The Film Business Isn't Short of Money. So What Are Venture Capitalists Doing in It?

China's fast-growing film market is nowhere near a zero-sum game. And as production becomes more industrialized, professional investors who care about rules, process and risk control will get more chances.

Last July a horror film called The House That Never Dies (《京城 81 号》) opened in cinemas. In a little over a month it took 410 million yuan at the box office, the biggest dark horse of the summer season.

Before it, no horror film in China had grossed 100 million yuan. The best performer had been Terror on a Lonely Isle, starring Yang Mi, whose 90 million yuan the industry regarded as a miracle. That film cost only 5 million yuan to make, a figure seen as the safe ceiling for investing in a Chinese horror film.

So when film company bosses heard about The House That Never Dies, a horror project with a 40 million yuan budget (meaning it needed at least 100 million to break even), most of them had the same first thought: the investors were mad.

He Xiaoqiu and her investment team saw plenty worth backing. Director Ye Weimin and screenwriter Wen Jun were reuniting after Embroidered Shoes, and both knew horror well. Stylist Zhang Shijie and art director Liu Shiyun were each masters in their fields, which made for a strong crew. The leads, Wu Zhenyu, Lin Xinru and Yang Youning, were all top-tier stars. Together these things set the film apart from the other horror films on the market.

"At the time The House That Never Dies had an astronomical budget for a horror film, but not because we overpaid. We really did spend a lot: props, costumes and sets all cost more. We wanted a quality different from the usual cheap-looking domestic horror," He told QDaily.

He Xiaoqiu is a founding partner and CEO of Shengwan Culture, a Shanghai-based venture capital firm. In early 2013 it set up its first fund devoted mainly to film, and in the three years since it has invested in 15 films, including Wanted, Girlfriends and Dragon Blade.

Film is seen as one of the most attractive places to invest right now. Over the past five years China's box office has grown by an average of 30% a year. Last year mainland takings reached 29.6 billion yuan, five times the figure of five years earlier. Films such as Love Is Not Blind, Lost in Thailand, My Old Classmate, The Breakup Guru and Breakup Buddies returned several times, even more than ten times, what their investors put in. And the money comes back fast, without the three to five years you wait while a tech project matures.

This year was Shengwan's second time at the Shanghai International Film Festival. For an outsider, the festival offered what it needed most: a chance to get close to the people who work in the industry.

Shengwan was not quite like the others at the festival. Its people often talked like venture capitalists. They are sharply attuned to numbers, know the costs and returns of projects at every level, and are used to "finding value in the numbers." They care about production process and control: before investing in The House That Never Dies, for example, they visited the set to check that the money for sets and costumes was really being spent, and talked with the director, producer and screenwriter to judge whether the crew was well run. And they pay close attention to risk, and will tell you how they design financial products to avoid or reduce it.

Shengwan has an investment theory for film that sounds highly professional, and its focus on commercial films fits what the market wants. But, contrary to what we expected, the films it ends up backing are, like the startups venture capital backs, often ones whose commercial appeal is less obvious. Projects with obvious appeal, clear returns and a clear market outlook are already being made by the big film companies themselves.

A still from The House That Never Dies

Because its industry resources cannot match those of professional film companies, Shengwan does two things. First, it allies with the big studios. Over the past two years, for example, several of its films were branded projects it invested in through bundled deals with Shanghai Film Group. "Sometimes the structure isn't optimal, but branded projects help us build things up, like Jackie Chan's films," He told QDaily. Second, it goes where the big companies have less control, such as the project-market sections of film festivals, to look for projects worth backing.

At this year's Shanghai festival, 35 projects were shortlisted for the project market. Each investor could book the ones it liked for a half-hour, one-on-one meeting with the director and producer. He said Shengwan booked nearly all 35. It missed a few only because "we were too slow, and their slots were full."

He does not expect a half-hour meeting to end in a signed contract. Most projects that reach the festival's project market are fairly arthouse, with a distinct directorial style. Shengwan hopes to find the commercial value in them and develop them further.

As Shengwan sees it, most of the directors at the festival are young, have some talent and are torn. In the end they want to make films that fill cinemas, but they don't want to give up their cool or their arthouse ideals. Shengwan's job is to help make these young directors' work commercial.

Sometimes the meetings are really about getting to know the director. When Shengwan talked with Shi Jierui, director of Black Classic, which won this year's Best Idea award at the project market, it learned he had several other projects under way. "By swapping business cards, we get to know each other and open a channel for later. We might learn that the director is better at another genre, or that another commercial film he has in reserve is already quite developed. Then it's a partnership with a person, not just a project on the market," He said.

But it also means few projects bring an immediate investment and return. In nine years the Shanghai festival's project market has incubated 24 theatrical films, and the great majority have earned no meaningful commercial return. By meeting these young filmmakers, Shengwan hopes to find patterns in the creative work at the top of the industry chain, and to help newcomers like itself work out which angles of entry best suit commercial success.

Few truly "mature" projects are left on the market for Shengwan to invest in.

One reason is that filmmakers may approach commercialization from a different starting point, and some even resent Shengwan's "venture-capital mindset" of data, spreadsheets and risk control at every turn. "We in the film business aren't short of money. The projects that come looking for you aren't good projects." That is often the first thing filmmakers say to He Xiaoqiu after meeting Shengwan.

In part, this talk of "not being short of money" reflects how scarce good film projects are. China makes more than 600 films a year. Nearly half, just over 300, reach cinemas, and only 50 to 60 actually make money for their investors.

