R&D finance is still a largely uncharted form of finance in Australia.

This guide will give you all the details you need to understand the basics of this new form of alternative finance. It will help you figure out if it can be useful to you and get the most out of your future R&D tax incentive payments. Additionally, it will give you the context you need to understand how R&D lending can contribute to innovation funding on a larger scale, by empowering your company to reinvest the funding you’ve already spent, much earlier than was previously possible.

What is R&D finance?

An R&D tax incentive loan is a new type of financial instrument that uses a company’s future R&D tax incentive payments as collateral for a debt facility.

The R&D tax incentive is a predictable source of cash for many Australian companies, but one of the major issues is that it’s very slow. For a company to be able to access the payments that it’s eligible for it has to:

1. Spend money on R&D in the current financial year

2. Wait until the company’s financial year end comes around

3. Prepare the accounts

4. File the R&D tax credit claim as part of the annual income tax return

5. Wait from 6–12 additional weeks for the R&D tax refund to be processed and paid out or offset

 

With R&D finance, the company can have access to the funds in the year in which the R&D spending occurs. This is often many months before their earliest possible repayment date by the ATO.

So, the timeline looks more like this:

1. Spend money on R&D in the current financial year

2. Draw down funds from mid-year onwards

3. Increase your spending until the end of the year

4. Use the funds earlier and net a larger R&D incentive payment at the end of the year

R&D tax incentive factoring is a close cousin to invoice factoring. An R&D loan is simply factoring for expected “invoices” from the government, in this case, from the ATO.

For you to be able to access R&D lending, the first and most important step is to qualify for Australia’s R&D tax incentive scheme.

This type of tax credit payment is not limited to companies registered in Australia. Many governments have adopted a proactive approach to encouraging technological discovery. So, there are equivalent financing options all around the world. For example, you could access R&D credit loans in the UK, or SR&ED loans in Canada as well, which our local Fundsquire teams can help you with.


Which companies qualify for the R&D tax incentive scheme in Australia?

One of the main factors in the qualification of a company is the size of their expenditure. The incurred eligible R&D expenditure has to be at least $20,000 for the financial year.

The legislation specifies:

“To be eligible for the R&D Tax Incentive you must:

  • Be a company that is liable to pay income tax in Australia.
  • Conduct at least one activity that meets the legislated definition of a core R&D activity.
    • Core R&D activities involve at least one hypothesis guided experiment that is undertaken to generate new knowledge.
    • Other non-experimental activities that directly support a core R&D activity may be eligible as supporting R&D activities.”

For Australian companies, the R&D tax incentive allows companies to deduct of their qualifying R&D spending equal to the company’s tax rate plus 13.5%. This amount is capped at $4m in R&D expenditure.

If the company is loss-making, this means that the company can receive around 43.5% of their eligible expenditure back in the form of a tax credit.

The types of companies that can apply for the ATO’s R&D tax credit include entities that were incorporated under Australian law or potentially foreign laws.  These can include companies and also trustees of trading trusts.

Entities that aren’t R&D eligible are individuals, corporate limited partnerships or entity that are exempt for any reason from income tax.

Companies won’t be able to claim for spending on R&D that was led by another entity. If eligibility requirements are met, though, the company that receives the main benefit from the R&D activities can claim these amounts. The company must prove that they have been the recipient of the benefit from the work of the other company, often a subcontractor.

R&D Finance Payments
Photo by Benjamin Punzalan on Unsplash

R&D finance options AU
Photo by Benjamin Punzalan on Unsplash

What is eligible expenditure for the R&D tax incentive in Australia?

The costs that are claimable under the R&D tax incentive are divided into two groups: “core R&D activities” and “supporting R&D activities”. To be eligible for the programme, you must have conducted at least one core R&D activity during the financial year. Supporting R&D activities are not enough to be eligible to file for a claim, but can. as an option, be added on top of core qualifying expenditure.

