When it comes to starting a Canadian business, especially one with expensive R&D aspirations such as those in the high tech industry, it’s of crucial importance that a startup leverages government funding to extend the runway of its venture.  

A startup that doesn’t capitalize on the wide range of government funding opportunities is putting itself at a huge disadvantage, which can not only limit profitability but also undermine innovation and relinquish equity that would otherwise remain centralized.

In order to maintain the vast majority of control in a company during the startup process, it’s important that funding leverages non-dilutive financing when possible. While dilutive funding can be advantageous to get over fiscal hurdles requiring a quick injection of revenue, dilution will affect executive discretion and detract from long-term profits as financers exercise their power as shareholders or seek high returns on their investments. Venture capital and angel investors should, therefore, be tentatively used during the startup process until after the risk surrounding commercialization has been surmounted and any leverage held by financers is obviated. The SR&ED tax credit program, in combination with the other sources of non-dilutive government funding, can maximize a startup’s potential for success by reducing the risk of research and development.

Maximizing Profits and Mitigating Risk with SR&ED

Canada’s Scientific Research and Experimental Development (SR&ED) program provides an amazing means of funding a business every fiscal year with tax incentives. That means small and medium-sized enterprises (SMEs) can start collecting substantial returns up to 35% on qualified expenditures following their first year of research and experimentation, as long as program criteria are met. The Canadian government’s commitment to supporting innovation ascends beyond almost every other industrialized nation in the world, as demonstrated by the more than $3B paid out each year to participating companies. A startup that structures their business to meet SR&ED requirements from the start will be all the more prepared to save countless dollars that can accelerate business growth and product development as the money is reinvested into further project innovation.

To qualify for SR&ED, first and foremost a company must be a Canadian-controlled private corporation with a total net income below $800k and taxable capital employed in Canada not exceeding $50M. A company can claim expenditures related to experimental development, applied and basic research, and support work by ensuring that these expenditures meet the three criteria of SR&ED’s assessment on scientific or technological eligibility. That is, a company must establish that their claimed project (1) has technological uncertainty that can only be overcome through (2) systematic investigation and that hypothesis formulation and experimental analysis during development (3) generates information that advances understanding of the underlying technologies.

Another critical requirement to claiming SR&ED is ensuring that the necessary information is collected throughout the year to comprehensively file a claim, which is why structuring a startup to track experimental development, employee labor, material expenditures, etc. is essential for maximizing business efficiency. With a practical tracking system in place, claiming SR&ED tax credits can be a lucrative strategy for financing prototype and minimal viable product (MVP) development, as well as funding clinical trials (in the medtech industry for example), because it affords a company the opportunity to take risks in their experimentation to improve new technologies and approaches, and ultimately help form and articulate patents/IP to garner further investment.

Combining Sources of Early-Stage Funding

Depending on the size of a startup and the stage of business development, companies can also avoid dilution by applying for multiple government loans and grants. Loans bear the cost of interest in return for less operational oversight, while grants serve as a non-repayable contribution that is contingent on meeting various qualifications.

The National Research Council of Canada’s Industrial Research Assistance Program (IRAP) offers an especially rewarding means of financing SMEs qualifying in technology innovation. IRAP funding typically ranges between $50k-250k, making it a great opportunity to subsidize research and experimental efforts without diluting shares or falling beholden to acquisitive creditors. The Ontario Centres of Excellence (OCE) is another great source to receive innovation funding through industry-specific programs with special emphasis on digital and software work within the information and communications technology (ICT) sector.

Acquiring Private Sources of Funding

Whenever a business does decide that private investment is the best way forward or bridge funding is required to overcome particular fiscal restraints, SR&ED financing can help to fill the funding gap in a non-dilutive manner, prior to subsequent funding rounds.

While the SR&ED tax credit program is critical for the viability of startup companies in Canada, the main challenge with the SR&ED program is that it often takes over one year before the funds can be received by the applicant. SR&ED financing helps to facilitate and alleviate existing cash flow issues in early-stage businesses, as startup companies often have difficulty commercializing their concepts after exhausting their previous rounds of funding. In this way, accrual debt financing in the form of SR&ED financing allows early-stage companies to bridge the funding gap and extend the runaway until the next funding round, thereby bolstering their business plans.

Moreover, a successful track record of securing government funding, such as SR&ED tax credits, can appeal to private investors by reducing the perceivable risk for funding product development.  

All of this funding information is sometimes a lot to process, but NorthBridge Consultants is here to help. If you have any questions or want to learn more about SR&ED for startups, please contact us.

Co-authored by Philip Finkelstein, Technical Writer, and Ela Malkovsky, Technical Writer/ Editor–in-Chief at NorthBridge Consultants.