Based on new study by ESMT Berlin, companies that receive research and development (R&D) credits are considerably more inclined to invest in their own R&D as well as acquire firms financed by venture capital (VC).

These results, which can be found as a working paper, are the result of research conducted by Merih Sevilir, an IWH colleague and professor of finance at ESMT Berlin, as well as William McShane, the head of the department of laws, regulations, and factor markets at the IIWH.

In addition to figuring out how R&D credits function in this market, the researchers also aimed to comprehend how established businesses contribute to the startup ecosystem.

They achieved this by utilizing data from more than 3,500 American-based businesses that over a 25-year span earned tax credits for research and development. Sevilir and McShane then examined the purchases made by these companies that obtained tax credits in order to see how they were making use of this tax benefit by using mergers and acquisitions (M&A) platforms, such as Thomson Reuters M&A data.

They discovered that these companies’ investments in M&A expenditures have an annual mean of 104.5 million USD and 115.18 million USD, respectively, which is comparable to the sample’s R&D expenditures.

Additionally, the researchers discovered that a decrease of roughly 10.6% in the predicted number of acquisitions of venture capital-backed companies is linked to a one standard deviation change in the tax-based cost of R&D capital. This demonstrates unequivocally that businesses are less inclined to buy startups if R&D taxes rise.

It’s interesting to note that larger corporations were only willing to use these tax credits to fund venture capital-backed startups, disregarding those who did not have such backing.

“For firms that receive R&D credits, much of the spending will go on human capital i.e. wages and expenses for inventors,” says Professor Sevilir. “However, there is no guarantee here that this R&D investment will prove to be cost effective or even create any new developments. For larger firms, it can make more sense to acquire a startup who is already creating an innovative product or service, and help to fund their journey, as opposed to starting from scratch on their own.”

According to the study, startups can greatly benefit from being acquired by a larger company. Since startups usually don’t have the taxable income required to qualify for tax incentives, being bought gives them a bigger financial boost that helps them expand and innovate.

Acquiring these high-performing startups, on the other hand, enables companies to expand their R&D efforts and, by leveraging an external team in addition to their own, better future prospective discoveries.

According to the study, startups who have a high need for cash but restricted access to it are greatly helped by the reallocation effect of M&A activity by established enterprises that is prompted by R&D tax credits.