Pumping up your research arm.

• Author: Shanley, Richard P.
• Position: Funding R&D costs

Had it up to there with trying to raise R&D capital? Then consider using SPARCs and SWORDs, an innovative financing technique that may be just the ticket for your company.

Is R&D starting to sound like "risk and danger" for your company? Financing product research and development has always been a dilemma for financial executives of publicly held companies. All public companies feel the pressure from Wall Street and shareholders to show short-term profits, but the cost of bringing a new product to market is enormous. Investing millions in a speculative product or service that requires protracted development can punish a firm's operating statement. Of course, the company could simply issue new stock, but diluting the stock price would make investors grumble.

The challenge has become finding a way to raise and spend R&D money without showing annual losses on the books for research costs. That's why financial executives in many industries are exploring the possibilities of special-purpose accelerated-research corporations (SPARCs) and stock-and-warrant offerings for research and development (SWORDs) -- an avenue once taken only by high-tech firms in the biotech, pharmaceutical and electronics industries.

The SPARC/SWORD concept has its roots in Silicon Valley, where electronics and computer companies were spending enormous amounts of money developing new technology alongside their commercially proven core products. The answer was to spin off their R&D activities into partnerships in which limited partners put up the money for the underlying company to continue developing the technology. The partnership was almost certain to sustain a big loss, but that was unimportant because the tax laws allowed the partners to use the loss to offset other income.

Then, in 1982, Genentech Clinical Partners became the first biotech company to set up a research limited partnership specifically to fund its R&D with an off-the-books technique. The concept is still used today, but changes in the tax laws in 1986 limiting the use of passive losses to offset other income made it much less appealing to investors.

CAN'T START A FIRE WITHOUT A SPARC

It took nearly three years for the biotech industry to come up with the SPARC/SWORD solution to those tax-law changes. With this technique, a freestanding corporation (SPARC) makes an initial public offering of its stock, which is subsequently traded on one of the exchanges or on the over-the-counter market. The entity goes...