The R&D Tax Credit Aspects of University Start-Ups



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Unviersity-Startups
        Research efforts at universities across the country have resulted in an increasing number of “spinouts”, business start-ups born out of university research labs.  The start-ups benefit by receiving  research funding, gaining access to school lab equipment, and in many cases even having their start-up costs completely covered by the school.   

        What’s more is that many schools act as liaisons, teaming entrepreneurs with scientists, fostering collaborations and breeding innovation.  In addition, the federal government is encouraging these actions in order to bring widespread innovation to markets.  Not only do they provide most university R&D funding but they also provide start-up incentives in the form of R&D tax credits.  The value of the dollar-for-dollar tax credits can be quite substantial especially when paired with state R&D tax credits.


The Research & Development Tax Credit

        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 December 18, 2015 President Obama signed the bill making the R&D Tax Credit permanent.  Beginning in 2016, the R&D credit can be used to offset Alternative Minimum tax and startup businesses can utilize the credit against payroll taxes.


Universities Create Increasing Start-Ups

        Universities and other research institutions created 818 startups in FY 2013, up from 705 in 2012 and 670 in 2011, according to the Association of University Technology Managers.  Startups created in 2014 include a broad range of innovative companies including the following:

        ADC BioMed is a biomedical research company spun out of the University of Minnesota that focuses on diagnostics and therapeutics to prevent and treat cancer, autoimmune diseases, and infectious diseases.
 

        BluHaptics is a spin-out from the Applied Physics Laboratory at the University of Washington that creates systems for underwater, remote-operated robots and drones.  The University of Washington launched a record 18 start-ups in 2014.


        Efficient Windows Collaborative (EWC) is a non-profit web based company spun out of the University of Minnesota.   EWC provides information on the benefits of energy efficient windows, descriptions of how they work, and recommendations for their selection and use.


        BARO is a mobile app company, out of New York University, that makes it possible for small businesses and consumers to rent high-tech items like Go Pro cameras, drones, and 3-D printers.


        EmboMedics is a University of Minnesota start-up that develops biodegradable drugs that can pinpoint tumors and block off blood cells to the area to in order to kill the tumors.


        Zepto Life Technology is a St. Paul, MN company also spun out of the University of Minnesota that researches early disease detection in order to provide more effective treatments to patients.


        Foxtrot Systems is a Massachusetts Institute of Technology and Tufts University start-up that created a web app to help distributors execute better and faster deliveries.  


Getting More Out of University R&D

        The rise of a global, knowledge based economy and increasingly competitive global markets has intensified the need for strategic partnerships that go beyond funding of research projects.  Although the number of university start-ups is on the rise, the potential that university/business collaborations can bring to the national and worldwide economy could be even greater.  R&D spending in 2014 is projected to be about 2.8% of U.S. GDP.  Of the $465 billion that was projected to be spent on R&D last year, over $68 billion was spent by universities alone.  That $68 billion is a large slice of the world’s largest economy however, businesses and universities can better maximize the economic value from those research dollars if they can lay out a collaboration plan that better meets business objectives.  If researchers and businesses were more interactive, both researchers and venture capitalists would be better able to identify opportunities and build upon them.   

        MIT states in a 2010 Best Practices for Industry-University Collaboration study that, “it is important to have two-way knowledge transfer between the university research team and the company personnel managing the project.”  The report then lays out the following seven keys to collaboration success:  

1.    Define the project’s strategic context:
    • Use your company research portfolio to determine collaboration opportunities
    • Define specific collaboration outputs that can provide value
    • Identify internal users of this output at the working level

2.    Select boundary-spanning project managers with three key attributes:
    • In depth knowledge of the technology needs in the field
    • The inclination to network across functional and organizational boundaries
    • The ability to make connections between research and opportunities for product applications

3.    Share with the university team the vision of how the collaboration can help the company:
    • Select researchers who will understand company practices and technology goals
    • Ensure that the university team appreciates the project’s strategic context

4.    Invest in long-term relationships:
    • Plan multiyear collaboration timeframes
    • Cultivate relationships with target university researchers, even if research is not directly supported

5.    Establish strong communication linkage with the university team:
    • Conduct face-to-face meetings on a regular basis
    • Develop an overall communication routine
    • Encourage extended personnel exchange, both company to university and university to company

6.    Build broad awareness of the project within the company:
    • Promote university team interactions with different functional areas within the company.
    • Promote feedback to the university team on project alignment with company needs.

7.    Support the work internally both during the contract and after:
    • Provide appropriate internal support for technical and management oversight
    • Include accountability for company uptake of research results as part of the project manager role.  


        By working closely and interactively on research projects, start-ups and universities can turn innovative ideas into profitable ventures.  Google Inc., Sun Microsystems Inc. and Yahoo Inc. are all prime examples of extremely successful university spinoffs.  Still, acknowledging the entrepreneurial success of those companies is no reason to be content. When companies and universities work in tandem to push the frontiers of knowledge, they become a powerful engine for innovation and economic growth.  

        Silicon Valley provides a good example. Long-running collaborations in the region have given rise to some of the biggest breakthroughs of the 20th and 21st century.  

        Other regions around the country have recognized the potential for economic stimulus that comes from research clusters like Silicon Valley and the collaboration with local universities that occurs there.  

        In New York, for example, certain zones that are created through partnerships with colleges and universities are tax free for businesses under the START-UP NY program.  Under the program, start-ups and other businesses   will be free from state tax for a period of ten years while employees will be tax free for the first five years.   START-UP NY is aimed at businesses that correlate with the academic mission of the sponsoring colleges and universities.


Funding For Start-Ups

        For innovative start-up companies, there are several clever avenues to funding innovation.  A few of them are described below:

1.    Incubators – A start-up incubator is a company, university, or other organization that gathers resources such as cash, marketing, laboratories, consulting, and office space in exchange for equity in small companies.


2.    Venture Capital – Venture capitalists are investing at an increasing pace as the economy continues to rebound.  During 2014, venture capital firms raised $29.8 billion.  That amount was a 69% increase from 2013 and the strongest annual period for fundraising since 2007.   What’s more is that many of these investments are in start-ups as well.  The recent New York Times article, “Throwing Money at Start-ups in Frenzy to Find the Next Uber” describes a few companies that didn’t exist a few years ago and are now worth billions of dollars.  The article also describes the trend of venture capitalists investing in the start-ups, despite many of them lacking revenue and even a market plan.    


3.    Crowdfunding – Crowdfunding involves gathering contributions from a large number of people, usually through the internet or social media.


Conclusion

        Research efforts at universities often result in large corporate opportunities and successful start-ups.  Given the increasingly competitive global economy, researchers at universities and relative businesses are being encouraged by the government and other stakeholders to collaborate with each other in order bring more research results to market and generate the most possible economic value from the efforts.  Federal and state R&D tax credits are available to help stimulate and support the innovative efforts of university start- ups.

Article Citation List

   


Authors

Charles R Goulding Attorney/CPA, is the President of R&D Tax Savers.

Michael Wilshere is a Tax Analyst with R&D Tax Savers.