Why Self Funding?
Self funding is generally the first tranche of funding source that is tapped by companies conducting research and development, and one that often fits naturally with the high risk/high reward ratio that is typically perceived in the early stages by a key innovator within a company. This is often even a necessary stage to reach a point of development whereby there is something of substance to show for past efforts and to provide a platform for outside funding requests.

What Is Self Funding?
For a start-up or early-stage company, self funding is backed by the individual making the investment. It can take the form of direct cash injections from founding shareholders, possibly extending to the use of personal credit cards and leveraging personal assets including homes. Another common source is paying much less than market rates for key employees conducting research and development. Each of these fund injections may or may not be accompanied by formal agreements for future stakes in the company (e.g. via stock options and their tax deferral benefits) and/or the new product development when eventually launched (e.g. via royalties). For a closely-held private company, formal agreements may not be needed unless there is asymmetry of sweat equity (or cash injection) to future reward. The individuals affected ultimately tap into their own private lines of credit and/or constrain their current consumption for the future, an investment that they may have varying degrees of control over as the development unfolds. The emotional investment may be high and decisions on research and development not always impartial.

Funding Research Alongside Commercial Operations
For a company conducting research and development alongside a business that is more or less commercially stable or growing, self funding has the further option of diverting some or all of the profit from that business to the new product development. Although most shareholders in a public company expect a certain degree of self funding, depending on the industry, defending the funding of research from internal sources may be somewhat contentious. For a small private company, decisions to re-invest profit from current operations for the promise of future growth are informed by the insider knowledge of the same individuals. A small private company that operates a profitable business alongside its R&D may need to be aware of the revenue thresholds that may unexpectedly bump them from a 35% refundable down to a 20% non-refundable status. TSGI can proactively work with you to structure your organization to maximize your future SR&ED tax credits.

The Negatives and Positives of Self-Funding
The downside of self-funding is, most generally, that it can be limited in magnitude especially for small start-ups or even in public companies where the business cycle is volatile and poorly synchronized with funding requirements. The natural upside is that self-funding preserves the control and ownership of the technology development held by the current owners and shareholders without dilution from external sources. If the research and development and the company is ultimately successful and capital gains on the shares eventually realized, those gains may be eligible for capital gains exemptions in private companies and deferral of taxation on gains in both private and public.

For refundable claimants (Canadian controlled private companies or CCPCs) eligible for SR&ED tax credits specifically, self-funding via below-market salaries can be very negative because R&D tax credits can only recognize costs actually incurred, not notional market salaries. Therefore when all the factors are considered, including rules such as the “proxy bump” (an SR&ED allowance for overhead costs that may have the effect of increasing claimable costs related to salaries of non-specified shareholders) and the numbers crunched, paying below-market salaries for research and development may actually leave the owners of a CCPC in a worse position than if full market rates had been paid. TSGI can guide your company through these and other complexities and apparent contradictions of the SR&ED program.