AAS | Events | 14-15 February 2008

Leanna Read Leanna Read conceived and managed the spin-out of TGR BioSciences from the CRC for Tissue Growth and Repair in 2001. She is a physiologist by training, with 90 scientific papers and adjunct professorial appointments at Flinders University and the University of South Australia. Leanna has over 15 years' experience in research and commercialisation of bioactives from natural products. This includes discovery of the protective effects of TGR's milk bioactive extract in mucositis and inventorship on two of the patents that underpin this opportunity. She has been CEO of successful research and commercial ventures, including the Child Health Research Institute and the CRC for Tissue Growth and Repair. Leanna has been appointed to the boards of national bodies including the Prime Minister's Science, Engineering and Innovation Council, the Federal Industry R&D Board, and South Australia’s Economic Development Board, as well as her appointment as Fellow of the Australian Academy of Technological Sciences and Engineering. She has received a number of prestigious awards including a Flinders University Convocation Medal and Doctor of the University of SA, as well as the inaugural Industry Service Award by the Australian Biotechnology Association and the 2006 South Australian of the Year in the Category of Science and Technology.

I must admit I was rather surprised when I was asked to talk on this. I didn't want to call it Finance for beginners, because I know you are not beginners and you probably know a lot more than you give yourselves credit for. And you are actually science leaders, and I would like to talk in the context of what science leaders do need to know about finance.

Someone said to me that really all you need to know is how much is going to come in, how much you are going to spend, and how much is left over. That is true, but I actually think there is quite a bit more: there is a lot you can do in planning for the future that is much broader than that.

You probably think, 'Well, she would understand finances, wouldn't she!' notwithstanding my background. Here I am now, at the dark suit end of town, in the company, and living and breathing money – and with the odd bottle of Grange. So of course I would understand finance.

But why should this creature understand finance to that extent? Is it important or is that my past role and you don't really need to know it?

Well, the conclusion I would hope I can bring you to is that, while it is a bit different being in a company – there are clearly some different drivers – some of you will end up in companies anyway, but also there is a lot that is in common as between companies and research organisations and probably a lot more in common than we give credit for. So let me take you through that.

As Graham Farquhar said, when I started up the Child Health Research Institute I was relatively young, about 34 years old. It was a new research institute in Adelaide, totally empty, and had to build up. So clearly I had to understand finances, but I had no idea and when they started talking about the finances and whatever I did literally ask the question, 'What is a balance sheet?'

I do think it is easy to take on finance. It is much easier to learn finance than it is to learn science, and I definitely have no finance qualifications. It may be useful for you to gain some sort of formal finance qualifications, but I think you also learn a lot simply by realising it is important and therefore learning by observation, and probably not glazing over quite so much when you see finance data.

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Not surprisingly from what I am saying, it is definitely not the formal training that is absolutely crucial. Some of you may recognise these people. Their names are well known in Australian society. They all have been or are CEOs in the top 15 Australian companies on the Australian Stock Exchange. Between them, those companies control about one-quarter of the wealth of this country.

What is common to those six individuals is that they are all science or engineering trained, and very few of them have any finance training. I think a couple might have MBAs, but that is all. A couple have other qualifications – clearly Ziggy Switkowski has a PhD. So these people are scientists, and they have gone into positions, for example in Wesfarmers, which probably have very little now to do with their science. These people must have a good understanding, a lot better understanding of finance than I would have, and they have come to it from a science background, not with formal training.

I want to take you through the key issues in a very basic sense.

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I think it is considered different in research organisations from the way it is in companies – this is a bit of a generalisation, if you will forgive me – but certainly the purpose of funding in companies and research institutes is quite different. The concept is that you want to get funding in and then you think about spending it. You are spending it to do good work and you want to plan it and use that funding very carefully. But in a company you think not just, 'I've got a dollar in. How do I spend it for good work?' You have got to think about how you are going to turn one dollar into four. There are two sides to that equation in a company.

