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Techopia Live: How startups can leverage SR&ED to boost cash flow and accelerate growth

Are you a tech startup that is starving for cash? Or are you an established company that is doing innovative research? How would you like to receive tens of thousands of dollars or hundreds of thousands of dollars in annual recurring incentives from the federal government?

In this episode of Techopia Live podcast, OBJ publisher Michael Curran interviews Matt Pearson, who helps lead EY’s tax incentive practice in Canada. Pearson has a Ph.D. in engineering physics, specializing in telecommunications. He is an inventor on 12 granted U.S. patents and an author of more than 50 published papers and conference presentations.

The following transcript has been edited for clarity and length.

TECHOPIA: If you are a tech founder, especially if you’re pre-revenue, you are hungry for funds. Funds to develop your products and services, funds to pay your team, and funds to do quite literally everything you need to do to become a success. So besides bootstrapping and friends and family, where can you turn for money? Well, one of the really important options is something called SR&ED, that stands for Scientific Research and Experimental Development Incentive Program. That’s a mouthful. People just call it SR&ED.

This is a federal program that is quite unique to Canada. In fact, I’ve heard local tech titan Terry Matthews described the program as one of the best in the world.

To explore this world of SR&ED tax credits, here is Matt Pearson. Tell me a bit about yourself, Matt.

PEARSON: I work for Ernst & Young. Like many people on our team, my background is not in accounting. It’s more in science and technology. I got started in large corporations. I worked at Intel in the U.S., and then came back to Canada and worked in the telecom sector for about 12 years or so.

I was a co-founder at a technology startup in Ottawa and helped run that for about eight years or so and took it public on the venture exchange. So I have a background that sort of helps me understand why the SR&ED program is so important. It’s something that so many startups live and breathe on a day-to-day basis just because it is so important to them. I exited that company back in 2012, and now I help lead the technology sector and the financial services sector for our incentives practice at EY.

TECHOPIA: Matt, I gave people this high-level sense of SR&ED of the tax credit program, but maybe we’ll get you the true expert to define this.

PEARSON: SR&ED is the flagship R&D tax credit that exists in Canada, and it’s really there to incent companies to do their R&D in Canada. It is, as you mentioned, one of the most generous R&D incentives programs anywhere in the world. It  helps to cover R&D costs performed in Canada.

The challenge with the program is that not everything qualifies for SR&ED, so not everything that you do in R&D will qualify as SR&ED. And that’s where most companies need help. And that’s where our team ‒ engineers and scientists who have been through this before ‒ can help prioritize what you want to highlight in those applications and what’s important to those reviewers just from a pure eligibility perspective.

TECHOPIA: Matt, we’re not going in-depth and nitty-gritty on eligibility. But I just want to emphasize to our Techopia audience that SR&ED is potentially your most non-dilutive capital early stages. Would you say that’s correct?

PEARSON: Absolutely. And that’s why it’s so important is because it’s probably the most prevalent source of funding for technology startups. Hands down. And it’s non-dilutive financing like you said. So you’re not giving up equity. You’re not giving away shares to get this funding. It’s being provided to you to help create jobs and do that research in Canada.

Because of that, it’s leveraged by so many startups, almost all startups, and it doesn’t have to be technology, either. It can be manufacturing. It can be oil and gas, even forestry. Every different sector is able to leverage that program, and that’s why it’s just so prevalent across all industries.

TECHOPIA: To be clear, I’ve focused on startups, but to be clear, it’s not only for startups, and it’s not only for technology companies. Maybe talk to us a little bit about that.

PEARSON: That’s right. So any company of any size can leverage the program. There is an enhanced credit within the SR&ED program that does benefit smaller Canadian-controlled private companies. And it does make a big difference. So that credit can be 35 per cent for those small Canadian-controlled companies, whereas the same work done by a larger corporation attracts 15 per cent credit.

So it is a big enhancement for startups, but every company can leverage it. And the other interesting thing is that there’s no size limit to a SR&ED claim. It can be a very small project, or it can be a very, very large project. There’s no maximum amount to that claim every year.

TECHOPIA: It’s a great point, and we’re not going to generalize here. I will say, in my personal experience, when I’m speaking with local tech companies, it can be in the tens of thousands, hundreds of thousands, even for a startup.

PEARSON: Easily.

TECHOPIA: Matt, what types of things would companies claim in this program?

