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R&D Finance: How it Works
Want to know how innovative tech companies are accelerating their R&D spend? R&D finance allows you to bring forward government funding to when its most needed so let’s read on.
Finance remains vital in every business, whether it’s a startup or an established enterprise. With research and development playing an important role in business growth and competitiveness, funding remains a major setback. That said, sourcing for R&D finance can be quite tricky especially from financial institutions like banks.
Luckily, there are better alternatives sources of funds that don’t require your business assets as collateral. One of the best is a government incentive – i.e. the R&D Tax Incentive. However, the major setback with this source of funding is time.
Being retrospective in nature, this incentive can only be traditionally achieved when the financial year has ended. This can impact businesses negatively considering the upfront funding requirement for research and development ing forging new technologies. But all hope is not lost as you can still access the R&D funds earlier when it’s convenient for your business.
Still do you know what R&D finance is? Or the steps you need to follow to get it? With little information know about this source of funding, it remains largely untapped across different business sectors – so let’s cover it in more detail.
What’s R&D finance?
R&D finance is an innovative loan that relies on the annual receipt of the R&D Tax Incentive as the collateral. Thus, your business can only access this funding if it is expecting an R&D tax incentive for developing innovative technology. Through the R&D tax incentive scheme, eligible innovative companies can have a guaranteed source of funding when the financial year comes to an end. And through R&D finance, they can access this fund in advance when they need it most.
Why you need R&D finance
Are you still in doubt whether you need R&D financing? Don’t be, the tax incentive which is offered by the government is designed to foster research and development efforts in your company. In many cases, you may get back up to 43.5% of what you spend on research and development activities. However, the traditional way to get this funding is includes first spending on R&D, preparing an R&D application, preparing the annual tax return and if eligible obtaining a benefit.
Further, it takes 12 months or a whole financial year to access this funding. And that’s why you need R&D finance. This is acheived through a third party financer that will disburse the funds to you via a loan with your expected R&D credit as collateral.
Thus, through RD finance, your company can proceed to grow and develop via R&D at an accelerated pace. And this is without the sort of compromise (as seen with with many equity financing situations) that may affect the management of the company.
Eligibility for R&D financing
- How will you know your company is eligible for this funding? Let’s find out with the some following criteria:
- Your company should be Australian based for tax residency purposes.
- Have at least one activity that makes your company legally eligible for R&D tax incentives including:
- Experimental research and development guided by hypothesis to create a new invention or knowledge;
- Any other activity that supports research and development is also eligible for R&D tax incentives; &
- The R&D activity must be in Australia
- Further, your company should be under the laws of Australia. However, if your company is exempted from paying tax, then you are not liable for these incentives and this means you cannot access R&D financing.
- $20,000 minimum in AUS expenditure on R&D must be achieved in financial year.
Main Benefits of R&D Financing
Whilst in the research and development phase, traditional finance can often be inaccessible to many innovative businesses. R&D financing and its specific focus however has great potential that can accelerate your R&D efforts. It can be a financial lifesaver especially if other funding avenues are unavailable or are hard to obtain. That said; let’s find out the main benefits of R&D finance:
• Better Business/Company control
This source of funds allows you to maintain full control of your business or company. And this applies more to pre-revenue companies which often issue new shares to investors to generate revenue. The dilution of their shareholding percentage leading to an accruing loss of control over their company.
But through a research and development loan, founders can worry less about outside investors dabbling with company ownership. They can access funds with ease without having to sell their company shares or use business assets as collateral.
• Speed of financing
Speed is critical when it comes to the competitiveness of a business in the current marketplace. Through speed of execution, your business can develop or retain a competitive edge and stay ahead of your rivals. And this can mean tapping early into the development & commercialisation of new technologies where a choice opportunity presents itself.
However, this agility is best facilitated through reliable access to funding – cue where an R&D loan comes in. This allows your business or company to access expected R&D finance from R&D tax incentives as discussed earlier. And with this funding, you can invest in your capacity to innovate & develop new technologies.
• Avoid trading on equity
Research and development finance is a convenient and inexpensive source of funding. It’s an often more convenient alternative as compared to other options like issuing shares which can complicate the ownership and on occasions, stifle major company decisions. And this is because it also protects you from loss over the control of your business. Further, you are often provided fair & commercial terms in which to pay back your loan – where effectively no additional outlay is required since the repayment is via the payment of funds from the government.
• Reap from the virtuous cycle
For the business growth rate to increase exponentially, more resources need to be directed to research and development. Additionally, company technology should be sufficiently advanced for competitive purposes. This advanced progress can be possible through funding, and thanks to the advance from R&D finance, this is also not overly difficult to facilitate.
With this fund, you can expand your staff and tech qualified for R&D expenditure. And through this additional spend, you will also be increasing your potential for R&D tax incentives further. In this virtuous cycle, you will amplify the flow of cash through additional research and development tax benefits.
Considerations whilst using R&D financing
• Possible cheaper funding alternatives
While considering this source of funding, it should be noted there may be cheaper alternatives that are worth reviewing first. Some of them include tapping into personal savings, accumulated profits, mortgage redraw accounts, government grants and low-interest loans from affiliates.
