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Category Archives: financing

New unbiased blog about Canada’s SRED tax credit program

August 4, 2011 by raymond

There are no good sources of intelligent information about Canada’s SRED tax credit program. Besides Revenue Canada’s own Web site on the topic, most information is biased (in favour of consultants), inaccurate, poorly-written and not that useful for business owners and managers.

SREDFacts (www.sredfacts.com)is a new blog that delves into all aspects of SRED, from determining eligibility to claiming expenses to living through an audit. It’s a useful blog for startups, technology companies and anyone else interested in learning more about this tricky program.

When does $5 million = $50 million? Comparing entrepreneur payouts.

December 8, 2008 by raymond

There has been a lot of healthy discussion about the true implications of VC investments. Markus Frind (plentyoffish.com) wrote about it a year ago and Basil Peters (AngelBlog) has been analyzing how VC math influences a startup’s DNA. Dharmesh Shah’s (OnStartups) excellent video briefly mentions the expected value of entrepreneur payouts in VC-backed ventures and I wanted to expand on that.

In a nutshell, a $50 million exit = a $5 million exit when you factor in two things: risk and payout (the cash you actually take home). In the example below, the upper tree shows a $50 million exit and the bottom shows a $5 million exit:

The $750k represents the expected value in both cases. How come they are the same?

The VC-backed example represents a “home run or bust” investing philosophy. The exit is bigger ($50 million) but so is the risk (only 1 in 10 will make it). Also, your portion is smaller, only 10% at exit in my example. So if there is only a 10% chance you’ll earn your $5 million payout, the expected value is only $500k (10% X $5 million). Add to this a 50% chance of a “sideways” exit, i.e. not much, and you get $750k.

The other example is a startup done lean or with some friends, family and Angel money. The exit may be much smaller because the funding isn’t there to go big. But nor is there the desire to “go big or go home”. So out of a much smaller $5 million exit, you retain $2 million (a bigger chunk) plus your chance of success is now 25% instead of 10%. So 25% X $2 million = $500k. Add to this a 50% chance of a “sideways” exit, i.e. not much, and you get $750k.

Some people may object to the numbers:

  • 10% ownership at exit is too low – Actually, you may own less these days given lower valuations. See this presentation from Union Square Ventures.
  • 90% chance of failure is too high – I agree this may be pessimistic but there are a lot of VCs out there who don’t have one home run every 10 investments.
  • The success rate is too high for modest exits – Few people would claim they could get higher rewards with lower risk…

I’m definitely not suggesting that the numbers I’ve used are the right ones for you. But they are a revealing way to explore alternatives when funding your company. Every option has pros and cons and it’s up to you to understand them. This method gives you a way to quantify those options.

You may be surprised to find out that bigger is not necessarily better, at least not in terms of how much money you take home when you exit your company.

Bootstrapping Part 2: Government Funding

October 24, 2008 by raymond

You wake up everyday and look in the mirror and say, “I am a capitalist.” You have The Wealth of Nations on your bedside table. But in tough times, smart people look for handouts from the government. $700 billion worth of bailouts has even made it socially acceptable!

In Canada, almost $2 billion (just .28% of the US bailout) is granted annually to companies doing R&D via the SR&ED program. Most provinces also piggy-back on this program and provide additional funding of their own. For (Canadian) startups, these subsidies mean cash in your pocket because they come in the form of refundable tax credits. This means you still get money back even if you aren’t profitable, which you probably aren’t. In Quebec, for example, the combination of federal and provincial tax credits means you could get 80% of your developer salaries refunded to you. That $80k developer really cost you $16k!

What’s the catch? First, you won’t get your refund until after you spend the money. You file for your SR&ED tax credits at the end of your fiscal year and after 4-6 months of “processing” you receive a check in the mail. So what’s the use of a refund on expenditures if you can’t afford the expenditures in the first place? Good point and one that the lending market still hasn’t quite solved yet. But you can turn a potential tax credit refund into cash in the following ways:

  1. If you have a good balance sheet and a some personal assets, you might find a bank to loan you a portion of your expected SR&ED refund in advance. Honestly, if you’re a pure startup this will be very difficult because the bank cares more about your real assets than a future tax credit. Some government programs will provide loan guarantees which can help you get that bank loan. But banks are notoriously conservative about even taking on a tiny amount of risk (anyone out there with some stories they’d like to share?).
  2. If you have finished your year-end there are now some secondary lenders who will loan you a % of your SR&ED refund for the 4-6 months it should take to get your check. These guys are expensive (1-2% per month) but they might be your best/only option. I know of two who advertise their services: Goldeye Capital and R&D Capital. I haven’t worked with either personally.
  3. Many investors highly value the cash flow that SR&ED tax credits bring and might be convinced to invest more dollars, using your future tax credits as collateral. I’ve done this several times myself and it usually works out well for everyone because, unlike banks, investors know people who can claim the tax credits even if your startup, gulp, isn’t around to collect.

Canadian startups need to be very familiar with government programs given the economy and the relative lack of startup capital we have in this country. Next time we’ll talk about other programs that exist including Quebec’s new e-business tax credit and some of EDC’s funding programs.