Actually, that is one of the things that first hit me when I became CEO of a company. I suddenly thought, 'This is actually quite different. I can't just think about how I spend money; I have got to say, 'If I spend a dollar, how is it going to be four in five years' time?' In research institutions you don't have quite that dilemma, but when you think about it, actually in some respects you do: you still want to grow what you're doing, and the more you can do that, the better you are.

Planning ahead is crucial, and I will get to that later. You would hope that everybody thinks long-term, but it is very easy to fall into the trap in the research environment of thinking grant horizons, and perhaps to be led by what is in a grant opportunity versus what you really want to do for your strategic plan. But I think if you go and hear top people give talks at conferences – if you have heard Bob Williamson or Philip Kuchel talk – you will find that what they tell is a whole story. It is a whole picture of, 'How I went from A to B,' and looks at a whole range of aspects of that. You can see the integration of that story.

Planning ahead on a financial basis has to be achieved to be able to make that story possible. You do not do it by being a reactive grant applicant. Clearly in a company you have to think long-term. We apply for grants; in industry we are in the process of applying for a commercial ready grant. And I stress to my people when they are doing that, 'Don't you dare put one experiment in that grant application that you would not do otherwise.' I think if you take that as a good philosophy, you'll be putting yourself right for this long-term thinking.

Untied funding is probably given inadequate consideration in the research sector, as I will come to later. But really it is the Holy Grail of having flexibility and being able to plan long-term, not grant horizons.

Cash and accrual: you tend to work on a cash basis, 'How much is in my account that the university is telling me about?' whereas industry has to use both accrual and cash. I will tell you later in a brief way why you should be thinking of accrual as well.

Balance sheet: we don't really think about those issues, but again I will come back and say they are important to you.

And there are those horrible 'unreal' costs that you curse your administration for: infrastructure, depreciation and so forth.

I would like to finish this consideration with a little bit on technology valuations, really for the times when you are going to be working, potentially, with commercial partners.

Why are planning ahead and untied funding important? Untied funding is crucial to planning ahead, because grants, as you know, are tied: 'I can only employ this research assistant,' or, 'I can only use these consumables.'

How do you then get flexibility? Suppose Moira Clay has come to apply for a job for you, but she says, 'Well, I've got my fellowship but what are you going to do when my fellowship is finished?' How are you going to be able to keep good people on and build a sustainable group? I think that institutionally universities, hospitals and so forth will often think a bit along the lines, 'Well, the key leader of a research area goes so we tear that down and we start again.' It would often be better to be able to be sustainable long-term.

And there is the issue of being proactive rather than reactive, so that you are not thinking grant horizons; you are thinking, 'How can I build this new opportunity, ready for the next one?' and so forth.

Redundancies: if you have got a grant, you say, 'I'll employ my research assistant for the length of that grant,' but nowadays if you are on more than a couple of grants you are actually going to be considered permanent employees, and you are going to have redundancy issues that you are going to have to factor in to funding. And your research institution won't always come along to help out.

To turn to a very brief lesson in finances, let's consider accrual versus cash accounting, and balance sheets. Why isn't cash accounting good enough? Why is it that you need to know more than simply what is left in your account?

I will do this by using an example of cash flow that you might do. (This is a quarter-by-quarter analysis.) Let's say, for example, that in your group/department/whatever you start the year with $1 million in cash. In the first quarter you get in a lumpy amount of funding, as you always do in research – this is probably a fairly health research group. But you are fairly good about how you spend, so you have a fairly consistent spend pattern: you are spending $2 million, going out each quarter. So at the end of the year that looks pretty good. You started the year with $1 million in the bank and you are ending the year with $5 million. So you have done well. You've planned, you've got your funding up, you're in a good position.

However, there is that postdoc in your group who has thought, 'Gee, it's come to the end of the year. I'd better spend up – we've got all this money left over.' So what happens actually on income/expenditure? Well, the problem with cash is that those extra consumables or whatever that your postdoc has purchased have not come through the system yet, so although you think you have got $5 million, actually what it may be is that you have the same income coming in but if this postdoc has come along and spent $7 million in the last week of the financial year, I'm sorry but you're insolvent.