A core R&D activity is defined by legislation as an expertimental activity:

” 1. Whose outcome cannot be known or determined in advance; but can only be determined by applying a;
2. Systematic progression of work that proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions;
and are
3. Conducted for the purpose of generating new knowledge.”

These can include direct staff costs, subcontracted expenses and software that were integral to the process of R&D.

Supporting R&D activities are a bit more nebulous and are defined as “activities directly related to core R&D activities” which is not the easiest thing to interpret. This could be any activity that directly supports the experimental process of the core R&D activities and can be conducted before, during or after the core R&D. An essential caveat to supporting activities is that they cannot be considered if they result in or aid in the production of goods or services.

Another essential part of claiming R&D refunds is documentation. You must keep detailed records of how these experimental activities were conducted and be prepared to present those in the claim document.

The best source of information on what is eligible both on core and supporting R&D activities is the ATO’s own The R&D Tax Incentive – A Guide to Interpretation.

How does the R&D finance process work?

There are a few simple steps to the application. On average, it can take between 2–4 weeks from the initial conversation to the loan agreement.

The first stage of the application is the due diligence that happens before a Term Sheet. At this stage, the lender looks at both the company’s history with the R&D tax credit (if the company has a history with it) and at a few key company documents. This includes things like the previous year’s accounts and a cash flow forecast. This allows the lender to understand the company’s status quo and its business trajectory and goals.

Then, the future borrower is issued a term sheet which contains the headline terms of the loan: the size of the facility, the interest & any other fees, the term and a list of any other needed documents. Once the term sheet is signed, the application fee is paid and the credit review process starts. At this point, a few additional documents and clarifications are requested and the credit team is dotting the Is and crossing the Ts.

If the credit review goes smoothly, the loan agreement is signed, the security is created and the payment schedule is agreed.

R&D lending
Photo by Kelly Sikkema on Unsplash

What are the benefits of R&D Tax Incentive Finance?

An R&D tax incentive loan can be a great source of liquidity for a growing company. This works especially well for companies that are pre-revenue or between funding rounds.

Other types of funding are either unavailable at this stage, like most bank loans, or very expensive, like venture debt.

It’s a virtuous cycle

As a high growth company with considerable technology, chances are you will continue to invest in tech. So, at least some of the advance funding you receive will go back into R&D. If, for example, you use the R&D tax incentive advance to hire an additional developer, around 33% of their salary will flow into a larger R&D tax refund at the end of the year.

With R&D tax loan funding, the company receives its R&D tax incentive in increments throughout the year. This allows it to get a positive net cashflow at the ATO repayment date compared to the traditional timeline.

It allows you to act fast

In technology, speed is everything. With barriers to entry at an all-time-low, new companies can catch up and surpass even giants in a matter of months. But all too often, funding is the bottleneck on a company’s growth path. With an R&D loan, the company can access funds early, when they can use them best.

It allows you to maintain control

For a company that is pre-revenue, it can seem that selling equity is the only viable funding option. R&D tax credit finance is a good alternative, as it uses a future asset to fund current liquidity. All this without diluting the position of current shareholders or inviting investors to the table.

Investors can, of course, offer value beyond the sheer amount of funding. Even then, it doesn’t hurt to seek investment from a strong operating position.

It’s cheaper than selling equity

With debt financing, you know exactly how much you will end up paying the lender: the principal plus fixed interest fees.

A major difference between debt and equity financing is that selling shares is permanent, while debt is temporary.

Alternative Lending R&D
Photo by Melissa Walker Horn on Unsplash

How to apply for an R&D loan

For a company to apply for an R&D tax credit debt facility the requirements are simple:

  • An Australian (or Canada/UK) based company
  • Significant levels of R&D expenditure
  • Qualified expenditure for the ATO’s R&D tax incentive scheme
  • Be pre-profit

If you want to chat with us at Fundsquire about the option of R&D Advance Funding, you can chat to us.

Alternatively, if you feel pretty certain about your eligibility you can skip the line and apply directly (takes about 15–20 minutes). This helps us get you to a term sheet much faster. It also speeds up the overall process to your potential R&D tax credit advance.

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