Stalking the Next ‘Paranormal’ Blockbuster

Looking to score with the next “Blair Witch Project”? You might wind up backing the next “con the rich” project instead.

Just ask all those investors who put thousands of dollars toward, say, their nephew’s project and even attended a screening—but never got a penny of their money back.

Now, firms that help pool investors’ money, often investing in multiple projects, are hoping to burnish the business’s image. They say the independent film industry, which operates outside of the studio system, should be considered its own asset class, one that isn’t tightly correlated to other investments. And they are devising new ways to invest in film that can reduce the risk.

“This investment can make more sense, especially as investors have gotten smarter and the industry has become more transparent,” says John Sloss, a principal at media-advisory firm Cinetic Media in New York, which helps structure film investments. Mr. Sloss and others structure investments that rely on conservative strategies, such as lending money against tax credits and investing in so-called print and advertising funds.

Major studios are making fewer movies, most of them blockbuster productions. But markets like Russia, Brazil and China are “growing at huge rates” and want “Hollywood-quality movies,” says Ben Browning, CEO of Wayfare Entertainment Ventures, a film production and financing company that is backed by private capital. That creates an opportunity for independent films financed by high-net-worth investors to fill the void, he says.

The fact that film isn’t directly tied to stock, bond and other markets is often used by promoters to show that film can be a viable part of an investment portfolio. Those claims may or may not pan out during the next market crisis. But global box-office receipts for the entire industry totaled a hefty $32.6 billion in 2011, up 3% over 2010 and 24% over 2007, according to the most recent data available from the Motion Picture Association of America. The increase from 2007 was driven in large part by international box-office figures.

The classic—and riskiest—way to invest in a film project is equity investing: funding some or all of a project in return for an ownership stake. That can be lucrative. For example, the surprise horror hit “Paranormal Activity,” released in 2009, was made for $15,000 but raked in more than $190 million world-wide. The movie “Precious,” which was funded with around $12 million from investors, made more than $63 million world-wide.

All too often, though, seed money can disappear, never to be repaid. If a movie doesn’t acquire a distributor, for example, the investor might never get back their original investment. And much like hedge funds, there are no reliable outside data about companies’ track records.

The new ways of investing in film products carry their own risks, says Lisa Andrews, a fee-only wealth adviser in Madison, Wis. She views such investments as a hobby, not as a way to generate retirement security.

One of her clients, Wissam Mattar, a 33-year-old gastroenterologist, has invested $20,000 with his brother to make an independent film and plans to put in an additional $30,000 by year-end. He says it was money he otherwise would have put in a real-estate deal or hedge fund.

Ms. Andrews keeps the investment in its own “sandbox,” outside of Dr. Mattar’s portfolio. “The odds of making money on his brother’s independent film are better than the lottery, but worse than blackjack,” she says. “His financial security cannot rest on investments like this.”

Such investments are best suited for people who already have put aside between $3 million and $5 million to retire and have between $5 million and $10 million in net worth, says Christopher Jones, a fee-only financial adviser in Las Vegas.

There are safer ways to invest to ensure your money has a greater chance of being protected. These include lending money against tax credits in certain states that will give filmmakers incentives. For example, an investor might offer to front a producer $8.4 million contingent upon the state giving incentives worth $10 million. The investor would keep the difference, and receive the money after the producer proves the money has been spent according to the state’s specifications.

Investors also can invest in “finishing funds,” which step in when a film needs more money to be completed. In return, they are the first to be repaid, Cinetic’s Mr. Sloss says. Returns can be as much as 50%, he says.

Another strategy: investing in a print and advertising fund, which raises money after a film has been completed and helps fund marketing and advertising costs. Investors can expect about a 15% return without taking a lot of risk, Mr. Sloss says.

Contributing to finishing funds and print and advertising funds is considered one of the safest ways to invest, as those are senior debt loans that get repaid before riskier “mezzanine loans” and equity.

Another way to invest is to lend against presold domestic and foreign distribution rights, says Christopher Woodrow, chairman and CEO of Worldview Entertainment, a production and investment company whose investor base includes high-net-worth investors and family offices. All of those strategies have one thing in common: They don’t rely on box-office returns, so investors can recoup their investments earlier and still earn a premium. All four films that Worldview has produced have averaged double-digit returns, Mr. Woodrow says.

Worldview consults with foreign sales agents to compile estimates of how much they can sell distribution rights for overseas, says Ethan Lazar, business development manager at the firm. It relies on those estimates to make decisions about whether the cost of the budget can be recouped before the film is released. It takes about a year for investors to get their money back, along with any premium, Mr. Woodrow says. Another film-financing firm, the New York-based FilmNation Entertainment, uses a similar model.

Technological changes also are enabling production companies to rely on other avenues for returns. For example, some technologies that weren’t available before, such as distributing the film via iTunes or video on demand, are proving effective ways to get returns in addition to the box office, says Mr. Sloss.

Investing before production means development funding can be tied up for years, says Mr. Jones, the adviser. While it can take a number of years for other strategies like hedge funds and mutual funds to produce the expected returns, he points out that those funds are a lot more liquid than investments in film.

Before allocating any funds toward a film, investors need to be mindful of the producers they approach and should ask basic questions about their track records to protect themselves, says Teddy Schwarzman, founder of Black Bear Pictures, an independent film-production and financing company, and the son of Blackstone Group CEO Stephen Schwarzman.

Investors can approach producers on their own, but Mr. Jones recommends pairing with a wealth manager or family office with experience in the sector.

Investors also can work with intermediary companies whose job is to match equity with producers. For that service, those companies often will take a fee in the form of a percentage amount of the overall budget for the film. Investors don’t need to pay those companies directly, though ultimately their investments will help cover the fee.

Putting your money in a film can pay out in other ways, says Mr. Schwarzman. Unlike art, which arrives already completed, film production is a collaborative, dynamic process investors can witness up close.

It also offers other perks, such as set visits, dinners with actors and directors, tickets to film festivals and on-screen credit.

“Perks aren’t a reason to invest in film,” says Steven Samuels, a real estate developer who invested in the new film “House at the End of the Street.” “But when your product is finished and you take it to a film festival, it feels good to be able to show your work and be proud of it.”