So you can't afford simply to base it on cash. You have to actually know, in a way, what your commitments are that have not shown up in your cash account at this point.

That can be positive and negative. You may have more than you think you've got, or you may have less, because what income/expenditure does and what 'accrual' means is that it puts the money where it actually is appropriate. So if you are going to spend it in that final quarter, it will show there, even if you haven't actually committed the dollars at that point.

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You might say to yourself, 'Okay, I'll scrap cash accounting. I'm going to tell my university that we're going right across to accrual accounting and it's all going to be income/expenditure.' That ain't enough either, because there is this thing called 'balance sheet' – which is just a list of your assets and liabilities. (Assets are things that you own, like equipment and so forth. Liabilities are the things that you owe.)

If we take, for example, an income/expenditure similar to what I have just shown you, but rather than $7 million you have spent up a bit in that last quarter but you know about it, because you've got good monitoring systems, so you are still nicely better off than you were at the start of the year.

However, there are these things called 'balance sheet items', and equipment is one of those. So if you actually get an income/expenditure statement, equipment is not considered expenditure – which seems a bit weird. It will show on the cash, but it is not expenditure. Why is it not expenditure? That is because expenditure is considered to be what you have actually used of an asset.

So, if you have got a computer which is going to have a life of two to three years, and you have had that computer for one year, then you say you have actually used one of the years of its life. So that one year of the cost is expenditure, the rest is a balance sheet item. It is still an asset. That doesn't necessarily make a lot of sense, but the bottom line for you is that there are items in income/expenditure that do not even show on that. So I am sorry but you're insolvent again. You've bought up some fantastic new piece of equipment for $6 million – perhaps you've gone out and ordered a synchrotron or something, who knows – and you're insolvent again.

These are the sorts of reasons that you need to take all these things into account. You don't have to have a good understanding of the intricacies of how you do them, but the basic things of what is meant by cash, what is meant by the income/expenditure and what is meant by the balance sheet are pretty fundamental things for you to understand. And I am sure many of you have had experience with your institutional financial services, and I'll bet that many people here in the room would say they are frustrated by the financial information they get.

Unfortunately, research institutions are pretty basic. When we started up the Child Health Research Institute, the hospital did the finances. (I am sure Bob would have had a similar situation.) It was so totally incomprehensible, and things were there that you had no idea what they were saying, it was so complex that it meant absolutely nothing and so we ended up having to do it ourselves. Even if you can't do it yourself, it is important to understand a bit better what information is being provided to you.

Someone who does understand finance mentioned this example to me the other day: suddenly a line appeared as an expenditure against her cost centre. She read this, thought, 'Well, I don't know what this is,' and went and asked them. They said, 'Oh, we didn't know who spent that, so we just put a bit across everybody's cost centre.' She could pick it up; others might not. So it is that sort of stuff that you really want to be able to pick up.

Why are depreciation, infrastructure and overhead costs important?

I remember this quote extremely well from early in the days of the Child Health Research Institute, because research institutes are independently funded and struggle to meet the indirect costs. That is the major problem. They probably are getting now, but at that stage did not get the RQF [Research Quality Framework] type funding through DEST [Department of Education, Science and Training], so that they would never get infrastructure funding associated with a grant. John Shine was struggling at that stage with the Garvan Institute, and he said, 'I cannot afford a more prestigious grant, because it only pays the direct costs. But these indirect costs are very real.'

So when you are thinking about income/expenditure or cash and so forth, thinking about what are the costs of doing research, clearly you are thinking about your direct costs: the costs of your research assistants or your consumables. Maybe you are thinking about marketing. I'll bet you are not thinking about a lot of these other things that are there. In fact, you probably think it is rather insulting that your institution wants to lay a few of those on you and take something away from those grants that you get, to fund these things.

