After coming up with a fantastic business idea, the main challenge of a founder is to align people and funding. It's not surprising, then, that these are some of the most common areas where companies stumble. While attracting great employees isn’t easy, getting funding is often an even more sophisticated art and science.
For early-stage companies, there is usually no question: funding either means bootstrapping or selling equity. Scaling usually means selling more. And only once the business has significant revenue do the banks take an interest, bringing along the other type of financing: debt.
Companies often overlook other options that are out there. For the many Australian businesses investing in innovation, one option stands out above the rest: research and development (R&D) financing based on the R&D Tax Incentive.
But first things first, let's have a look at what the R&D Tax Incentive is all about.
What is the R&D Tax Incentive?
The R&D Tax Incentive scheme is run by AusIndustry and is an Australian tax incentive created for companies investing in innovation. It offers companies with eligible expenditures (that qualify as R&D by their definition) to offset these costs and reduce their tax liability. Because this incentive is refundable for companies with a turnover of below $20 million, for many companies with low or no tax liability, this results in a cash tax offset.
Companies can get up to 43.5% of their eligible costs back, making the Australian scheme one of the most generous such programs in the world, though not the only – similar systems are the SR&ED tax incentive in Canada or the R&D tax credit in the UK.
To access Australia’s R&D Tax Incentive, you'll need to apply with the Department of Industry, Innovation and Science, keep appropriate records and wait. In Australian, we’re fortunate that the process is relatively quick, with registration typically approved in 2 to 10 days and the tax refund normally coming through another 2 weeks after that. Before you apply for the R&D Tax Incentive, you may want to check if you're eligible for R&D financing.
How Does R&D Financing Work?
R&D finance is a loan facility that uses your future R&D Tax Incentive benefit as collateral. Similar to asset finance or any debt instrument that uses a guarantee, R&D financing is nonetheless unique in that it relies on a future receivable from the government.
To be able to apply for R&D financing, your company must first be eligible to receive the R&D Tax Incentive. Most technology-intensive start-ups and scale-ups fit this definition. Their investment in R&D usually far outstrips their revenue in the first years, leading to more eligible costs than taxable income.
To apply for R&D finance, you need to work with a knowledgeable R&D advisor and provide the lender with a bit more information on the company. This could include a cash flow forecast, management accounts, and some context on your plans. The due diligence usually takes from 1-3 weeks, and funding can happen on a monthly or quarterly basis or as a lump sum closer to the end of the financial year.
What are the Advantages of R&D Finance?
There are a few good reasons why it could be worth looking into R&D forward funding. The most obvious one is that it is a debt funding option available to companies that are usually too early-stage for other types of debt. R&D funding can help lengthen your runway, provide bridge financing between rounds, and even help you avoid needing to sell more equity.
Another advantage of R&D financing is more subtle but has an almost magical feature. Lenders often call it the virtuous cycle or the “gift that keeps on giving”. If a company has significant investments in R&D and accesses R&D finance early in the year, it can reinvest these funds into more R&D. The reinvestment creates a larger pool of R&D expenses than was previously available and results in a larger tax incentive benefit.
It also increases the size of the collateral available for the lender, making the potential loan larger. The virtuous cycle also contributes to offsetting fees and making the whole R&D Tax Incentive pie larger.
When is it Not a Good Idea to Get R&D Funding?
Even if it’s a great way to fund a growing innovative company, and including its magical properties, R&D financing is still a form of secured debt. And debt is debt. If your company is looking for (further) investment from venture capitalists or angel investors, it could come up as an issue. Often, equity investors like to be the only security holders over a company, and having secured debt alongside their investment might need to be negotiated. It could be worth discussing your interest in R&D finance with investors early on and highlighting the benefit of extra liquidity.
At the same time, if your investment in R&D is still at a low level, it could be hard to access R&D funding. Most R&D lenders work with medium-sized and larger expected tax offsets, from around $100k and up. This means that it can get tricky financing a smaller tax offset, though it’s still worth investigating.
What Now?
There are as many ways to grow a company as there are talented entrepreneurs. However, it's always useful to know about the tools you can use to get there. R&D financing, along with other types of alternative business funding methods , could be one of the missing puzzle pieces.
We hope this short introduction to R&D finance was useful. Feel free to reach out to the BlueRock Grants and Incentives team to chat through your situation.
