Federal Grant Accounting for Biotech and Deeptech Startups: You Only Earn What You Spend

US Federal Grant Accounting for Startups

For a pre-revenue deeptech or biotech startup, a federal grant award letter feels like a lifeline. But unlike a venture capital term sheet, that award amount isn't cash in the bank; it's an authorization to spend. Understanding this distinction is the key to successfully managing accounting for federal grants in startups. Misinterpreting the rules for SBIR or STTR funding can lead to misstated financials, failed audits, and demands for repayment, putting your runway and future grant eligibility at risk. Proper accounting is not just about compliance; it is about accurate financial reporting that builds confidence with your board, investors, and the granting agency.

The Core Principle of Grant Accounting: Cost Reimbursement

The single most important principle of federal grant funding is that it is not a lump-sum payment. Instead, federal grants like SBIR/STTR operate on a cost-reimbursement basis. This means you must first spend your own capital on approved project activities and then submit for reimbursement from the government. This fundamental difference from VC funding, which provides upfront capital, dictates the entire accounting and cash flow management process for your startup.

Every dollar of grant funding you ultimately receive must be directly tied to a legitimate, documented, and allowable expense incurred after the grant's official start date. For most pre-seed startups, this reality means that managing cash flow becomes an even more critical exercise, as there is a lag between spending cash and receiving reimbursement from the government.

Recognizing Grant Revenue Under US GAAP: You Only Earn What You Spend

A common mistake for first-time grant recipients is booking the entire award amount as revenue upon receipt of the notice. This dramatically overstates your income and presents a misleading picture of your company's financial health. The correct approach is governed by US GAAP. Specifically, grant revenue recognition is guided by standard ASC 958-605, which treats grants as 'conditional contributions'.

The “condition” is that you must incur a qualifying expense to earn a portion of the revenue. Until you meet that condition, the grant award is a liability on your balance sheet, not revenue on your profit and loss statement. In practice, this is managed through a Deferred Revenue account. Consider a biotech startup awarded a $250,000 Phase I SBIR grant. Here is how the accounting works in a system like QuickBooks:

1. Award Received: The full $250,000 is recorded as a liability. You would typically create a journal entry debiting Grants Receivable and crediting a liability account named “Deferred Grant Revenue.” Your P&L shows $0 in revenue from the grant at this point.
2. Expenses Incurred: In the first month, your team incurs $30,000 in qualifying expenses: $25,000 in salaries for two scientists working on the project and $5,000 for specific lab supplies.
3. Revenue Recognition: At the end of the month, you “earn” the portion of the grant corresponding to those expenses. You make a journal entry to debit Deferred Grant Revenue for $30,000 and credit Grant Revenue (on your P&L) for $30,000. Your balance sheet now shows $220,000 remaining in Deferred Grant Revenue, and your P&L accurately reports $30,000 in earned grant income.

This process ensures your startup grant financial controls are sound and your reporting is accurate, reflecting the true performance of your business.

Classifying Costs for Reimbursement: Direct vs. Indirect Expenses

To be reimbursable, an expense must be both allowable and properly categorized as either a direct or indirect cost. The official guidelines are extensive, with the rules for allowable and unallowable costs defined in the Federal Acquisition Regulation (FAR) Part 31.

Direct Costs

Direct Costs are expenses that can be specifically and exclusively identified with the grant project. This is the easiest category to understand. Examples include:

• Salaries and wages for employees working directly on the grant-funded research.
• Materials and lab supplies purchased specifically for the project.
• Travel costs for project-related meetings or conferences, if approved in the budget.
• Equipment purchased solely for the project.

Indirect Costs

Indirect Costs, or overhead, are general business expenses necessary to operate but cannot be tied to a single project. This includes costs like rent for your lab and office space, utilities, administrative salaries, and general office supplies. The government recognizes that these costs are real and necessary, allowing you to be reimbursed for a portion of them.

Critically, FAR Part 31 also lists costs that are explicitly not reimbursable. Common unallowable costs include alcohol, entertainment, lobbying, bad debt, fines, and most advertising. Segregating these expenses in your accounting system is essential for clean reporting and a compliant indirect cost rate calculation.

Managing Direct Costs: Audit-Ready Time Tracking and Documentation

For most R&D-heavy startups, the largest direct cost is labor. This is also the area that receives the most scrutiny during an audit. Setting up an audit-proof system for tracking time is not optional. The Defense Contract Audit Agency (DCAA) sets the standard for compliant time tracking, requiring contemporaneous (daily) records. “Contemporaneous” is the key word; it means timesheets must be completed daily, not recreated from memory weeks later.

