Thinking differently about university-business research partnerships: the potential of revenue-contingent loans

Ken Baldwin
Bruce Chapman
Glenn Withers

Revenue-contingent loans for research-based start-ups could provide a sustainable model for boosting Australia’s R&D output.

25 September 2023

Of great relevance to the Australian Universities Accord review is Australia’s internationally very poor record of commercialising university research, perhaps in large part because of its underdeveloped venture capital market. As a result, few research-based start-up companies succeed in passing through the “valley of death”, the difficult point where an innovation is yet to be successful in revenue terms despite longer term promise.

We propose a different mechanism for the funding of R&D to help overcome this problem involving agreed partnerships between university researchers on the one hand and businesses on the other. Critically for public policy, the approach proposed delivers research outputs with very little net funding support required from government. But while we believe that the idea is conceptually and administratively sound, a modest and sensible further exploration would involve a pilot program that could be promoted from the University Accord review.

The potential policy solution: revenue-contingent loans

We propose the introduction of publicly-financed, revenue-contingent loans (RCLs – analogous to HECS) to help innovative companies bridge the start-up funding gap at the same time as generating revenue to be shared with the university-based originators of the research ideas. If successful, the policy will potentially offer solutions to two major public policy objectives:

  1. increasing the level of sustainable R&D coming from university/business partnerships; and
  2. providing financial incentives to universities for the commercialisation of research which do not hit the government’s bottom line.

A RCL is a debt collected from business that depends on a measure of the company’s financial health – its gross revenue, as reflected in quarterly financial statements (as required by law as part of the Business Activity Statement (BAS)). RCLs have a major advantage over company grants or tax concessions because much of the finance outlaid by the government will be returned, but only when a firm has the capacity to repay in the future based on its revenue, thus allowing greater support for and coverage of prospectively good investments. Risks for the company are minimised, in much the same way as the Higher Education Contribution Scheme (HECS) minimises the risks to students in repaying tuition costs of their university education. In both cases, careful selection mechanisms can be put in place to minimise poor investments overall.

To make sure that there are no financial difficulties for the companies assisted, the loan is not repaid until the innovating firm returns a profit, which will be particularly significant if the scheme is applied to start-ups (the commercial space in most need of government assistance). Moreover, debt being paid would be based on a percentage of the company’s annual revenue. This feature of the RCL provides insurance for the innovating firm that is not available from commercial loans. The system can be designed to incorporate subsidies, with there even being the potential for full cost recovery, or more.

A proposed model

This could work as follows:

  • Research-based projects involving agreements between universities and companies are proposed, and these are peer-reviewed by a government-appointed committee that includes both industry and research experts;
  • Successful applicants will receive government-provided funding, which takes the form of a RCL, not of a grant;
  • Expected turnover or revenue based on past revenue will determine loan limits applying to the project;
  • Loans are recovered through the BAS system, starting with a very low per cent of annual revenue (for example, 5 per cent) until the loan outlay is recovered;
  • Government subsidies are minimised because it is a loan and not a grant, and repayments could even be structured such that successful companies make a net contribution above their repayments to the cost of the scheme (this is an issue for policy design);
  • A proportion of the revenue returned from the RCL is delivered to the university research unit to encourage and help finance future university-business commercialisation research projects and their facilitation.

Risks

The risk to the government with RCL start-up loans lies in the non-repayment of debts – this needs to be addressed through careful scheme design. The two main issues of concern relate to “adverse selection” and “moral hazard”.

Adverse selection

Adverse selection in this context is posed by the firms most interested in acquiring a RCL also being those least likely to succeed and therefore repaying (i.e., with the poorest prospective projects). This is important because these are also firms with, for example, start-up plans which have not been able to be financed through other commercial or personal arrangements and thus might be relatively risky. The risks must be mitigated through several mechanisms, such as peer-reviewed vetting procedures or the agreement of a university to partner with the venture. Careful selection procedures and processes are fundamental to the success of such projects, just as for grants but without the payback.

Moral hazard

Moral hazard would arise from start-up companies acting in ways to minimise repayments. This can be addressed effectively through quarterly revenue information required by law as part of the BAS. An additional aspect of moral hazard might involve “phoenixing”, in which a debtor company illegally declares bankruptcy to avoid loan repayments and sets itself up again in the future as a different company. This can be addressed too by requiring some part of the debt obligation be shared with owners of the enterprise. And recall that payback avoidance is a much smaller problem than with grants, which have no payback obligations whatsoever. 

Expected outcomes from modelling

For different but related RCL applications, we have undertaken simple illustrative modelling of the repayment of RCLs. These exemplar calculations restricted debt levels for firms based on four different expected annual future revenue streams, ranging from $75,000 to $3,000,000, using four different loan amounts, ranging from $25,000 to $325,000. The rate of collection of the RCL was assumed to be 8 per cent of annual revenue. The results for different scenarios of future aggregate economic health showed that in all cases the aggregate recovery of the debt for the government exceeded 95 per cent by the fourth year of repayment.

Next steps

Further and fully detailed modelling associated with a pilot program is required to determine:

  • viable loan caps dependent on different expectations of future revenue;
  • the implications for repayment of the debt given different assumed rates of repayment and interest; and
  • the consequences for expected debt repayment given different scenarios for successful companies to make a net contribution to the cost of the scheme.

A pilot program would be the sensible way for the Accord process to recommend how to proceed.

Professor Ken Baldwin was the inaugural Director of the ANU Energy Change Institute, now part of the ANU Institute for Climate, Energy and Disaster Solutions, and also the founding Director of the ANU Grand Challenge: Zero-Carbon Energy for the Asia-Pacific. The main focus of his work is to help drive the energy transition, particularly for Australia’s future export industries based on renewable energy. He is a Fellow of the Australian Academy of Technology and Engineering (ATSE), the American Physical Society, the Institute of Physics (UK), the Optical Society of America and the Australian Institute of Physics.

Professor Bruce Chapman AO is Emeritus Professor of Economics at the ANU, with a PhD in Economics from Yale University and has published over 300 papers in peer-reviewed economics journals and books, and around 100 articles in media outlets, in the areas of university financing, income-contingent loans (ICL), labour market economics and the economics of crime, cricket and marriage. He was a senior economic advisor to Prime Minister Paul Keating, 1994-96, and is considered to be the main architect of the Higher Education Contribution Scheme (HECS) in 1989. The application of ICL to many areas of public policy is his main research and policy engagement. 

Professor Glenn Withers AO is an Honorary Professor at ANU and at UNSW Canberra. He has a Harvard PHD, has been President of the Academy of Social Sciences in Australia, founding CEO of Universities Australia, and Strategic Adviser to Cabinet. Earlier, he was Head of the Economic Planning Advisory Commission, an ANU Professor of Public Policy and co-founder of the Crawford School of Public Policy and he received an Order of Australia as Co-Chair of the National Population Council for developing the immigration points system for Australia. He currently chairs the Global Development Learning Network of the World Bank.

This article is based on a submission made by the authors to the Australian Universities Accord review.

Image credit: Getty Images

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