R&D Finance 101

Stocks get hammered for missing financial projections by even 1 penny. Why? Because everyone knows that there's a game going on where the corporation can reserve or reveal earnings from period-to-period in order to give the appearance of smooth earnings growth. I can delay maintenance on equipment or buildings. I can push customers to take delivery of product as we approach year end. I can renegotiate long term debt to capitalized debt payments. Financial departments have a robust bag 'o tricks that allow them to reliably push forward or push back earnings from period to period.

Everyone wants predictability in earnings, so that financial projections can be reliably made. If you miss the projection by any amount, even 1 cent, then Wall Street knows you've tapped out all your reserves and there's an even larger unfavorable surprise soon to follow in the next earnings projection.

This is important for discontinuous discovery+, where the earnings are by definition discontinuous. We need a steady stream of cash to pursue  discontinuous earnings. The game requires continuous earnings, and if you don't play the game well then you don't secure funding needed for R&D. R&D departments find themselves subject to arbitrary across-the-board cost cutting exercises as part of the earnings game.

This calls for a very strong expertise in finance within the R&D governance function. The chief financial officer of R&D must be able to play the game within the confines of his or her R&D budgetary authority. Below are a few of the financial lessons learned from entities outside of industrial R&D:

  • Set up all R&D initiatives so they request only the funds they really need. Leverage the insights of Other People's Money+
  • Don't bleed all R&D initiatives during arbitrary cost-cutting exercises, asking teams to sacrifice for the greater good. Sacrifice entire initiatives or none at all.
  • Be much more aggressive in converting expenses (a debit) to investments (a debit). Cash out the door too often is viewed in R&D as an expense, when it could just as easily be converted into equity in an investment (which doesn't affect corporate earnings). See the 30-70 rule.

Industrial R&D needs to much more viewed as investments into R&D. Well-structured, it shouldn't matter where the ownership resides (internal or external). All that matters is that a successful blockbuster+ hunt when it happens, redounds to the benefit of the funding agent+, that is, the corporation.