Nowadays, it is a widely accepted notion that companies’ growth heavily relies on their ability to adapt to fast-paced business change and regularly introduce new generations of innovation. Start-ups, and generally less mature companies, are responsible for a large part of innovation breakthroughs. Government subsidies in the form of grants or other incentives help to maintain and increase our overall investment in Research as a country. In particular, the Government has set targets for Research and Development (R&D) spending to constitute 2.4% of GDP by 2027 (from 1.7% in 2016), and to reach 3% of GDP in the longer term. On the other hand, private investment is often provided to co-fund ambitious fast-growing innovative projects with commercial-disruptive potential. However, this leads to the question: How can private investment and government funding complement one another and support a company’s capacity to innovate?
Influence of Private Investment on Innovation
Since innovation is a key path to achieving competitive market advantage and financial success, it is likely that private investment will be invested in a manner that can increase knowledge and innovation. Private investment backing in particular can enable companies to undertake high-risk R&D projects with market breakthrough potentials and attract innovative personnel, whereas Private Equity (PE) investors typically take an active management role that fosters innovation. Furthermore, PE investors can facilitate knowledge sharing between portfolio companies. Such actions can be attributed to the expectation that PEs could achieve more favourable exit outcomes by promoting innovation, and therefore improving their portfolio quality.
Influence of Grants on Innovation
Government grants exist to drive innovation and create new jobs, positively influencing both inputs (R&D expenditure) and outputs (patents). The award of a grant is considered as a confirmation of a company’s growth and innovation strategy, since grant applications undergo a rigorous due diligence process and are competitively judged by a panel of field experts. This provides the company with an externally validated signal of quality that can greatly reduce the uncertainty associated with ambitious R&D projects. As a result, grant recipients have an enhanced ability to procure capable knowledge-resources such as top research staff, in addition to attracting privately owned financial capital that is crucial for materialising the later stages of their innovation project. Grants can also improve the project management approach of the recipients, since their requirements include thorough record keeping, regular monitoring and best practices in risk management.
Grants as a complement of or signal for PE backing
Grant recipients are able to use Government’s funds to acquire a higher knowledge base and innovation potential, while demonstrating that they are already innovative at the time of the award. Grant funding can be a way to finance the first stages of higher-risk projects that would not be particularly attractive to PE investors, allowing a company to achieve commercial proof of concept, bring breakthrough products to the market and increase its valuation. Consequently, government funding can bridge the gap between seed round capital raising and Series A, a business stage that PE investors have difficulty investing in, while also being able to complement the HMRC’s Enterprise Investment Scheme (EIS) and help EIS-eligible companies to materialise their R&D projects.
On the other hand, PE investors are known to screen investment opportunities in order to identify potentially profitable companies for their portfolio. While a government grant is relatively costless to the recipient, it is considered as a credible signal of quality with which a company can attract subsequent PE backing at a perceived reduced investment risk. Previous success in attracting grants can encourage potential investors by limiting the likelihood of miscalculating expected returns associated with an investment.
Growing innovation, initially supported by grant funding, can result in intellectual property growth which in turn increases balance sheet assets and a company’s capital appreciation. This is something particularly important for PE firms as it can increase the eventual value at which they can sell their portfolio companies. In addition, the receipt of a grant usually stimulates PE investment at an earlier stage in a company’s growth roadmap, at series A funding round instead of B or C, enabling innovative companies to benefit from the PE investors’ expertise and capital when they need it the most.
The earlier investment suggests that they will continue to invest in R&D even after commercialisation, enhancing R&D expenditure and being able to recover part of the invested funds through the generous UK’s R&D tax incentives. It is worth noting here that R&D tax relief and Grant funding are not incompatible, allowing companies in receipt of Notified State Aid (NSA) grants (e.g. Innovate UK, ERDF) to claim under the Large Company R&D Tax scheme (RDEC – benefit of approximately 12% of eligible costs) for the non-subsidised part of a project. Small and medium-sized enterprises (SMEs) in receipt of non-NSA grants (e.g. Horizon 2020) or SMEs receiving less than £200,000 of NSA funding within a 3 year period (De Minimis Aid) can claim under the more beneficial SME scheme (benefit up to 33% of eligible costs) for their non-subsidised project costs, with subsidised costs falling under the RDEC scheme.
Accessing government grants can be a time-consuming and complicated process. If you need an expert team to guide you through the process and maximise your chances of success, get in touch for a no-obligation consultation.
This article was written by Yannis Efthymiopoulos.
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