PEARSON: The SR&ED program is 100% focused at a technology level. So it’s less focused on the business and the market. It’s really, really focused at a technology level. So what we need to understand when we prepare these claims is what is that new innovation that you’re working on? What are the technology challenges that really get in the way of that?

If we can demonstrate that there are some existing technologies out there, obviously, that might be able to do most of what you want but they don’t do everything that you need, if we can show that gap and justify that there’s no clear obvious way to bridge that gap, then all of the work that goes into resolving those uncertainties, those challenges, we can often claim for SR&ED.

The beauty of the SR&ED program is that not only can we claim the hours, the labor costs that go into it, we can also claim overhead costs, the material costs that go into building prototypes. All of those can be included in there. And so by the time you collect all those various costs for a small startup claiming … say they have 100K in eligible salary costs, the actual SR&ED credit that we can get from that is well over 60K. So it’s an incredibly high percentage of those eligible costs.

TECHOPIA: Matt, there are people watching this podcast who might be thinking: “Yes, SR&ED. I’ve been doing it for 10 years. What’s new about this?”

PEARSON: SR&ED was featured in the latest federal budget, so there are some changes coming to the program. All of those changes appear to be very positive. The federal government announced another $600 million being allocated to the SR&ED program over the next four years. It’s all being allocated to improve the program and the way it’s administered and hopefully make the whole process a bit less onerous on those who are claiming it.

Some of the challenges that you mentioned are the fact that you do have to keep some records, some documentation for SR&ED purposes, and the application process for SR&ED can be somewhat onerous. It seems like a lot of the proposed changes are going to try to simplify that application process somewhat, potentially changing the rates.

There’s a number of different things the federal government is looking at to make changes, but all of them are positive. They’re all being driven by a consultation process that the Department of Finance is going through with claimants seeking new ideas on how to improve the program. It’s really, really positive.

TECHOPIA: And the larger economic point, and I don’t think it’s a political one for you to answer, Matt, is that both the current government and the governor of the Bank of Canada have repeatedly said that Canada has a productivity issue. So I think it would be fair to say that when the government thinks of the SR&ED program, this is probably one of the levers to improve Canadian productivity.

PEARSON: The SR&ED program is sort of the cornerstone of all federal incentives and a lot of provincial incentives. And then the other half of that coin are the discretionary credits. Those are the traditional government grants that you might get.

The difference between the government grants and SR&ED is that SR&ED is something that you can apply for every single year and regardless of the type of market that you’re in, whereas a lot of the discretionary grants are very, very focused on a particular sector or they require a certain level of job creation.

There’s different focuses for each program, but in SR&ED, it’s available to everyone every year, and that’s really a big, big difference between that and some discretionary credits.

TECHOPIA: That’s a big distinction, for sure. And that’s the perfect transition, Matt. We’re going to start wrapping up our great discussion, but I wanted to say that we focused a lot in our talk right now on SR&ED, but in fact, it’s not the only program that’s out there. As I understand it, Matt, other programs can kind of be integrated into SR&ED. Tell us about that.

PEARSON: I think the biggest challenge may be that people don’t fully understand when they start looking at incentives is this: one plus one plus one does not equal three. You cannot often get multiple government grants and SR&ED and just add them all up because there are some stacking rules that go along with a lot of these programs. And so what we try to do is build an incentive strategy around this where SR&ED might be the foundation, but we also want to go after some other government grants, other incentives.

TECHOPIA: As we wrap up here, Matt, I want to acknowledge the complexity in this and why someone listening to this podcast might need someone like you at EY. Give me the 60-second overview of how they would engage with someone like you.

PEARSON: Normally, when we connect with a new client, it starts with just a simple discussion about the work they’ve been doing over the past year, maybe what’s coming up in the following year. We try to identify the areas within there that are going to be relevant for SR&ED or for other government grants, other credits that we might go after. From there, we can put together an incentive strategy, like I said, where we can often do it on a contingent basis.

Nobody has to pay any fees until they actually receive funding, which is a big deal for a lot of startups as well. That whole process typically requires several months to go through. It’s something that you want to do as early as possible, but then from there, it becomes an annual part of the business. And it’s something that we revisit SR&ED every year. We look at new government grants that are constantly changing.

There’s always new programs that are created. Just staying on top of that whole ecosystem is an important part of any startup. And any small company that goes looking for new investors, the fact that they have explored those areas, they’re leveraging every incentive they have access to, really adds a lot of credibility to the founders when they go and talk to other investors. They know that they’re stretching every dollar.