What Are the Pros & Cons of R&D Financing?
R&D financing is a largely untapped form of funding across multiple business sectors. Find out the pros and cons in this guest article by Fundsquire.
R&D finance remains a largely untapped form of funding across multiple business sectors, even in technology. As it is still not very well known, we want to give you the essential facts about this form of financing, when and how it can benefit you, but also when choosing a different type of capital can be more beneficial. But first, the basics:
What is R&D Financing?
R&D finance is an innovative financial instrument that uses a company’s expected future R&D tax incentive payments as collateral for a loan. For many companies, the R&D tax incentive is a predictable source of cash every year. Through an R&D loan, this funding can be taken much earlier in advance.
The Pros: Why would you take on R&D Finance?
A few growing companies have understood the potential of taking out Research Development loans. It can be a good source of liquidity, especially for business entities that are between funding rounds or pre-revenue, and where other sources are unavailable or incredibly expensive.
The Simple Answer: Speed
In the modern competitive business landscape, speed is everything. Whether it’s building the newest technology or adjusting to dynamic market factors, acting fast increases your chances of survival. Typically, for a company to access their R&D tax incentive payments, it has to:
- Spend money on R&D in the current financial year
- Wait until the end of the company’s financial year
- Prepare the company accounts
- File R&D tax credit claim with the annual income tax returns
- Wait for up to 3 months for the processing of the refund or offset
This timeline, which stretches over many months, is compressed to one or two weeks if you choose to access R&D financing. Using funding that the company is eligible for sooner, sometimes up to 9 months earlier, is an excellent way to fuel growth that will pay dividends for the founders faster.
Benefit from the Virtuous Cycle
For a lot of companies with high growth rates, chances are that you’ll channel more resources towards tech as you continue to scale. This form of finance allows you to redirect some of the capital received from the advance back into R&D. For instance, if you hire additional staff to boost the efficiency of your R&D team, the eligible R&D expenditure will increase by the qualifying component of the employee’s annual salary. This process leads to more eligible spending at the end of the year and a more substantial R&D tax benefit.
Increasing the size of the final R&D tax incentive also allows you to offset fees and reinvest more in R&D in the coming year. This virtuous cycle enables many companies to report positive net cash flow from the tax debt repayment process.
Maintain Control of Your Company
Research & development financing allows you to maintain more control of your company. This is especially the case for pre-revenue companies. Companies that have not had any revenue often consider selling equity the only viable funding method but fear losing control to external investors or shareholders. While investors can sometimes offer more value than initially bargained for, it’s intelligent to welcome investors from a robust financial position.
Avoid Selling More Equity
The R&D finance option is a cheaper alternative, which, unlike selling equity, involves permanent loss of some control and helps you determine the exact amount of debt to repay while still in control. It’s always important to remember that debt is temporary and repayable while selling shares is permanent and often unrecoverable.
The Cons: When does R&D Funding not make sense?
While R&D financing is an excellent tool, it can be undesirable under certain circumstances.
When debt is an issue for investors
First, R&D Finance is a debt instrument and is most often secured against the company’s assets. This can be an issue if existing or upcoming investors don’t want the company to take on any (additional) securities. It’s advisable to find out whether the level of debt your company is getting into could influence the decision of a potential investor that you are bringing to the table.
When your tax debt is high
R&D tax incentives are offset against any existing tax liabilities. If your company is typically running up a high tax bill, R&D finance will not be a good source of funding. Lenders can only offer finance against an asset that is going to yield a net benefit.
When cheaper funding is available
Secondly, where other cheaper funding alternatives are available. These include accumulated profits, personal savings, low-interest debt by existing VCs or angel investors, or, potentially, more targeted government grants.
In conclusion, R&D financing is a useful tool that companies seeking external funding should consider. It increases the size of your final R&D tax incentive, allows you not to sell more equity, and is above all, a quick and reliable financing option. You will be able to access funds early, equip yourself with the leading technology, and also gain a substantial competitive edge in the market.
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Alexandra is a lending and origination manager at Fundsquire, a specialist international lender which helps innovative SMEs obtain funding to grow their business.