June 21, 2024

The Business of Blockbusters: Peter Klass Breaks Down Entertainment Finance

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Welcome to On Production brought to you by Wrapbook. Today I'm really excited to have Peter class, a leader in profit participation and entertainment counting on the show. Peter has a career spanning over two decades, including a significant tenure at GHJ advisors, where he's currently a partner and Sony Pictures Entertainment. Peter brings an incredible wealth of knowledge about the financial underpinnings of Hollywood. He's even written part of a book about it. He's here to teach me about profit participation and the complexities of entertainment finance. Peter, welcome to On Production.


Nice to join you Cameron. I'm looking forward to our conversation.


You know, Peter, I guess the very first question I want to ask you is what in the world do you do? What is profit participation just like lay out the basics for me. And then like, let's dig in and get to the nitty gritty.


I'm a partner at GHJ as you said, but my specialty is really in film and television, contractual accounting, and audits. Nothing to do with GAAP, not nothing to do with financial principles, but really to collaborate with clients to so they receive proper contingent compensation. And we facilitate a fair resolution with the adverse party, we facilitated dispute resolution. And my goal is really to help clients navigate the world of Hollywood creative accounting, and understand the deal making structure. That's in broad terms, in more pointed terms is we are finding value and money for for our clients who are talent, producers, investors, the rightful monies that are due to them from the contingent compensation, profit sharing deals.


Super helpful. All right. Well, with that, I have a couple of more questions. I would love to start with really the beginning of your career. Can you share how your early experiences at Sony Pictures shaped your perspective on profit participations? What is profit participations, and the broader financial mechanisms of the entertainment industry,


at Sony Pictures, my route to Sony Pictures was really the convergence of my love of films and the fascination with the film business. I mean, I was a kid I was going to the movies a couple times a week, I was reading the Box Office Mojo charts before they became popular, and I knew I didn't have it's to be a creative behind the camera. So I wanted to be part of the business. I worked through Sony. And what was most fascinating is just learning how movies make money and modeling their success because this is not a commoditized business. No one has a crystal ball, no matter what your experience level is, you don't fully know if if a movie will actually connect with the audience. No one knows that. And going into Sony was really just my launch buyout into various various areas. I was very much interested in modeling for ultimate but you know that's that's the lifecycle of a film the whole distribution. But I really fell in love with contractual accounting and profit participations. Profit participation in broad terms is essentially profit sharing. It's a profit sharing arrangements between a distributor or a studio in most cases, a producer and talent or an investor financier, profit participations go back all the way to the 1950s 50s I believe Lew Wasserman and Jimmy Stewart struck the first profit participation deal where they gave him half the film's profits in Leo, upfront compensation.


So that's really fascinating. I'd love to know, from your view, what are really the most critical financial principles that filmmakers in producers should understand and navigate? You know, the kind of complexity around profit participations. If you're an indie filmmaker, if you're a producer of a television series, like give us give us an understanding of the shape of these deals and how filmmakers can interact with a firm like yours to truly understand this and then also cut a good deal.


So I get asked this question all the time about very sophisticated producers. A lot of folks are very good when it comes to film finance. They But when it comes comes to the back end of the film or the contingent compensation around it. It's a little Byzantine for most. So I would just break it out into a few of these understand how a film is monetized. Oftentimes they get a call and I see it. Well, my movie made $100 million in the box office. And that's not what's shown under the theatrical line item. And I thought that would that's a fairly simple question. But a lot of folks still don't understand that what what's the actual gross this is not necessarily the distributors take. There's all these middlemen, there's the exhibitor, there's the streaming platforms take their view, then the studios also, of course, stick to our honors, distribution fees. So it's really the money how films are monetized and actually cover this in movie money which we can go into. I offered this spot where Steven Sills, the co author of movie money, who is a legend in profit participations, accounting and audits. And it's what's really interesting about it is that these lucrative deals are never really papered in long form, and I'm captivated by the gray area. And what I would love for the producers to get out of this is to see all sides of these contentious issues because they are not governed by accounting rules. It's all about the contract. It's all about the contract. It's whatever the two parties agree upon. Oftentimes, the studio's have the leverage, the bargaining power is not equal. And therefore, oftentimes, our clients or if you will, talent have to sign certain deals. And if they have good representation, they may get a few guests. But it's really all falls on the side of the fence of the distributor. The other thing is to see all sides of an issue. This is very important when you come into those negotiations. And then when you have a dispute around a profit, profit participation, these are gray areas, and it would be very, very helpful for in negotiation tactics. So whoever the stakeholder is, whether it's a producer or an investor to see what's at stake at the studios and what kind of levers you can pull to ultimately get more benefits. And lastly, I would say it's not personal. Usually these aren't, these are just contracting deals. I've been in very adversarial contracts, contentious issues around profit participations, and back end deals. And usually, once it's resolved, folks continue working with these deals, they don't take audits personal, they don't take these negotiations, personall, folks will always just continue the deal making process.


