Research and Development (R&D) costs are a central aspect of operations for most biotech startups, especially during the early stages of development when companies are often pre-revenue. Accurate accounting for R&D expenses is critical for compliance and can have significant tax benefits as well as financial reporting and operational implications. For example, inaccurate R&D cost reporting can create issues with tax filings or grant applications, reduce tax credits, and pose risks during audits.
However, biotech startups often overlook key components when reporting R&D costs. This often stems from insufficient attention to detail or improper cost allocation. A common issue is failing to fully capture the salaries and wages of employees directly involved in R&D activities. Other significant expenses that are frequently missed include costs for equipment, materials, third-party research services, regulatory fees, and software used in R&D efforts. As a result, reported costs are often less accurate than they should be.
Here’s why accurate accounting for R&D costs is so important for a biotech startup:
1. R&D is a Significant Expense, Even Pre-Revenue
- High Costs in Early Stages: Biotech companies tend to have a high burn rate during their development phase due to the nature of R&D, which includes clinical trials, lab research, testing, and regulatory processes. These costs often occur years before the company generates any revenue from product sales.
- Carrying R&D Expenses Forward: The good news is that in many jurisdictions, including the U.S. under GAAP and IRC Section 174, R&D expenses are deductible. If properly captured, these expenses can be carried forward to offset future taxable income. This means that accurate recording of every R&D-related expenditure is vital for future tax planning. Failing to capture R&D costs in early years could result in missed opportunities to reduce future tax liabilities once the company becomes profitable.
2. Incentives for Investors
- Attracting Investment: The ability to track and report R&D expenditures can provide confidence to potential investors about the company’s commitment to innovation and future growth.
- Tax Credits & Grants: Proper accounting and reporting of R&D expenses can help a company qualify for R&D tax credits, which are attractive to investors.
- Valuation Impact: Accurate reporting of R&D expenses and capitalization (where appropriate) can affect the company’s valuation.
3. Helps Meet Milestones
- Tracking Progress and Milestones: Biotech companies are often assessed based on their ability to meet clinical and development milestones (e.g., preclinical trials, Phase I, II, III trials, regulatory approvals). To accurately track progress, companies must have clear financial records of the R&D expenses incurred at each stage. This includes costs associated with regulatory filings, clinical testing, and clinical trial management.
- Budget Planning & Forecasting: Properly tracking R&D expenditures ensures that the company can align spending with its strategic objectives and effectively manage its cash flow. A well-documented R&D budget allows the company to prioritize resource allocation, ensuring that they remain on track to meet key development targets.
4. Supports Audit Preparation and Grant Compliance
- Audit Readiness: The process of documenting R&D expenses properly is critical for audit preparedness. Regulatory bodies, investors, and grant agencies may require verification of R&D spending, especially when it is tied to tax credits, grants, or funding.
- Grant Compliance: Many biotech startups rely on government or private grants to fund R&D activities. To ensure compliance with grant terms, the company must maintain detailed records that justify how funds were spent and the progress made.
Conclusion
Accounting for R&D costs is a critical component of financial management for biotech startups. Given the large sums spent on R&D activities, it is essential to accurately capture and allocate every eligible expense to ensure tax benefits, support investor confidence, track milestones, and ensure compliance with grants and audits.
Burkland’s team of seasoned professionals can ensure implementation of a proper accounting methodology, which includes maintaining an organized chart of accounts, understanding the classification of costs, and creating detailed documentation required for compliance and tax credit purposes. By leveraging Burkland’s expertise, biotech companies can effectively manage their R&D accounting and position themselves for long-term success. Contact us today to learn more.