22 June 2023
Amid rising interest rates and tightening in investment markets, finance is becoming increasingly hard to come by for start-ups and early-stage companies.
The correlation between investment in research, development and innovation and a company’s success and growth, particularly on international markets, is well established. That is the main driver behind the State’s quite generous supports for R&D activity in the form of direct grants from Enterprise Ireland and the R&D tax credit.
Innovative companies are facing a challenging environment when it comes to funding R&D activity at present. Start-up and early-stage companies, without the deep pockets of their larger counterparts, tend to have to finance their R&D activity from external sources. At a time of rising interest rates and a tightening in investment markets, that finance is getting increasingly hard to come by.
“When considering the most effective way to fund R&D expenditure, companies should first look at assistance available from the State,” says Mazars tax manager John Burke. “The most efficient way is to get a grant from Enterprise Ireland, claim an R&D tax credit on the proportion of the costs met by the company, and then seek funding from another source such as private equity, venture capital, a business angel, or another investor.”
The R&D tax credit regime is almost 20 years old, he adds. “Established in 2004, it has been made more attractive to companies over the years. Under the scheme, companies get a tax credit worth 25 per cent of eligible expenditure on R&D. Expenditure of €1 million will therefore attract a credit worth €250,000. Revenue statistics point to the growing attractiveness of the scheme. The total value of claims in 2021, the latest figures available, was €1.29 billion, the highest ever. Allowable R&D expenditure also reached a record level of €3.47 billion.”
The most recent Finance Act made changes to make it more attractive to smaller companies and micro-enterprises. “Up until this year the credit was made available through roughly equal instalments over three years. Finance Act 2022 revised that to 50 per cent in the first year, and 30 per cent and 20 per cent in the following two years.”
In other word, instead of receiving 33 per cent (€82,500) in the first year and €83,750 in each of the following two years, a company claiming the credit for a €1 million R&D project will receive €125,000 in the first year, €75,000 in the second year, and €50,000 in the third. This represents a very significant cash-flow benefit.
“It is also important to be aware of the fact that a company that is not yet earning profits such as a start-up gets a cash payment instead of a credit. Many start-ups are not aware of this key feature of the R&D regime and thus miss out on the cash injection provided,” Burke adds.
The other main source of State funding is a Research, Development & Innovation (RD&I) Fund grant from Enterprise Ireland. The RD&I grant can be worth up to 45 per cent of expenditure for small companies and 35 per cent and 25 per recent for medium and large enterprises respectively. Grants of 50 per cent are available to companies for digital process innovation projects, but the maximum grant is capped at €150,000.
Where a company gets a grant of 35 per cent from Enterprise Ireland for a €1 million R&D project, it can claim the R&D tax credit on the remaining €650,000 of expenditure which would be worth €162,500 over three years, bringing total funding to €512,500, and leaving the company to find the remaining €487,500 from other sources.
Finding that funding has become more challenging of late, with borrowing, even if available, unattractive due to increased interest rates. R&D projects are risky ventures, and innovative companies with few real assets will find it difficult to raise loan capital to fund them.
Another option is venture capital, but Burke points to investments from that quarter falling off of late. “Venture capital investment in Ireland has been declining following a very strong end to 2021 and early part of 2022,” he says. “While total investment during 2022 did reach €1.33 billion, an increase on the 2021 total of €1.13 billion, that masks a sharp fall in activity in the last quarter of 2022. Investment was €244 million in Q4 2022, its lowest level in two years and a steep fall from the €458 million invested in the same period in 2021.”
Venture capital and private equity investment are not easy to raise even in the best of circumstances, he adds. “The fundraising process can be quite stressful and time-consuming. They will also require an equity share, sometimes quite sizeable, in return for their investment.”
These sources shouldn’t be ruled out, however. “They are valuable funding sources, as are business angels who bring their expertise as well as capital to the table,” says Burke. “A combination of funding from those or other private capital sources with State supports is clearly the most efficient way of financing research, development and innovation activity.”
Source: Generous State supports for R&D available as Enterprise Ireland grants and tax credits – The Irish Times