You know, I wanted to kind of dig in on that. So you mentioned that profit participation disputes can be quite adversarial, quite contentious. Can you discuss a challenging situation you've mediated and what were the key factors that lead to a resolution


there's so many to pick from the dangerous part about it is many of them settle at the 11th hour. And I want to give you a just bite sized example here. I can't go into details because of confidentiality and as a profit participation advisor. We signed NDA on every matter. But that said it was during an audit settlement phase. So after an audit is conducted, we issue of GHG issues a report to the participant and the participant submits it to a studio or distributor, whoever that is due to other circumstances the participant had leverage here. Essentially, they were negotiating with their attorneys on doing another film while they were auditing historical film that they've done. And due to this leverage, this was escalated to the C-suite and potential arbitration. And when you're in discovery mode, you we are able to see a lot more documentation because even in a profit participation audit, which is not a financial audit, you do not see all of the info. Typically distributors will redact agreements, certain sensitive information is always held back. But in this case, we were able to get additional info posted the review period and get certain type of information that was only available in very highly sensitive data, because the participant had leverage because they work they had a certain property they want they had certain rights the studio wanted, they were able to bring up equity claims and settle on the 11th hour and what an equity claim is is essentially something that is not due to you contractually, and oftentimes studios will put in conflicting language let's say production costs we will account to you based on actual expenditure expenditure of product Motion costs. But it also will say in another paragraph that production incentives and benefits are shielded from the participant. That is conflicting language. And it's essentially not fair. We can bring up these types of pretty claims, but they usually don't go anywhere, unless you go into arbitration mediation or like you what


was the outcome there, Peter, I mean, the situation was one where you know, it, they settled it out, I know, you can't get into deep specifics, but they were able to have a productive, you know, working relation after the fact. And were there any things that could have been done or should have been done, before things even began to go on the road towards a litigious sort of interaction,


actually, diligence interaction, when less than 5% of projects go that are escalated. And the upside is that when you're going the litigious route, you have more information available to you. You can negotiate for interests or equity claims that I mentioned. But it's also very expensive. It's time consuming, it takes on an emotional toll. But we recognize that the client had leverage in, it wasn't clear, at the start of the audit, it wasn't clear that the the client was going to have leverage. But since they entered the deal making process with the Business Affairs side of the studio, we decided to press these issues when that when the iron is hot, and go beyond the audit period view beyond our review period. And essentially, we settled for, I would say, five times what we that normally, again, these are the settlements aren't perfect, it's more art than science, it's essentially two parties agreeing on a settlement. And because the participant had leverage, they were able to get several times on a higher multiple of what we expected.


