling combination of yield and downside protection. The key is understanding that in Hollywood, the safest place to be is at the top of the waterfall.

For more information about financing the stages of film production, view or download our white paper – Film Finance Demystified.

Or visit the LX Film Credit Fund overview.