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February 4, 2022
1 min read
Early stage start-up founders need to evaluate a multitude of options when deciding how to fuel their growth. While venture capital is the typical route founders take, fundraising through this way is often time consuming and expensive from an equity and company control perspective. Typically, the alternative then is to go through traditional bank financing, but this also can be difficult as banks often find it difficult to assess a start-ups potential and its associated risks, especially if the business model is nascent or unproven. As a result, there has been a gap in the financing market for non-dilutive funding that is catered towards early stage start-ups. However, there are companies actively working on allowing early stage companies to access non-dilutive capital and neo.tax is one of them.
Accordingly, in this post, we're going to explore four options for non-dilutive financing, including current company offerings and examples.
Tax credits are the most straightforward method to introduce non-dilutive capital into your company. These credits are available for US tax paying companies to take advantage of and are often offered as a way to encourage further investment, innovation and growth for SMBs. One particularly important credit for early stage companies is the R&D tax credit. This tax legislation was passed to encourage US companies to invest in innovation, yet it is often not claimed by start-ups. As a result, start-up oriented tax companies have grown in demand as they look to service young businesses that are dedicating themselves to building innovative technologies. One such company is Neo.Tax which files the R&D credits on behalf of companies in 10 minutes and for an industry low fee of 10% of the credit amount. Neo.Tax was co-founded by an IRS agent of 25 years as well as seasoned entrepreneurs who understand start-up pain points intimately. When choosing a partner, it's important they have the right background and can provide you guidance on an ongoing basis. Neo.Tax is a robust and intuitive product that will soon be able to handle all your tax needs on a cheaper and faster basis.
Example: If you are eligible to receive a $200,000 tax credit as one of their customers has, you would keep $180,000 of that! It’s free to check if you qualify and can do so here.
Annual recurring revenue (ARR) or Monthly recurring revenue (MRR) is income a company can reliably anticipate every year or 30 days. This metric is commonly used among subscription or SaaS companies. As SaaS companies become more prevalent, new forms of lending have emerged which evaluate the companies based on their ARR. Along with churn and renewal rates, ARR (or MRR) helps lenders assess if and how they will extend financing to a business. This type of lending is similar to venture debt, which allows companies to extend their runway without giving up equity.
Both Pipe and Capchase offer this type of solution. Their products provide options for recurring revenue companies to get paid upfront for their contracts. For example, Pipe companies (once approved), can offer up customer contracts that can be bid by investors. This allows these companies to ‘realize’ their monthly or quarterly customers all at once, while investors have the opportunity to invest in recurring revenue contracts they previously did not have access to. Capchase offers loans based on a company’s annual recurring revenue minus what is typically a 5 percent to 10 percent discount. Until this type of financing became available, SaaS companies mainly had to rely on debt, dilution, or bootstrapping to run their business. Now, companies can scale without dilution.
Example: Your company has a customer contract with Microsoft that is worth $15,000 a quarter. Based on the Pipe platform, investors could bid $55,000 for the contract. This would give you the upfront capital you need now, while giving the investors an ability to benefit from your operations via a $5000 discount to the contract. Or you're a company with $10,000 in monthly recurring revenue; Capchase may pay out $108,000 for the total $120,000 ARR in return.
Similar to recurring revenue based lending, another option is to get money upfront based on your inventory and sales. Clearco is a provider of such lending options, as they will invest funds for you to pay your inventory vendors. In return, Clearco plugs into your payment system and takes a percentage of sales until it recoups the investment ~ 6%. This type of lending is particularly attractive to e-commerce sites which depend heavily on suppliers.
Example: If a company is approved for $100K, Clearco would charge $106K and take payment as you make sales.
A business card offers credit for daily and recurring purchases. It’s a great way to extend your runaway as it essentially offers you a continual short term loan. Overtime, you should look to have your credit limit increased as your pool of available credit then also increases. A major differentiator between business cards is whether a personal guarantee is required or not. If it is required, you are putting your personal assets at risk. If you are using a credit card as a way to extend financing, you should avoid cards that require this guarantee. Companies like Brex, Ramp, SVB and many others offer this option and in general are tailored for the needs of start-ups (e.g. offering expense tracking, rewards, and higher limits).
