How to raise capital if your R&D tax credit puts you into a loss position

Your client’s company made a profit in this financial year. Naturally, they are thrilled. However, they spent a great deal on R&D, and the resultant R&D Tax Relief has reduced their corporation tax liability to the point that it looks like they have incurred a loss. While R&D tax credits do not create a true loss, merely a ‘loss’ on paper, if your client is trying to raise capital they may be afraid to claim R&D tax relief. That’s because investors may be more inclined to fund your business if it is showing a profit.

The good news is there are ways to secure funding and raise capital if your client finds themselves in this position.

How R&D tax credits can reduce profit in your accounts.

When businesses make a profit but also spend a lot on R&D work in a given financial year, R&D tax relief can create a loss position for the business. This can happen as a result of the enhancement mechanism present in the SME R&D tax credit scheme. The SME scheme lets companies deduct an extra 130% of their qualifying R&D costs from their yearly profits. It, therefore, has the potential to reduce your client’s corporation tax, thereby making it appear as though they have incurred a loss.

Why might your client care about appearing to be in loss?

There is a marked difference between profitability and profits. A business’s profitability is based largely on the nature of its cash flow in the long term. However, regardless of whether your client has a promising business outlook, profits on their financial statements look good when viewed by third parties. Additionally, profit margins are usually more important when these third parties are considering offering funding, such as grants or loans. One of the main ways businesses raise capital is through a funding round, where independent investors provide funding in exchange for equity in the business. Potential investors will look at various aspects of the business when deciding whether to invest; a solid business plan, a unique idea, an experienced management team, and profitability, to name a few.

Securing funding is often an important element of maintaining positive cash flow in a business. R&D tax credits can serve as a valuable consideration for improving cash flow, both in the short and long term. This is because the SME scheme also allows for companies to claim a cash credit by surrendering their losses. The cash benefit offered, which is 14.5% of the total losses surrendered, can be realised in the short term when compared to the Corporation Tax reduction of the scheme at large. The latter is felt at the end of the given financial year whereas the former aims to be delivered within 28 days of a claim.

Related: How to increase your client’s cash flow with R&D tax credits.

Ultimately, it comes down to a choice between what the immediate need for the business is in that particular financial year – profits or cash flow. A steady flow of capital is essential to sustaining a business, but showing a profit may be key to securing capital funding in the future. What’s best for your client will depend on their situation, so consulting with an R&D tax credit specialist is advisable.

How to raise capital if R&D tax relief puts your client into a loss position

As mentioned, a funding round is a common way businesses go about raising capital. Even if your client is in a ‘loss position’, there are ways to instill confidence in potential investors and raise the capital they need.

  • Prepare a thorough business planIt is important your client clearly demonstrates the need for raising capital and how they intend to spend it. This should include expenditure for at least three years, a detailed financial plan, and even an exit strategy focusing on repayment. Comprehensive record keeping will aid in this process, as well as demonstrate your client’s credibility.
  • Consider debt restructuringRenegotiating the terms around existing debts can lead to an increase in capital. One tool for restructuring is a debt-for-equity swap, whereby creditors accept equity in exchange for a cancellation of all or part of the company’s debt. Similarly, a renegotiation may be made with bondholders for a ‘haircut’, resulting in interest payments or a portion of the debt being written off. Finally, your client may have callable bonds for use when they can’t make interest payments. They can redeem these early in times where interest rates are decreasing.  
  • Create a crowdfunding campaignCrowdfunding refers to raising small amounts of capital from a large pool of individuals. Often, investors who participate in crowdfunding campaigns are less scrupulous in their approach to investing than investors who take a more traditional approach. Furthermore, they may be more likely to make investment decisions based on emotions rather than pure fundamentals. As such, businesses that undertake R&D work that qualifies for tax credits may generate sufficient excitement such that the “paper loss”, as previously described, is less of a concern. Ultimately, connecting with a pool of investors could increase your client’s chance of raising capital. 
  • Seek venture capital for the businessVenture capital comes from private investors and is usually given to startups that show promise of long-term growth. Being in a loss position can make it difficult to convince potential investors to invest in your business. However, because your client will not be experiencing an actual business loss, and as R&D often leads to future business improvements, seasoned investors such as Venture Capitalists are likely to identify that and invest based on the long term opportunity the business presents. Once again, a solid business plan, forecasting and growth, and an exit strategy are key to securing capital from this type of investor.

Maximise your client’s benefits with made.simplr

Companies looking to claim R&D tax credits can often benefit from expert advice and consultation. Our expertise, together with our all-in-one R&D tax credits software, is a simple and cost-effective way for accountants to secure the maximum benefit for their clients.

Book a demo today!


Sarah Malter

Sarah Malter is the Managing Director of made.simplr and has more than a decade of experience in the field of R&D tax credits. She not only seeks to increase awareness of innovation incentives but is also deeply passionate about shaping legislation to help SMEs grow in the UK. Sarah regularly teaches at major UK universities and mentors women in business through various schemes.

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