Blog contributed by Alex Kaschuta at Fundsquire
If you think about startup finance, you’re probably thinking about selling equity, VCs, angels, convertible notes, friends and family, series A, B, and beyond. A more distant thought could creep in, maybe to access some form of a bank loan or even venture debt once you get the ball rolling. What many founders don’t realise is that the money they’ve already invested in product development can be leveraged to finance their future as well.
The benefits of research and development are clear: building a unique product, getting investors interested, gaining an edge over the competition. What many companies don’t see is that R&D can be the gift that keeps on giving if the company is eligible for R&D tax incentives, and it very probably is. Through R&D finance, the tax incentives you’ll be eligible for in the future can turn into the cash you need today.
What is Research and Development Finance?
R&D funding is a type of financing option that relies on the organization’s future R&D tax incentive payments as security for a debt facility. For many companies based in Australia, R&D tax incentives are a consistent source of funds. However, the major drawback is that it can take a very long time to process them and get a payout. R&D Finance allows companies to access the funding they are eligible for in the year that the expenditure occurs, so they do not have to wait an extra financial period to use this money to grow their business.
How are R&D Tax Incentives paid?
Despite being a very reliable source of funding, a major problem with the R&D tax incentives is that it can take a very long time for them to materialise. This makes sense as the Australian Tax Office (ATO) has devised a careful approach to ensure that taxpayer money is not handed out with wild abandon. Typically, after applying, startups need to wait for several months until their payments come through. Also, it’s not always predictable, as audits can complicate the repayment and can take additional months to clarify.
The normal timeline for a company trying to access funding from the ATO includes:
- Spending money on R&D at any point within the current financial year
- Waiting until the end of the current fiscal year
- Preparing the accounts
- Preparing and filing the R&D tax credit with the annual tax return
- Waiting for at least 12 additional weeks for the R&D tax to be fully processed and offset or paid out
This whole process can take 6-12 months depending on where the company is in its financial year when it requires financing. For organizations on a steep development path, this slow but steady pace can turn out to be glacial.
Which companies can access R&D funding
To qualify for R&D Finance, your company must first qualify for the R&D tax incentive, which will then be used as collateral for the funding. To find out whether your company qualifies for the R&D tax incentive in Australia, a few factors matter, but one of the most basic entry requirements is expenditure. At the time of writing, to become eligible, a company must record a total eligible expenditure of at least $20,000 by the end of the financial year. Other important factors include: Being a business that is eligible to pay tax in Australia and having conducted at least one activity that legally meets the definition of R&D activity. Some of these activities include at least one experiment that is guided by a hypothesis that is aimed to create new knowledge, or other non-experimental activity, but that supports a core R&D project.
For companies based in Australia, the R&D tax incentive lets organizations and companies deduct their spending that is equal to the tax rate, plus an additional 13.5%. If a company is making a loss, then it means it can get around 43.5% of its cost back in the form of a tax credit.
If all eligibility requirements are met, the company that gets the main benefit from the R&D activities is allowed to claim the funds.
Why access R&D funding
There are many reasons why you’d want to take advantage of R&D Financing, the main one being that it can be a reliable source of funding for many companies, especially tech-heavy companies that are on a steep growth trajectory.
Some of the best use cases for R&D financing are businesses that want to extend their runway between funding rounds or for businesses that are investing in technology but are still pre-revenue. Most of the time, at these stages, other funding options are either not available or could be very expensive.
One of the main reasons a company would access R&D financing is that time is of the essence in their development journey. If a company has set its sights on disruption, needs to beat a competitor to market, or simply wants to “blitz scale”, using all available resources to fund their projects at a reasonable cost is key.
Last but not least, a major advantage of accessing this type of funding early is that it creates a virtuous cycle. When a company accesses R&D financing early in the year, based on the expected payout at the end of the financial period, it can reinvest those funds in R&D. The final result is that your company increases the size of the final R&D tax incentive benefit because more money was available for R&D investments during the year.
The bottom line
Thanks for reading, we hope that you this post and are at least a bit intrigued by the potential of R&D finance. We tried to cover the basics of R&D incentive finance, but if you’re a bit more curious about how it all works, we’ve written a more extensive guide to R&D finance. Also, if your company has international operations, R&D finance programmes similar to the Australian one are carried out in the UK and Canada as well. However, we also understand that we might have left something out. Thus, if you feel so, feel free to talk to us in the comment. Please feel free to comment if you have experience with R&D Finance or think we’ve missed something and share this post if you think that there might be someone out there who can benefit from it!
Blog contributed by the team at Fundsquire
If you liked this article, check out 7 Capital Raising Mistakes a Start-up Should Avoid or The Capital Raise Checklist – Are you ready for a raise?
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