Acquiring the capital necessary to fuel company growth is one of the biggest challenges for founders. While raising money from VCs is a traditional option for start-ups, there are increasing amounts of non-dilutive financing options now available. These options are beneficial to both the companies and its investors, as it allows them to continue operating without ceding equity or spending valuable time fundraising. Founders will find this particularly appealing as they then get to retain their control over a company’s operations while still boosting their growth and valuation.
Making a decision on financing is ultimately going to be down to the type of business and what stage of growth the company is currently in. For example, recurring revenue SaaS businesses will be able to take advantage of revenue share financing earlier than deep tech businesses. However, deep tech companies might be able to take advantage of more tax credits as their payroll is more dependent on technical resources.
The main takeaway is that venture funding should no longer be the only focus of a capital raise for companies. There are many options that are straightforward to take advantage of throughout the lifecycle of a company. Depending on the context of your business, the desire to retain equity and control, and your growth goals, a combination of non-dilutive financing can make a meaningful difference in your financial position.
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In July, the government moved for a summary judgment ruling that Kyocera AVX, the multinational ceramics and electronics manufacturer, is not entitled to the $1.3 million amended Section 41 R&D Credit they recently claimed. The company had hired PricewaterhouseCoopers (PwC) to make the filing, and the accounting firm did interviews with subject matter experts to compute the eligible amount of Section 41 credits they could claim for the tax years 2017-2020. PwC found $1.3 million worth of unclaimed credits, which they filed in the amended Section 41 study. But, ultimately, the IRS claims that the R&D Study and documentation provided were not sufficient to support the claim, and when the IRS requested additional documentation to support the claim neither Kyocera nor PwC could produce it.
Two of the government’s objections in its case against Kyocera are especially relevant to any company that files for an R&D tax credit: 1) “The PwC study exclusively relied on interviews to determine employees' time spent on projects; it did not use documentation” and 2) “Kyocera does not have a centralized system for tracking employee time, and generally does not track employee time on projects.”
The IRS has been emphasizing the necessity of contemporaneous documentation for decades, as far back as Eustace v. Commissioner in 2002. But this recent motion for summary judgment against Kyocera could mark a potential shift towards a stricter application of their long-standing policy.
The direction seems clear—reliance on after-the-fact interviews without supporting documents is increasingly untenable.
Kyocera's reliance on a PwC-conducted study, which was ultimately deemed insufficient by the IRS due to lack of proper documentation and over-reliance on estimates, highlights a systemic risk in the current practices of R&D credit calculation.
The IRS mandates strict substantiation requirements for claiming R&D tax credits under Section 41 of the IRC. Specifically, Treasury Regulation § 1.41-4(d) emphasizes the necessity for contemporaneous documentation to support the expenditures claimed. This documentation must detail the nature of the qualifying activities and their direct connection to the claimed credits—a challenging task for businesses relying on traditional methods, particularly for those that do not have employee time tracking systems in use.
In the case of Kyocera, the IRS disputed the R&D tax credit claims due to inadequate substantiation of the research activities claimed under Section 41. The agency focused on the lack of contemporaneous documentation, relying instead on retrospective estimates from interviews conducted by PwC long after the fact. This method was seen as inadequate in the eyes of the court; they demanded a more rigorous substantiation to prove that the activities qualified as R&D.
This is where Neo.Tax separates itself in the R&D tax space. Unlike traditional methods that often rely on after-the-fact recollections and manual calculations, Neo.Tax leverages advanced AI to analyze real-time data from integrated systems such as Jira and GitHub. This not only ensures greater accuracy but also provides a contemporaneous, auditable trail of documentation that meets IRS requirements. Better yet, our AI not only reviews these systems to identify the research activities, but also uses the meta data to help allocate the time. And because the meta-data is recorded "at the same time" as the tickets in Jira, it is — by definition — "contemporaneous documentation."
