SR&ED Financing or SR&ED Advance Funding as it is sometimes called, is still a largely unknown form of financing in Canada. This guide will give you all the details you need to understand this underutilized 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 SR&ED refunds.
What is SR&ED/SRED financing?
An SR&ED tax credit loan, also known as a SHRED loan, is a type of financial instrument that uses a company’s future SR&ED tax refund as collateral for a debt facility.
The SR&ED Investment Tax Credit (ITC) is a predictable source of cash for many Canadian companies, but one of the major issues is that it’s very slow to materialize. For a company to be able to access the payments that it’s eligible for it has to:
- Spend money on R&D in the current financial year
- Wait until the company’s financial year-end comes around
- Prepare the accounts
- File the SR&ED tax credit claim as part of their T4
- Wait from 4-10 additional weeks for the SR&ED refund to be processed and paid out by the CRA.
With an SR&ED tax credit loan, the company can access the funds in the year in which the R&D spending occurs, many months before their earliest possible CRA refund date.
The closest financial instrument it resembles is invoice factoring. An SRED loan is simply factoring for expected “invoices” from the government, in this case, from CRA.
For you to be able to access an SR&ED tax credit loan, the first and most important step is to qualify for the Canada SR&ED ITC program.
Note: The SR&ED program in Canada is not unique. Given that many governments have adopted a proactive approach to encouraging technological discovery, there are equivalent financing options all around the world. For example, you could access R&D incentive loans in Australia, or R&D tax credit loans in the UK as well, which our local Fundsquire teams can help you with your shred loan claim.
Which companies qualify for the SR&ED ITC in Canada?
Canadian Controlled Private Corporations (CCPC) can receive a refundable tax credit on qualified SR&ED expenditures. The Federal refund sits at 35%, plus the provinces kick in 8-15%. All things combined, the refund can be up to as much as 55%+, depending on where you’re company is doing business. The SR&ED credits are first applied against other taxes payable, and the balance is refunded in cash.
For other corporations, such as publicly listed companies, the ITC is 20%. This can be applied against other taxes payable and is non-refundable.
What is eligible expenditure for the SR&ED ITC?
The costs that are claimable under SR&ED are salaries and wages, materials, contracts, equipment lease costs, overheads & third-party payments. These costs must be directly attributable to the projects you’re claiming for, backed up by timesheets and documented, and should be defendable in an audit.
What is eligible technology for a claim?
In the words of the CRA:
“’Scientific research and experimental developmentʼ means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis”
Simply put, for a technology to be eligible it has to be innovative in itself, and not be just a reconfiguration of existing technologies. An important distinction here is between technological innovation and market innovation. Developing a new AI algorithm is a technological innovation, and would qualify while applying pre-existing AI modules in a new market, is a market innovation and would not qualify.
But no worries, things aren’t that black and white. If, for example, you introduced pre-existing AI models into the insurance business and that resulted in additional software solutions created around it by your developers, that could qualify for SR&ED.
A good rule of thumb: if you have a technological problem and can’t find the right solution off the shelf, on the first 3 pages of search results or on StackOverflow, you’ve hit on eligible SR&ED.
Knowing these criteria, you now know with a good probability if you’re eligible for the SR&ED ITC and approximately how much you are eligible to claim back. If your potential claim is sizeable but still many months away, it could be a good idea to access it now through SR&ED Advance Funding.
SR&ED Advance Funding can begin as early as 6 months into your financial year, so there’s no need to wait until you’ve filed your claim like a traditional bridge loan.
There are a few simple steps to the shred loan application and it can take between 2-4 weeks from the initial conversation to the loan agreement, sometimes even less.
Step 1 – Application
At this stage, the shred loan lender looks at both the company’s business history with the SR&ED tax credit (if the company has a history) and at a few key company documents, like the previous year’s accounts and the cash flow forecast. This allows the lender to understand the company’s status quo and its business trajectory.
Step 2 – Term Sheet & Due Diligence
The future borrower is issued a term sheet that 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 from the business applying for the shred loan and the credit team conducts due diligence, dots the Is, and crosses the Ts.
Step 3 – Legal Docs and Financing
Legal docs are sent to the client, signed, and returned. Security is registered and the loan is then funded .
Step 4 – Monitoring and Repayment
The lender and the client remain in regular contact and share information through the loan period. The loan principal + interest and fees are repaid on receipt of the CRA SR&ED refund.
What are the benefits of an SR&ED Loan?
An SR&ED tax credit loan can be a great source of liquidity for a growing company, especially if the company is 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.
Make the most of the SRED financing feedback loop
As a high growth company with considerable technology, chances are you will use at least some of the advance funding you receive to further invest in R&D. If, for example, you use the SR&ED tax credit advance to hire an additional developer, around 33% of their salary will flow into a larger SR&ED refund at the end of the year.
With leveraged (SRED Tax Credit Loan) funding, the company receives its SR&ED tax credit in increments throughout the year. This allows it to get a positive net cash flow at the SR&ED refund date compared to the traditional timeline.
The freedom to act fast
Speed is everything, and growing your competitive advantage is key. 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 a shred 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 for their business. SR&ED tax credit finance is a good alternative, as it uses a future asset to fund current liquidity, 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 interest & fees.
A major difference between debt and equity financing is that selling shares is permanent, while debt is temporary.
What do you need to apply for an SR&ED loan?
For a company to apply for SR&ED tax credit debt facility the requirements are simple:
- Canada based company, incorporated in Canada
- Significant levels of R&D expenditure
- Qualified expenditure for SR&ED investment tax credit
If you want to chat to us at Fundsquire about the option of SR&ED Advance Funding for your business, you can contact us here or if you feel fairly certain about your eligibility you can skip the line and apply now (takes about 15-20 minutes).