It is also important that you are aware of the importance of maintaining compliance with the rules for the R&D Tax Incentive since R&D financing effectively increases your claim and thus your exposure to a review in the future.
• Debt not supported by investors
Just to be clear, R&D finance remains a form of a debt. This could be a challenge if there are investors who are not in support of additional debts to the company. Therefore, you may need to get in touch with the investors or consult the shareholders agreement before choosing to get this funding.
Steps to accessing R&D finance?
1) Get in touch with Fullstack or representatives of a seasoned R&D finance company. At this stage, you will learn more about this process & eligibility. This will include the process you will follow as well as people you will be working towards your financing.
2) Documents submission: this stage involves preparing all the necessary documents required for formalities during this process. You will be provided with a checklist with a list of documents you need to hand. Once all the documents are ready, you can submit them to the relevant person you are working with commerce the process.
- That said, the following are some of the information requests you may have to provide:
- Company information
- Executive summary of a company transaction
- ASIC report
- Credit history
- Ownership details
- Tax Details
- Superannuation payments
- Past few years of income tax returns
- Previous year ATO account
- R&D details
- Prior R&D activities
- R&D entitlement form
- Prior ATO response on R&D eligibility with regards to your company
- Financing details
- Loan request
- Security (R&D rebate)
- Loan timing (upfront or quarterly)
- Finance info
- Current debts arrangements
- Cash flow predictions
3) After submitting all the necessary documents, you will have a session for questions and answers with the R&D finance representatives. These questions will be necessary for the verification of your company expenditure as well as claims. Therefore, you need to be well acquainted with your accounts of your company, or have a good accounting firm on your side.
4) Letter of comfort – at this point, you should also obtain a letter of comfort from your R&D Consultant. With this letter signed, it means the representatives are satisfied with your company records and claims. The letter may also include the expected R&D rebate as well as the extra research and development you will spend for the rest of the year.
5) Documents for R&D finance – at this point, expect to receive documents for R&D finance from the financing company. This document entails the full details of the expected loan that will be granted to your company.
6) Once you are satisfied with the loan allocated to your company, it’s time to exchange tax return details. And this involves exchanging the account details of the company on the tax return with that of the financing company so that they can receive the rebate on your behalf. This process would be undertaken by your company’s tax agent to ensure everything is official and the process is confirmed.
7) Funds Release – at this point, the funds will be disbursed to your company. this means you will receive the full fund you applied for within a short while.
This whole process often takes a few days which is in a different league comparing to waiting for a whole year to receive the tax incentive. Thus, for cashflow purposes, its more convenient & timely in supporting your company’s R&D programme.
Myths about R&D finance
1. R&D financing is the last resort
It’s important to state that this is not true. This can be a viable option for funding your business as long as it’s eligible for the R&D Tax Incentive. Through this loan, you can invest well in the growth of your R&D and still increase the amount of R&D credit you are qualified for at the end of the year. And while doing this, note that your company shares and assets are most often not required as securities to facilitate the loan – but its always good practice to check with the financier directly.
2. Your company must be running R&D activities only
First, the research and development activities that make your company is eligible for this incentive must be conducted in Australia. However, your company is free to run business abroad with ease.
This means you can run other activities that generate revenue for your business and include R&D activity to improve the quality or quantity of the products or services you are offering. And with this, your company may still qualify for this grant from the government.
3. Financing is expensive
Traditional sources of capital for businesses especially startups are indeed quite expensive. And as such, many people still believe that R&D financing is not different from them. But that’s not the case.
R&D financing can be cheaper compared to many other funding sources. Further, it’s often quite simple and involves just a few processes to access the loan. Additionally, you usually don’t need to use assets or business shares as security to access this fund as the R&D grant is more than enough to acquire this loan.
4. This loan takes all your R&D tax incentive
Also not true but just a myth. Rather you will mostly likely be left with a material balance to run your company affairs once the loan and principal are deducted from the R&D payment. Most loans are based on 80% of the anticipated R&D credit allowing for a significant ‘buffer’ to help ensure you don’t over extend on the loan.
5. You need company assets as security for this loan
Some companies or organizations are skeptical about seeking R&D finance with the fear of using their business assets as securities. However, this is just a myth as this loan only uses the R&D grant as collateral. This means your company assets are not needed as security. Further, it improves your business credit records in banks or other financial institutions.
R&D financing is a great financial tool innovative companies can use when they need external funding. Being reliable and convenient, innovative companies can tap into this funding as long as you are eligible with the necessary documents to prove so.
Through it, your shareholding in the company will be less exposed to investor dilution since you will not have to trade on securities to generate revenue. Thus, if you want to improve the growth of your business without any sort of compromise due to investor capital, R&D financing can help make that possible.
If you’re interested in R&D financing for your business please reach out to the R&D team at Fullstack whom can help organise a reputable R&D financier and process the R&D application where suitable.
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Stuart Reynolds is the founder of Fullstack Advisory, an award-winning accounting firm for businesses leading the future. He is a 3rd generation accountant who specialises in tech companies, crypto and entrepreneurs.