The first couple of years of any new business can easily be the toughest, and that only becomes more challenging if you need to outlay money to undertake research and development activities.
To help start-ups get through those early years, the federal government’s R&D Tax Incentive program allows technically challenged R&D firms to claim their annual R&D expenses and receive a 43.5% cash reimbursement in the following year through the tax system. As the cash refund may take up to 18 months to claim back “it wasn’t hard to work out what these companies want,” says R&D Capital Partners (R&DCP) director Gerry Frittmann. “They want money and they want it now – not in 12 or 18 months. They’re generally either too early to raise equity or they’ve raised equity but they’re going to run out of money soon.”
R&D Capital Partners is the brainchild of Gerry and fellow director Quintin Freeman. The company is joint venture between Gerry’s TCF Services and Quintin’s Freeman Capital, combining their respective skills and experience to provide cash flow up front to businesses that are looking to engage in the government’s research and development program.
“We can provide that cash flow through the R&D tax incentive six, nine or even 12 months earlier, which changes the entire landscape for many new R&D focussed businesses,” Gerry explains. “In some cases, it means that a business can get to a revenue position thus negating the need to raise external equity at all.”
“In reality, the loan is a working capital facility secured by the government” adds Quintin. “If you’re using the additional funds to accelerate your R&D activities, not only are you going to achieve your next R&D milestone earlier but you will also be able to claim an additional 43.5% refund on the increased level of R&D expenditure incurred, thus providing, greater than a 30 -1 return against the costs involved with entering into the loan agreement.
Early stage business is like walking a tightrope, we provide a safety net that can assist through those initial milestones. There’s plenty of good reasons why you would use the service.” As Gerry notes, there have been many times over the past 25 years in the industry that clients have been approved for a government grant, yet due to the timing of the grant payment were asking him for a mechanism to provide an advance.
“All we’ve done now is formalise that structure. Through the R&D Tax Incentive we can actually get the refund paid into our trust account so there’s a secure position there,” he says. “because most of the start-ups don’t have any charges from banks we can also take a charge. That’s basically the security position we take. If we’re happy with the eligibility of the activities and expenditure, the management team, governance and runway, then we’re generally happy to provide funding.
“Our security is that we’ve got a first charge over the company, a PPSR charge on the personal property security register and an irrevocable direction that our trustee bank details go on the tax return so the funds get paid directly back to us from the ATO. That secures our funding which is unique to this sector. There are some complexities when R&D firms already have facilities with the bank and you can’t get a first ranked charge.”
Gerry and Quintin were pioneers in this new territory. Quintin has some 35 years in the financial sector through investment banking and major accounting firms. Gerry’s background as a qualified customs broker and R&D tax consultant providing intimate knowledge of the various government incentives.
At a business level, TCF Services is one of Australia’s leading R&D tax consultants with more than 25 years’ experience advising corporates on various government assistance programs. Equally,
Freeman Capital has some 30 years’ experience as a specialist corporate adviser and financier to the SME sector.
As good friends for many years, Gerry and Quintin saw the opportunity to bring their individual skills and the experience of their firms to provide a quality service.
“It’s an obvious marriage of the two businesses,” says Gerry. “TCF has been going for 25 years and delivered more than $2 billion in grants and assistance. We’ve got a very experienced staff, we’ve got a large client base. Then with Quintin’s expertise we’ve got an exceptional banking and accounting background to complement the skills. Putting the two together enabled us to have the required expertise to be able to do what we’re doing.”
While the concept sounds very simple and clearly useful to relevant start-ups, is there really that much demand for such a service?
“Under the program there’s about 15,000 companies claiming,” says Gerry. “About 75% of them get the refundable tax offset and then, of those ones, some are in profit so they pay tax and they use the offset to reduce their tax. Of the ones that get a refund from the total annual spend of $3.2 billion, about half of that money would go out in refundable cash which is potentially able to beprepaid.
“Out of that $1.6 billion, not everybody has a cash flow need nor is every potential client a good credit risk. I therefore believe the actual market size for a loan would probably account for about 10% of that money growing to up to $200 million a year.”
Although the finance is based on government money, there is still a large amount of due diligence undertaken by R&DCP when assessing a new client. R&DCP’s sister company TCF Services conducts this process and provides a sign-off letter to R&DCP stating that its undertaken a review and used its best endeavours to confirm the client’s eligibility to the program and ability to remain a going concern until such time it repays the loan from the ATO cash receipt.
“We want to ensure that the business has other financial resources to make sure that it stays alive,” adds Quintin. “We’re still lending the company money. We need to act as responsible lenders to check that they’ve got the capability to repay that loan. We do check on their corporate governance and just the general culture of the organisations to be comfortable that we’re backing the right horse”.
In this sense, Gerry says that they are there to “compliment equity, not to be equity. We don’t do subjective equity valuations or require complex shareholders’ agreements”. They have also rejected loan applications from R&D companies who have tried to use R&DCP as a last resort lender, as they don’t want to be in a position where they are trying to get a benefit back through an administrator.
While R&DCP may only have been around for three years, it already has several excellent success stories, having written over 45 loans ranging from $50,000 and up to $3 million in loan size. The likes of zipMoney, Botanical Innovations and Truscreen have all achieved great success after utilising Gerry and Quintin’s service.
In the case of Truscreen, creators of a cervical cancer medical device, the company borrowed funds from R&DCP as a bridge to ensure that any equity raising occurred after receiving China Food and Drug Administration approval thus reducing the need to further dilute existing shareholders, its share price went up 50%, enabling them to raise $5 million in fresh equity – something that would not have been possible earlier.
Success stories such as these add to the growth of R&DCP. As Quintin notes, the first couple of years were dedicated to “funding the internal clients of TCF Services to test the service and processes”; however, in the last 12 months they have been able to branch out using external R&D consultants.
“We employ our own staff and we’re interfacing with the other R&D consulting community very successfully,” Quintin says. “We’re very keen to look at clients advised by other R&D consultants.
We need to ensure that the required disciplines and procedures are in place.”
The service provided by R&DCP is undoubtedly positive to those start-ups looking for advanced cash flow, however the full implications could be far greater. Australia has a proud history in innovation, invention, and research and development, yet is often let down by the venture capital sector. Such an approach is putting control back in the hands of those who deserve it. A positive marriage of skills for everyone. BFM