super fascinating. I mean, it seems like it's a case by case basis. But it absolutely makes sense that these contracts become extremely important very quickly, especially when some IP is involved, and it's becoming successful and a value to the studio system. That's


it's really the leverage you have or if the studio distributor sees you as a repeat customer, essentially, they will continue to do business with you over and over again. And in the EU, perhaps of giving you certain gifts in a new deal. You go audit, and you can make up some ground on an audit. It's a way to reward your your hard work your efforts. And I worked at the studio side. And at times, we were instructed by senior management, even though there were two participants in the same fell. Same type of claim. Yeah, we'll make these guys halls but not these guys. And it's really hard to deal with leverage we want to work that


makes a lot of sense to me. You know, I want to pivot just a little bit. Thanks for sharing that story. It is super fascinating. But you know, you've been in the business for two decades. Now. I want to know, from your view, how is the landscape of entertainment finance changed. With the advent of streaming services, and digital content platform,


this industry is always evolving, but I've never seen the speed of disruption. And the magnitude of disruption that we've seen the last five years or so essentially, the streaming service so disrupted the business that all of them models to traditional models, profit models are broken. First of all, it condensed the windowing process. And that means the distribution process, it disrupted the whole business cycle that we were working for 20 years, for example, a film comes out on theatrical, then it goes out on DVD, then it would go out on rental then it would go out on one window that says premium like Cinemax, HBO Showtime, then it would go on free televisions, vacation and so on. And now with the streaming a film can come out on a streamer or make it to your home, they want same as a theatrical release. It's really just depends and it continue on the streaming service forever. So it really makes it much more difficult for distributors to a make money. It's just to maximize their downstream profits because they cannot chop up all the media rights to territory rights. Usually, a streamer will want exclusive rights rather than selling to specific territories. And the margins have really gone down for the studios since the height the peak DVD era where consumers are buying DVDs or digital downloads for $15 $20 a pop and now it's in fact Overall rentals VOD rentals or folks just you know, put it on their string. I would also say that CX Oracle, there's really not consensus on this. But theatrical has not bounced back Despite the success of Barbie and Oppenheimer only really event and cold films continue to do well on the utricle. It's, I'm really bullish on IMAX and screening on IMAX, the event films blockbusters, more and more IMAX is actually the difference how successful you are or how profitable a movie will be, really to have a billion dollar film franchise. If you look at it that way, you can't do it without a theatrical window about an exclusive theatrical window. We saw it in the pandemic, and it just didn't pan out. To get out Top Gun numbers, you need a theatrical window. And really, IMAX really helped. So I'm bullish on that. I do think that casual films and theaters will continue to struggle and decrease their footprint, because streamers are all the rage, it's it's really hard to get people out of their house, you have to make something special.


On the other hand, you know, the streamers are also really hungry for content. I know they've been competing with each other and some of this content they've invested in or even licensing to these other streamers to make it up. I mean, what are participation contracts fighting over these days if the model has been so disrupted? Like, if you were giving advice just broadly to an independent filmmaker, or even not an independent filmmaker, but just a more experienced producer who's trying to kind of get back into the game? Where are you guys advising folks in terms of these contracts? It honestly


it really depends on your risk profile. So streamers, change the equation for profit participation, essentially streamers operate on a buyout model, they'll give you a little bit more than your opt upfront to compensate you for the lifespan of the film or series, but there will not be any back end you will not participate in the success of the film. So the downside is that there are no longer huge windfalls with streaming streaming deals, you will get a fictitious profit participation statement. But traditional traditional profit participation deals, you know they would sell it can be great you can you can shoot for a home run, especially when it's television. I mean, the the windfalls are incredible, especially on television shows. So I think talent is hitting more singles with streaming, maybe even a double here or there. But there's no opportunity for all homeruns there is no opportunity for life changing money. If you are, let's say a participant on Seinfeld or friends, these are this is generational wealth. So the model has changed that way. Most folks that I work with collaborate with who are producers tend to be they tend to be gamblers, they're they're very confident in their product. And therefore I say roll the dice if you really believe in the success of your your series or film, go through that traditional studio model. If you have a slate of pictures, you can decide to put someone at streaming, these are the safer bets, at least you will make a little bit of money and roll the dice on the movie The way you have an upside and go the traditional route. It's really dependent on your risk profile. Although this is not good for our business, because we are profit participation accountants, auditors and advisors. Obviously it's better for us when there's studios out there. But I would say most of the talent and clients will make more money. Overall, in the streaming in the streaming universe, essentially the streamers are overpaying by not paying out profit participation.


super interesting. You know, Peter pivoting just a little bit again, I mean, you mentioned it a little while ago, but you you helped write a book, you know, Movie Money, and it talks all about Hollywood's kind of creative accounting practices. What motivated you to co author this book? And what do you hope readers take away from it?