A scenario we repeatedly see is a startup failing an audit simply because their brilliant scientists filled out timesheets once a month. To avoid this, your time tracking system, whether a spreadsheet or dedicated software, must include:

• Employee Identification: Full name of the employee.
• Time Period: The specific period covered by the timesheet, such as weekly.
• Daily Log: A daily entry of hours worked, broken down by project or “cost objective.” If a scientist works 5 hours on the SBIR project and 3 hours on an internal R&D project, the timesheet must show that split.
• Brief Work Description: A short note on the tasks performed for each project.
• Signatures: Dated signatures from both the employee and their direct supervisor, certifying accuracy.

This level of detail for both time and other direct costs, like invoices for materials clearly labeled with the grant number, is fundamental to managing federal grant audits successfully.

Calculating Indirect Cost Rates for Grants: De Minimis vs. Actual

Getting reimbursed for overhead is crucial for your startup’s financial health. To do this, you must calculate an Indirect Cost Rate (ICR) and apply it to your direct costs. The formula is simple in theory: Total Allowable Indirect Costs ÷ Total Direct Costs = Your ICR. However, the process requires diligence.

For startups new to federal funding, there is a straightforward option. A 10% 'de minimis' indirect cost rate can be used on Modified Total Direct Costs (MTDC) if your startup has never had a negotiated federal indirect cost rate. MTDC is your total direct cost base after excluding certain items like equipment, capital expenditures, and the portion of any sub-award over $25,000. This is a convenient option but may leave money on the table.

In practice, we see that many biotech and deeptech startups have actual indirect rates of 30%, 40%, or even higher due to expensive lab space and other significant overhead. In these cases, calculating your actual rate is worth the effort. Consider this simplified example:

• Total Allowable Indirect Costs: $100,000 (includes $70k in rent, $20k for an admin’s salary, and $10k in utilities).
• Total Direct Costs (your base): $250,000 (includes $200k in direct research salaries and $50k in lab supplies).
• Calculated ICR: $100,000 / $250,000 = 40%.

In this case, for every $1 of direct costs you claim, you can also claim $0.40 for your overhead. If you had chosen the 10% de minimis rate, you would have only claimed $25,000 in indirect costs instead of the full $100,000 you are entitled to. This $75,000 difference is significant for any startup's runway.

Action Plan: Setting Up Your Startup's Grant Accounting System

Successfully managing federal grant accounting does not require a large finance team, just a disciplined process. For a founder using QuickBooks, here are the immediate actions to take:

1. Configure Your Chart of Accounts: Add specific accounts like “Grant Revenue,” “Deferred Grant Revenue,” and “Unallowable Expenses.” Use class or project tracking features to tag every single transaction to a specific grant or to an “Indirect” or “Internal” project.
2. Establish Daily Time Tracking Immediately: This is the number one audit failure point. Create a compliant timesheet template and enforce its daily use from day one of the grant period. The habit is more important than the tool.
3. Segregate Unallowable Costs: Instruct your team to code expenses like client entertainment or marketing to the “Unallowable Expenses” account. This makes it simple to exclude them when calculating your indirect rate.
4. Choose Your Indirect Rate Strategy: Run a quick back-of-the-envelope calculation. If your estimated rent, utilities, and admin salaries are more than 10% of your direct research costs, you should strongly consider calculating your actual rate instead of taking the de minimis.
5. Reconcile Monthly: Close your books each month and perform the journal entry to move earned revenue from your Deferred Revenue liability account to the P&L. This ensures your financials are always accurate and ready for review.

Continue at the topic hub for government grants and contract accounting.

Frequently Asked Questions

Q: Can I use SBIR/STTR grant funds to pay my own salary as a founder?A: Yes, founder salaries are an allowable direct cost, provided the compensation is reasonable for the work performed on the grant project. You must document your time on daily timesheets just like any other employee, and your salary rate should be comparable to what you might earn in the private sector for similar work.

Q: What is the main difference between a federal grant and a federal contract?A: A grant is a form of financial assistance to carry out a public purpose, where the government has limited involvement. A contract is a procurement tool to acquire goods or services for the government's direct benefit, involving significant oversight and specific deliverables. SBIR/STTR awards can be either, so check your award documents.

Q: Do I need special software for DCAA-compliant time tracking?A: No, expensive software is not required. A well-designed spreadsheet can be fully compliant as long as it captures all necessary information: employee name, daily hours broken down by project, a brief description of work, and dated signatures from the employee and supervisor. The key is consistent, daily use.

Q: What happens if my indirect costs change during the grant period?A: It is common for indirect costs to fluctuate. If you are using a negotiated indirect cost rate (NICRA), you will typically use that provisional rate for billing. At the end of the year, you calculate your actual rate. Any difference between what you billed and what you were entitled to is reconciled with the government.