By accessing data from systems such as Jira and GitHub at the time of tax preparation, Neo.Tax’s platform can automatically extract, classify, and substantiate qualifying R&D activities. This method aligns with the IRS's emphasis on contemporaneous records. The agency prefers these types of records because they are more reliable than documentation created far after when the activity occurs — certainly, an engineer creating a timesheet of his work at the end of the month is likely more accurate than asking them to recollect their work on a project completed a year, or multiple years, in the past.
Unlike traditional R&D studies conducted by large accounting firms, which rely on retrospective interviews and questionnaires, Neo.Tax’s solution utilizes real-time data to support R&D credit claims. This direct link to project-specific activities minimizes reliance on employee recollection and significantly enhances the accuracy and defensibility of claims during IRS audits.
We often speak of the way our AI solution saves time for controllers, heads of tax, and engineers by eliminating the need for time-consuming retrospective interviews. But the Kyocera case highlights another, far more stark and costly risk of relying on memory and estimations for look-back claims. The IRS is making it clear that they’re emphasizing the need for contemporaneous data. Companies who rely on the R&D credit should take note.
As businesses increasingly adopt project-management tools that capture their developmental activities in real-time, a new approach to R&D tax credit documentation is possible. Neo.Tax’s AI-powered platform provides a reliable, efficient, and IRS-compliant method to claim R&D tax credits. By leveraging data directly from the systems so-often used by innovative companies, Neo.Tax ensures that your spending on R&D is rigorously documented in accordance with current tax laws.
We can get you the money you’re owed. Just as importantly, we can deliver the data-rich study that the IRS prefers and expects.
Given the importance of extending runway in today’s high-interest-rate reality, it’s shocking to learn that just 3 out of every ten companies that qualify for the R&D Tax Credit claim the money they’re owed. In 2011, “the largest 0.13 percent of all firms in the US claimed 14 percent of the credits,” according to research by the Mercatus Center at George Mason University. So, if you’re on the fence about claiming the credit, remember that the big guys are claiming it; shouldn’t you, too?
But this isn’t an article designed to make you feel foolish. FOMO Marketing is not our thing. We at Neo.Tax have built our AI-powered R&D Credit filing tool to make sure every innovative American business can claim the money they’re owed. So, get in touch with our team of experts to walk you through the process! And if you didn’t file for your credit last year (or the year before that, or the year before that…), don’t worry. We can help with that, too!
Many people don’t know this, but you can claim the R&D tax credit for the current tax year plus amend returns for the previous three tax years. For example, in 2023, you could claim credits for 2023, 2022, 2021, and 2020. That retroactive tax filing could be worth hundreds of thousands of dollars (or more) for your company. Neo.Tax doesn’t just stop at your prior three years, though. Due to the mechanics of the credit calculation, it may be beneficial to go back even further to substantiate qualified research activities to maximize the credit in your amended tax years. We can help with that – the lapsing of time is not a limiting factor to our technology! We know that’s getting very inside baseball; again, book a call, and we can talk you through it…
But even those who do know about the value of a Multi-Year Lookback R&D Credit often decide against filing because of the expenditure of time and effort to correctly calibrate the amount you’re owed. The big change with Neo.Tax is that by linking with your existing project-management system, our AI-powered tool can seamlessly identify qualified expenses from past years. What used to be difficult (or impossible, if enough engineers had moved on and are unreachable for interviews) is now quick, low-lift, and much more accurate than human memory could muster.
With Neo.Tax, it’s simple: if your company has a project management system that goes back x number of years, just plug it into Neo.Tax, and our groundbreaking tool can generate the projects and assign the effort for employees across each of those years. In solving for the pain of filing an R&D credit, we also built a tool to make Multi-Year Lookbacks painless and worth it for every innovative company.
The big guys have been claiming it for years. Now’s the time to claim it too.