Who is this book for also, I have to say that I've joined and I'm a co author of the third edition of Movie Money, but the first two editions were and I have the book here, Albert like it, but the first two editions were authored by Steven Sills, Bill Daniels and David Lee. The third edition it was really myself and Steven cells and Steven Sills is a legend in this industry. He is one of the reasons why it came to GHJ because I saw his passion for advocating for talent. And I really wanted to replicate that, in moving money is different in than a lot of film financing or the business of television books is that it's written in simple terms, it's written for you to understand and have a basic understanding of film distribution business, the historical context of profit participations, and Hollywood accounting. Basically, I would love for folks to take away that the difference in profit participation comes down to the definitions to the deal, rather than the ultimate success of the film. In terms of viewership. The value of the stakeholder ultimately is more impacted by profit definitions and its interpretation rather than viewership. And that's really hard to comprehend for most, but it's really the deal that's really at the stick of this.


I mean, I know of a very famous one, of course, is like Star Wars, right? And then particularly the licensing agreement on merchandise, I would do you pursue with your clients, these types of unique licensing agreements, or just different carve outs of where profit could be generated, you bring up a good point, equity or profit making is very different than viewership. I mean, some content could theoretically have smaller viewership, but monetize in some other really powerful way through IP that gets purchased or reused. Like who knows the permutation but just curious, like, what sort of unique things? Are you seeing timely question,


because a lot of a lot of new players are entering the industry who have no, I mean, the video game business is bigger than the film business. And a lot of these video game companies are entering films, we are advising them to carve out certain rights, that you go to a studio, you can either be passive investor, so profit participants and have a right to participation or you could be a co pinion see or end a rights participant holder, that being a co financier gives you a lot more control and a lot more upside. But all that said, we would still advise to always carve out the market where you are able to better exploit it. So if you're a video game maker, keep the merchandising rights and certainly keep the video game rights, all interactive rights. If you're a musician, if you're not musical artists, keep the music rights. Keep whatever's in your wheelhouse. If you're, if you're a toy maker, and you have an iconic toy, keep them keep the merchandising rights for yourself. The film or the series is really there to promote your product.


You know, Peter, I want to that's a really good point. I do want to ask you a question though. So I mean, like, it sounds as if there is a more voracious appetite from distributors and streamers to just buy out a project. And that could be good for a filmmaker, you know, it's more money up front, the distributor, they feel like they can monetize it on the longtail make up that premium that they're paying for, maybe they get a hit every now and again, that pays for the premium they're buying in terms of large tranches of media but to even enter into a negotiation as a producer with some content to even ask a distributor or a streamer to consider profit participation. Does there have to be some sort of leverage before you even start, like I understand if I'm a video game producer, and I have a very large audience, and I'm simply trying to find a new channel for distribution of these stories. You can probably go to a lot of different studios, it's on the table that you're going to be doing profit participation, immediately, like no question of course. But if I'm an indie filmmaker, with a slate of 20 films, maybe I've sold, you know, to various streamers before but look at I really want some back end on this. What's the timing? What's the what's the kind of lifecycle of a producer when they're ready to get into profit participation? Versus like, look, you're just better off selling?


Well, I would say if you're building your career, and you want viewership, I would go with a streamer. And I would go particularly with Netflix. Netflix is a is a global television network. Certainly if you exhibit your let's say small independent film on Netflix, it will have a much larger audience. It has a chance for a much larger global audience than if you really sit theatrically because most likely it will be a platform release or a limited release and it will likely not be really too many tears, simply think about the barriers of entry that the advertising cost prints and so forth. So going through Netflix helps you build that audience. At the same time. It's like a walled garden, it lives on Netflix, it will forever live on Netflix, and I've had people tell me, I wish I could take it down. I wish I could have my movie back. It's been 10 years. And Netflix is now becoming more of transparent, and they're showing their viewership data. And a lot of, you know, most of their content, no one is watching. It's just sits there, it's quickly forgot that it's you, well, maybe at some point, there's going to be more pressures on the streamers to generate cash. And then they will license that out that, for example, whether it's video, or on other channels, or other territories. I mean, there's, there's only so much you can do on one platform. Once you have established following, then whether and that's And social media is actually big these days, studios do look at it, the type of social media following you have the type of track record you have, you are able to negotiate meaningful profit participation deal, then with a studio or traditional distributor, when it's the right project for you. Certainly, if it's a project where you think that there's going to be more of an upside, or if there's going to be evergreen pike fell. I mean, think of home alone, what Home Alone live on less legs away, it's, it's become part of the culture worldwide.


