The rise of SR&ED financing in Canada

Venture capital investment in Canada has been a rollercoaster ride over the past few years, characterized by record-breaking highs and flat lines within shifting market dynamics. Q2 of 2021 saw the highest VC deal value deployed in Canada, with $5.4 billion entering the market across 238 deals. Conversely, there has only been one Canadian tech IPO in the last 18 months, delaying VC payback and tying up capital.

The rollercoaster's twists and turns seem to originate from the central bank interest rate moves, first to the low of 0.25 percent in March 2020, where it held for an unprecedented two years, then the move to a high of 5 percent, where we haven't been in over two decades. These swings have created a VC market of over-exuberance, followed by cautious restraint. All the while, Canadian companies have had to navigate these twists and turns while building their capital stack and maintaining momentum.

The recent Canadian Venture Capital and Private Equity Association (CVCA) Q3 2023 report reveals a landscape that is evolving and adapting to these changing market dynamics. Among the many insights and data points in the report, one notable trend is the growing prominence of SR&ED financing. Of the 317 non-dilutive financing deals reported to the CVCA to date in 2023, 88 percent of them were through SR&ED financing. Let's take a look at what SR&ED financing is and the role it's playing in the Canadian SME funding landscape.

Understanding the shift to SR&ED financing

The Scientific Research and Experimental Development Tax Incentive Program (SR&ED) is the largest source of government funding for R&D. Canadian companies that conduct eligible work can claim associated expenses and receive a federal and provincial/territorial tax credit (depending on where they are located — for example, companies operating in British Columbia can earn an additional 10 percent R&D credit on top of the federally awarded 35 percent). These tax credits provide a refund or a write-down on taxes owing, depending on a few criteria. 

Companies that accrue refundable SR&ED credits can leverage them through SR&ED financing to access non-dilutive capital when it suits them, rather than waiting for an annual lump-sum refund from the CRA. They can continue drawing down as they accrue more tax credits throughout the year, creating a cash flow cadence that aligns with their cash burn needs.

This unique funding source is gaining traction across Canada. The simple and predictable access to non-dilutive capital is attractive to companies, and the self-resolving nature of the financing and non-restrictive terms make it appealing to existing investors who want to protect their equity.

A practical example: Nimbus Synergies works with SR&ED financing provider, Easly, to support its portfolio companies

Nimbus Synergies, a Vancouver-based venture capital firm, exemplifies the trend toward broader adoption of SR&ED financing. Its portfolio companies invest heavily in research-focused endeavours, so SR&ED refunds play a significant role in their funding.

With SR&ED refunds taking up to 18 months from when eligible expenses begin to accrue, managing lumpy cash flow becomes a significant challenge. The average time between VC funding rounds is around 18 months, posing the question: where do companies find capital between these windfalls?

Nimbus Synergies' co-founder and partner, Jason Robertson, began referring the firm's portfolio companies to Easly so they could advance the capital tied up in their earned SR&ED credits and address the gap in funding. 

"Easly Advances ensures that our companies are getting the right amount of money at the right time. Its innovative financing solution brings capital to bear alongside our own equity, so that our companies can do more with less dilution to the founders and investors."

SR&ED financing has become an important part of the funding strategy for Nimbus Synergies' portfolio companies, turning distant lump-sum SR&ED refunds into usable cash. As a complementary part of an existing capital stack, SR&ED financing is a valuable tool to have in your capital toolbox.

"Using Easly Advances alongside other forms of capital is an intelligent way to leverage available funding sources,” said Robertson. “I suspect you will see more companies leverage capital in a more efficient and smarter way as part of their long-term growth strategies.”

Read more about Nimbus Synergies and Easly here. 

Embracing the trend

The rise of SR&ED financing is not just a temporary trend but a strategic response to a complex market. More and more Canadian companies recognize this, as evidenced by the increased adoption noted in the CVCA report.

Nimbus Synergies' successful collaboration with Easly underscores the value of SR&ED financing in addressing the specific challenges faced by companies investing in research and development. By converting SR&ED tax credits into timely funding, businesses can bridge the gaps between funding rounds and maintain momentum.

If you are exploring ways to optimize your capital stack, SR&ED financing might be the solution. Connect with Easly to learn more about this financing option and ensure your business is equipped to thrive in any financial climate.

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