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Loring is a Los Angeles-based writer, director, and creative producer. His work has been commissioned by a diverse range of clients- from Havas Worldwide to Wisecrack, inc.- and has been screened around the world. Through a background that blends project development with physical production across multiple formats, Loring has developed a uniquely eclectic skillset as a visual storyteller.
At Wrapbook, we pride ourselves on providing outstanding free resources to producers and their crews, but this post is for informational purposes only as of the date above. The content on our website is not intended to provide and should not be relied on for legal, accounting, or tax advice. You should consult with your own legal, accounting, or tax advisors to determine how this general information may apply to your specific circumstances.
Participation agreements are a unique form of payment incentive that grants signees an active stake in a project’s financial performance. Under the right circumstances, they’re a powerful tool that enables filmmakers to unlock both more creative and more flexible financing options.
There is, however, a catch. Participation agreements are notoriously complicated. From labyrinthine contract terms to long-term revenue implications, participation agreements require a level of complexity that could make even a seasoned accountant weep.
But hang on; don’t reach for your tissues just yet. Knowing is half the battle, and this post is going to demystify one of the entertainment industry’s most opaque processes by breaking it down to its most basic parts. Below, we’ll dig into the key components, common issues, and strategic considerations of engaging with participation agreements.
Let’s start with a fundamental question.
In the context of the film and television industry, a participation agreement is a contract that guarantees a signee’s right to receive remuneration based on a project’s long-term revenue. It is the legal cornerstone of profit-sharing in any form.
A typical film or TV project has multiple stakeholders who may be entitled to some degree of profit participation. Generally, the involvement of financiers, distributors, and similar business entities is fully contingent upon such agreements. Less frequently, creative talent like actors, directors, writers, and producers may be able to negotiate a backend deal in exchange for less compensation upfront.
Participation agreements can have a profound impact on a project’s financing. By dictating profit-sharing terms, such agreements heavily influence the potential value of the project to each stakeholder, which in turn influences any decision-making about the stakeholder’s financial or professional involvement. Within this chain of influence, the single most critical factor is usually the type of participation that an agreement guarantees.
What is a participation agreement’s most important detail? While there are dozens of crucial clauses and terms worth your attention, the heart of any profit-sharing agreement is exactly how it defines “profit.” The exact type of participation that an agreement guarantees will have a dramatic effect on the agreement’s long-term financial value.
In general, there are three distinct types of participation that a stakeholder is likely to encounter.
The term “gross participation” refers to the type of profit-sharing in which a stakeholder receives their backend compensation based on a project’s revenue before any expenses are deducted. In other words, a stakeholder with a gross participation deal makes money off any revenue that a project generates, even if the project is not yet profitable in any technical sense.
Gross participation is the most straightforward form of profit-sharing and—as you might imagine—the most valuable. However, financiers and other large-scale financial stakeholders are understandably concerned with recouping their costs before sharing profits. For that reason, gross participation is also relatively rare.
The term “net participation” refers to the type of profit-sharing in which a stakeholder receives their backend compensation based on a project’s revenue after all expenses and fees have been deducted. A stakeholder with a net participation deal only makes money after a project recoups the costs of its creation.
Net participation is the most common form of profit-sharing in the film industry, but it is frequently the subject of controversy. Criticisms center around the murky practices of “Hollywood accounting” in which fees and expenses are manipulated to make films with high revenues appear technically unprofitable. Harry Potter and the Order of the Phoenix, for example, grossed nearly $1 billion worldwide but nonetheless faced a loss of $167 million on paper.
The terms “adjusted gross participation” and “modified adjusted gross participation” both refer to a category of profit-sharing in which a stakeholder receives their backend compensation based on a project’s revenue minus a predetermined set of expenses. In such cases, the costs that must be recouped are subject to negotiation before an agreement is signed.
Adjusted gross participation represents a middle ground between gross and net participation. It grants more favorable terms than net participation by creating a clearer framework for backend compensation. At the same time, it also grants large-scale stakeholders a path to recouping their most fundamental costs before spreading revenue around. Due to this balanced approach, adjusted and modified adjusted gross participation agreements are increasingly common in independent and mid-budget profit-sharing deals.
Beyond the fundamentals of participation type and profit definition, there are a variety of factors that can influence a profit-sharing deal. Below, we’ll break down some of the film financing concepts you’re likely to encounter in a participation agreement.