I mean, I think you're saying something that, to me, makes me extremely excited about the future of cinema, for particularly creative people who historically maybe never had a shot to get a movie made, you know, I have a very good friend. He's a New York Times best selling author, I think He's authored a few of his books. But in a world where he has this amazing audience, he has an amazing writer, and the cost of cinema and production is just different than it was 20 years ago, here's an opportunity where, you know, go to a streamer, get the views, build up your audience even more sell more books, Vice versus the second or third movie profit participation maybe makes sense. And now all of a sudden, you're rolling, and you're making something really meaningful in terms of mass media and consumption of interesting, good stories.


I mean, that makes a lot of sense. It's really cool. Exactly. As you say, uh, we often advise folks, when it comes to when they have finance to film on the distribution, whether the you want to go with a streamer, or maybe a domestic streamer, and pre sale the rights internationally? Or do you want to go to a traditional route you, there's various scenarios you can do to maximize the monetization of the film, or the series. One thing, exciting thing you said is that it's the crowd film funding aspect of it all. When it comes to independent film, I mean, the barriers are lowered. When it comes to independent film, it's it's not necessarily a money making Avenue, but it's really building your audience building your name out there. But there are ways to get past these barriers, and one of them is crowdfunding. pre sales still exist. But whenever you are able to actually have a film finance, you come with a lot more leverage, and you can actually negotiate a meaningful profit participation deal whether it's with a streamer with a streamer or a studio. Now,


Peter, I think, you know, you and I have had the chance to have a coffee and talk about some of these, like far out things. And I know your take on this, but I think for our listeners will be really interested. You know, if you look into the deep future, how do you anticipate new technologies like blockchain, NFT's impacting profit tracking, distribution, profit sharing and the entertainment industry? Well,


it's very hard to predict. I remember that 10 years ago, everyone said, VR is going to deal that rage or augmented reality, virtual reality hasn't really panned out. And if these were all the rage, last three years, it kind of has subsided, the film and television industry, you know, it's still shaking it out there. You know, who's to say what's going to be out there and 10 in 10 years, but I do think that the whole blockchain technology and aspect of that is good for crowdfunding. It's good for protecting from piracy, useful for tracking intellectual property rights, and maybe the next few decades As I said, aside from the event fill the franchise's the the film that will be made by Hollywood, the smaller films, maybe there will be direct, direct consumers with fewer middlemen. And this is where blockchain would be very useful to do, similar to the music industry. But I still I still think it's years away. And at this point, it's just a trickle. It's not a meaningful amount. So there it's not at scale to really impact film finance, or I would say the major players,


I'm sure it's not precisely your area of expertise. But I would be unsurprised if you audit these things. There are like global standards and centralized entities that are tracking consumption viewership that I would imagine goes into your audits, is that right? Who are the big players in kind of the rights management of films will will films it's it's interesting, because like Netflix, they're they're buying this stuff out, right? And they have their own metrics, their own data, that's maybe irrelevant, but for like going the studio route, or or other technologies that are currently being used in the stack versus blockchain, do you happen to know about that?