Projects with real investment value often set off scrambles among the big studios. Bona and Letv, for example, offered higher guaranteed box-office splits than their rivals to win the distribution rights to The Continent and The Crossing. Shengwan puts the safety of its capital first, so it rarely wins hot projects through gambles like these.

The Crossing

That is exactly why The House That Never Dies won Shengwan over. It was not widely tipped, but it had decent production values and a star cast, a clear genre, a good summer release slot, and a lead producer, Fujian Hengye, with years of experience distributing horror films. Together these persuaded Shengwan to invest.

Given its production budget and later marketing and distribution costs, the film needed at least 150 million yuan at the box office to break even. Up against Tiny Times 3 and The Continent in the same slot, it took more than 400 million.

"If a film passes 100 million, the first wave of people may have been lured in by the marketing. But if it passes 200 million, that has to be word of mouth. For a film to reach 400 million, people must have liked it and recommended it," He said. "Or it was a pleasant surprise, because expectations were so low. Some people even thought it was a love story, about winning one person's heart and growing old together."

He believes the buzz and sustained attention generated by the film's later marketing were a major reason for its success. Luck played a part too: lead actor Wu Zhenyu, for example, drew a lot of attention from the second season of Hunan TV's Dad, Where Are We Going?, something the investors had not foreseen.

Film has been a commercial industry for only a short time and has not built up enough data to support the kind of fine-grained decisions Shengwan could make when investing in an internet product. So it has to design deal structures that reduce risk.

For The House That Never Dies, it used "mezzanine financing," common in finance. Traditionally there are two ways to invest: lend money on terms that it must be repaid, or buy equity. Mezzanine financing sits between the two. Depending on the agreement, the investor can hold it as debt and wait for principal and interest, or convert it into shares and share in the growth.

"In this case, say the film needs 200 million at the box office to be safe, we only need to recover 50 million. The only risk is that the film doesn't even make 50 million, in which case we would still lose money," He explained. Structures like this guarantee Shengwan the right to be paid back first.

It uses other financial structures to manage risk too. On Blood Ransom and Red Amnesia, for example, Shengwan gave short-term financing for marketing and distribution to producers who were short of cash once shooting wrapped. The financing paid "mainly fixed plus floating returns, or purely fixed, or tied to the box office," Du Shiqian, general manager of the investment department, told QDaily.

In fact the biggest risks in film are non-commercial ones that no one can control.

The film market is not well regulated. Production works more like a small workshop than a company with clear financial statements, capital management and team discipline. Without proper rules, investment becomes chaotic, money comes back slowly and shady dealings creep in. "The chaos in film investment is still being cleaned up. It will take more professionals before the industry becomes professional," He said with resignation.

There is also almost no barrier to entry. Plenty of rich bosses dabble in film. They usually set up film companies but often lack a professional team to run them and find projects. "When a boss has succeeded in his own industry, he has his own way of doing things, and it may not fit a new industry." In He's view, what the film business lacks most is professional talent.

Because of the way the industry works, Shengwan has, over several years, drawn up fairly thorough agreements setting out each side's rights and obligations. But if you run into a crook, no number of clauses will help. So Shengwan generally works with big platforms such as Shanghai Film Group and Youku Tudou. Breaking faith costs such platforms a lot, and He put it bluntly: "With big companies the quality is guaranteed, and they're also more standardized."

Blood Ransom

Shengwan is now putting more money into other links of the industry chain. In a sense it is no longer just an investment firm. It is also a film company.

That is partly because more and more professional investors are crowding into the industry and competition for projects is growing fiercer. IDG Capital began investing in film a few years ago, in projects with big directors and big stars such as Under the Hawthorn Tree, Red River and Snow Flower and the Secret Fan. Cornerstone Capital invested in So Young, Zhao Wei's directing debut, which grossed 720 million yuan.

When a mature commercial film project looks for investors, it cares, beyond the money, about how much value and help an investor can bring. That help might be a star actor, a strong distribution network, online marketing skill or support in getting screens at cinemas. In short, if all you have is money, you are at a disadvantage. That is what He and Shengwan worry about most. "If we were purely a financial company, we would have no advantage at all. We put in 5 million, the other side says, I don't want interest, just my principal back. How do we compete with that?" He said. She has to build an advantage in resources elsewhere: "We have to bring in artists, or come in together with a marketing company, which may even become our partner later. We use acquisitions, equity stakes and long-term strategic ties to build close relationships with them. Money alone isn't enough."

Shengwan is not alone in this thinking. More and more venture capital firms are setting up film and TV funds aimed at companies along the industry chain.

Matrix Partners China, for example, invested in Bona Film Group and Guomai Pictures, which worked together last year on Han Han's The Continent, a hit that took 630 million yuan. Hony Capital and SMG Pictures jointly launched a 3 billion yuan fund to invest in films and TV series. And China Media Capital, which has been unusually active in entertainment in recent years, followed its investments in Oriental DreamWorks, Canxing Productions and TVB by announcing a new fund with IMAX to invest in 10 films.

As in venture capital generally, when the companies seeking investment aren't so short of money, an investor's connections, resources and ability to give expert guidance often decide who wins the deal. That is why good projects still seek out experienced companies such as Huayi Brothers and Enlight Media. And by that measure, rivals such as Matrix, IDG and China Media Capital look a good deal stronger than Shengwan.

The good news for Shengwan is that this fast-growing market is nowhere near a zero-sum game. And as production becomes more industrialized, professional investors who care about rules, process and risk control will get more chances.