How Lean New Business Startups and R&D Tax Credits Integrate



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        The traditional new business start up process of painstakingly developing a new product and preparing a comprehensive business plan before announcing to the market has increasingly been replaced by the Lean Startup. The Lean Startup methodology has been described in detail by Eric Reis in a new bestselling book aptly entitled "The Lean Startup." The Lean Startup business plan steps integrate nicely with the statutory tax requirements for a Federal R&D Tax Credit.


The Research & Development Tax Credit

        Many of the private industry and industry supported University R&D efforts will be eligible for Federal Research and Development tax credits. Enacted in 1981, the federal Research and Development (R&D) Tax Credit allows a credit of up to 13% of eligible spending for new and improved products and processes. Qualified research must meet the following four criteria:

  • New or improved products, processes, or software
  • Technological in nature
  • Elimination of uncertainty
  • Process of experimentation

        Eligible costs include employee wages, cost of supplies, cost of testing, contract research expenses, and costs associated with developing a patent. On January 2, 2013, President Obama signed the bill extending the R&D Tax Credit for 2012 and 2013 tax years.


What is a Lean Startup?

        A Lean Startup is a reiterative process that eliminates traditional unnecessary costly time consuming business start up steps by quickly bringing a business to market. With traditional startups a long period of time is spent perfecting the new product and preparing a comprehensive business plan. With a Lean Startup a first mover can create and dominate an entire new market quickly. Business plans get replaced by presenting business ideas and quickly presenting a Minimum Viable Product (MVP) which is actually a rudimentary work in process. Not only is extended start up time expensive with the traditional long term development approach, the new business may miss the market allowing a competitor to control the market or the new startup may miss the opportunity to pivot or quickly adapt the product to a larger business opportunity. Examples of famous companies that moved quickly to market using lean principals include Groupon, IMVU, Votizen, Wealthfront, Aardvark, and Zappos.


R&D Credit Requirements for Lean Startup Elements:



Prototypes (Traditional Startup vs Lean Startup)

        The Lean Startup approach anticipates a Minimum Viable Product (MVP) that is used to test market acceptance. MVP's are introduced to the market as soon as possible when the developing product is at the minimum level where a prospective customer can examine the product.

        The Federal R&D tax credit eligible expense amounts include labor and material costs for prototypes. Traditional more developed startups have prototypes eligible for the R&D tax credit that are much further evolved than MVP's. Accordingly, MVP new product iterations which by definition are less developed would be even stronger R&D tax credit candidates.

Conclusion

        Lean Startup methodology is becoming the prevalent new business model. Lean Startup taxpayers should retain their step by step lean model process iteration documentation and utilize that documentation as part of the required R&D tax credit documentation.

Article Citation List

   


Authors

Charles G Goulding is the Manager of R&D Tax Savers.

Jacob Goldman is the VP of Operations at R&D Tax Savers.

Sean Brophy is a Tax Analyst with R&D Tax Savers.


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