I'm not an expert here. But I would say that this industry, traditionally is not very transparent. Until, until about last year, you had very little visibility into what streaming on television, Netflix actually started showing their data, but the studio's they aside from Box Office Mojo, and there's other websites that measure theatrical box office productions, there's really not a lot out there. That's what I would call reliable data. When it comes to digital downloads, or physical goods, or where it's showing on television, we actually have to contract with third, third party providers that actually monitor where a film is showing. So therefore, we can test for completeness and make sure that our clients are being paid for the rights that are being exploited. There is no centralized database, and oftentimes, what's out in the internet space is, is not fully correct. The box office numbers that that everyone sees, oftentimes, there are often up there are provided by the studios themselves. These are mostly estimates. And everything else. I wish it was a lot more transparent, but it's not. So, you know, people have bits, bits and pieces of information, and they're putting together a puzzle. But there isn't a one stop shop that tracks performance of film or television. The Nielsen ratings aren't as reliable as they were in the past. And it's also hard to to compare apples, apples to apples, if you have a streamer like Netflix, and then you comparing it to Apple, which has much lower viewership data. How do you compare the two? Maybe you compare to if you're in the top tab. It's all ever evolving.


So it sounds like you know, like if you're structuring, if you're advocating for a particular contract structure, it's not gonna be based off of viewership per se. It's like, what's the revenue? And then we figure out how to how to break it up from there. Is that Is that a fair articulation of kind of a thoughtful strategy on this? Or is it based off of totally different standards that I'm not


thinking so I clients are always at a disadvantage because of the information, the inequality of access to information, obviously, the distributor or the studio sell a lot more information at their fingertips. So what I would say in what I often we often advise is, without the information readily available, you can still build in certain escalators. For example, if it's in the top air, if it gets renewed. If a series is in its fourth season, you can't say that it's not successful by definition, the more seasons you have, the more successful it is, you can build in escalations for each additional season. I've even seen certain bonuses for not only awards but how much social media engagement is out. So there's ways to get around it. And now that Netflix has started supply the data I'm sure the industry and we're working with with within the industry to come up with a more equitable framework for talents to participate in the successes


the show, that's really wonderful. I mean, as always, the entertainment industry remains so complex and so wonderful and so challenging, but also fundamentally, this just me massive opportunity for connection and storytelling, and even money, even though it changes. I'm curious, Peter, you know, what advice would you give to a young finance professional thinking about or actually entering into the entertainment field today? What should they focus on, in your view to build a successful career like yours,


I would say that first, pick a route. Either go the studio route, that's traditionally you learn the business, that way, you make a lot of contacts that way. It's a promiscuous industry, people jump around from various studios or even production companies. You can start the production company route, and build yourself into a producer, but a producer that it's always very useful. No one can ever take it away from you knowing all the financial and accounting terms. Just really knowing the business, you can go to a financing firm route. You can even go to an agency, even agencies, like CAA, they have folks who are on the financing side or modeling side. And you can go to a service provider, such as GHJ, there's various firms that are are part of the industry and we collaborate, help others in order to get the resolution that's done early in your career, you want to get as much broadened information as possible, jump around, go from place to place, see what works for you. And at some point, maybe 10 years into your career, take a specialization. For example, when I went when I was Sony early careers, I wanted to profit participations I wanted to do internal audit, I want to do film modelling I went to to understand systems. I wanted to work with business affairs, the motion picture group. And at some point, I picked my specialization and mine was contractual accounting, contractual audits and everything or our profit participations. That was that was what I chose. So at some point, choose your focus and supplements that focus, create a network create a network of individuals that have complementary experience, but are different places whether it's on the production or financing side agency side, that would be my advice. Well,


Peter, as always, you are so incredibly insightful. Of course, you are the co author of the fantastic book movie money, but for listeners that want to follow you learn from you engage in your services, tell us how we can kind of follow you and get in touch if we ever need to. Or you can


always find me on LinkedIn, Peter Klass, I am out there. I'm fairly active on LinkedIn. That's one way to find me PKlass@GHJ Advisers. You can of course email me I love to grab a coffee. I don't turn down readings. I love to mentor young folks. I'm actually involved with one of the local universities and help early careers people make it into industry or actually funnel them to something that's right for and appropriate for them. Well, wonderful.


Peter, thanks for being here and joining us On Production.


Thank you so much, Cameron, I appreciate the opportunity and enjoyed our conversation.

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