The concept of “audit rights” refers to a profit participant’s legal rights to examine a producer’s or other stakeholder’s financial books. It is a proactive contractual measure designed to ensure transparency between parties involved in profit-sharing. If a participant has the right to audit a producer’s accounts, accounting mistakes are less likely to slip into those accounts without notice. Audit rights increase the importance of due diligence for all parties, ensuring mutual accountability in the process.
A cap on expenses and allowable costs may restrain the amount or type of deductions that can be made before profits are shared. Contract language to that effect acts as a guardrail against excessive costs and is obligatory for any agreement that guarantees adjusted gross participation.
Contingent compensation triggers are distinct events whose occurrence would trigger a payment as pre-determined within a stakeholder’s contract. For example, a director’s contract might stipulate that she be paid an additional sum beyond her base fee if her film’s box office earnings reach a certain amount. In that case, the additional payment is contingent upon a specific level of financial performance. Reaching that level of performance triggers the compensation.
A most favored nations (MFN) clause is a contract clause guaranteeing that the terms of a particular stakeholder’s deal are as good as those of other stakeholders in a similar position. An MFN clause ensures a baseline of equal treatment among equal parties, preventing individual stakeholders from negotiating terms that might benefit them to the detriment of others.
Also known as a recoupment schedule, a recoupment waterfall outlines the flow of backend compensation as a project accumulates revenue. In other words, the waterfall stipulates exactly who gets paid, how much, and in what order. For example, backend compensation might first be delivered to a studio to recoup costs, but it would be paid to an actor, director, or writer only after revenue exceeds a certain amount.
The term “reporting frequency” refers to the timing and formatting of participation statements. One or more clauses in the participation agreement will detail reporting requirements as deemed necessary. Among these requirements, the reporting frequency is of particular importance because it dictates how often (e.g. annually, quarterly, etc.) communication about a project’s financial performance and potential backend payments will have to be reported to stakeholders.
When negotiating or working under a participation agreement, it’s important to be aware of potential challenges and sources of dispute. A basic understanding of common problem areas can help you to both prevent negative outcomes before they happen and protect yourself in the unfortunate event that they come to pass.
Here are just a few potential issues to keep an eye out for when working with a participation agreement:
As is always the case when contracts are involved, the best course of action is to seek the guidance of a qualified entertainment attorney. They’re equipped to answer all your burning legal questions, from participation agreements to attorney-client retainers and everything in between.
It can be all too easy to get lost in the details of a participation agreement. That’s why it’s so important to maintain a big picture point-of-view during negotiations. The right principles can help you to protect your interest in the face of overwhelming complexity.
With that in mind, let’s take a brief look at how a few stakeholders might approach the negotiation of a participation agreement.
For producers, clarity and consistency are key. The easiest way to protect your interests in a profit-sharing negotiation is to establish firm, agreed-upon definitions from the outset. Doing so will minimize room for profit manipulation and maximize your ability to accurately forecast a project’s impact on your finances.
Similarly, producers should avoid introducing unnecessary complications with their own demands in a profit-sharing negotiation. Over-promising on a project’s financial performance or stacking too many backend deals can lead to costly errors, like miscalculated payments or compensation trigger disputes.
For accountants and legal teams, the key is to prioritize alignment between the participation agreement and the project’s recoupment model. This ensures that compensation triggers and the recoupment waterfall are clear, thereby minimizing the risk of disputes or errors.
By contrast, if the terms of an agreement fail to line up with a project’s distribution plan, the resulting mismatch increases the likelihood of missed or miscalculated payments, causing a general confusion that could lead to legal disputes down the road.
It's also critical that accountants and legal teams track obligations over the life of the project. This ensures compliance with all the relevant agreements and helps to avoid the risk of future liability.
One of the most daunting challenges associated with profit participation is tracking and managing participations over time. A successful film or television project may continue to generate revenue for years or even decades after its initial release. Depending on the terms of their contract, profit participants may be entitled to compensation as long as that continues.
While there’s no easy solution to managing participations over a long timeline, there are best practices. Here are a few that stakeholders should consider implementing:
You may notice that clarity, consistency, and transparency are running themes throughout the profit participation process. When integrated into relevant processes, these fundamental values go a long way towards minimizing risks and maximizing efficiency.
Participation agreements are a pivotal part of the business of professional filmmaking. When approached with transparency and clear communication, they help to make the film and TV industries less conflict-oriented and more sustainable.
For more on film financing, don’t miss our exploration of film debt financing or our comparison of equity and liability in film finance.