For example, with depreciation, you might think, 'I've still got that computer sitting in front of me. How come I'm showing depreciation against it?' Well, the fact is that that computer is breaking down. Whether or not it is still sitting there at the end of three years, the fact is that you'd never use it again because it's too out of date. So it is gone, in effect. And you have to think about that for depreciation, if for no other reason than (thinking long-term again): how are you going to replace all this equipment and infrastructure that is crucial for you to do your research – as well as things like support services, libraries and whatever that the whole institution has to worry about?

Leave provision is quite important as well.

Depreciation, infrastructure and overhead costs are important for a range of reasons. You want to replace ageing equipment. Staff is important, because if you have got staff on contracts, accrued leave is relevant. The staff may have to finish working before their contract is actually up, because they've got leave to take, and your institution will not allow you to go past that grant period or they will be paying for it. And, remember, if you have got more than a couple of grants those people will probably be permanent and there will be a redundancy on top of that as well.

The other reason is that it is very important that you as research leaders have a good understanding of the true costs of doing research. It is very hard to get that. When we were doing our CRC application, we had this 'overhead' issue. Any of you who are involved with that will always come up against, 'What do institutions charge in overheads?' Being in a small institute, it was quite easy for us to actually work out a true cost of that overhead. Effectively, at that stage – this is back a decade or so – it was about 80 per cent of any scientific salary, on average, be that a technician through to a senior person. So every time you employed a person it took 80 per cent of their salary to service that, and that was in a very defined research institute – no libraries, none of this sort of stuff. Other organisations that will remain nameless tended to say, 'No, no, ours is three times multipliers,' and we said, 'Yeah, yeah, you want to fund your yachts and whatever else.' The company GroPep knew very much what their overheads were, and we used those. But they were very real costs. If you want to keep your research unit and organisation viable, it is important that you understand what those things are.

The other aspect is that you are going to be at some point, if not now, working with industry. Someone is going to come along and say, 'I really need your expertise. Let's do a bit of collaborative work or contract research.' Now, if it is contract research you should be charging at the very least the full costs of that research. Why should you subsidise one of that dark suit end of town like me, coming in to want to use your expertise for research? You may even want to charge a profit. If you don't actually understand the full amount it costs to do research, there is a fair chance you might underdo yourself, and I think a lot of researchers do. (I shouldn't say that, because I will probably be approaching you for research. But it's true.) So it is very important to understand that.

How do you value your technology when you are going in to discuss a licence agreement, for example, or even spinning-out a company? These are intangibles – it is very hard. You might have some formal intellectual property there, but even that is not easy to value. It is what is in your head; it is your knowledge, your know-how. Certainly intangibles are not usually included in financial statements, and in fact it is a problem when they are, so it is not something that occurs that you can read off a finance sheet. But it is still very important and I think it is very useful for you to at least have a basic understanding of this, because it can be contentious otherwise.

If I come to you as a company and say, 'Well, I think your technology is worth $200,000,' or something, and you are saying, 'But you're going to make $100 million out of it. My technology is worth $50 million,' there is a disconnect there. It is useful to you to understand how people come to an understanding and agreement on what a technology is worth. So it is worth finding out a little bit of the methods that are used to value technology. It is not easy, there is no straightforward way, because often it is very early and you're not making money out of it yet, so you can't really predict. But there are various ways to do it, and it is worth having a little knowledge there.

It is also, I guess, a reality check to ask: what does industry, what do investors attribute to technology as a percentage value in the whole product development proposition? And it is often pretty sobering.

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I am in an angel investment conference in Canberra at the same time as this. Being a business angel is another one of my hats, so we invest in and mentor young companies. A US angel put this up, talking about what credit, when they look at a deal, they give to the different stages. (They would be thinking of an investee company here, but the point applies to you as well.) The important point to note here is that the product concept and technology are only 15 per cent of what they consider is the value of the total proposition. Why are they doing that? It is because at the end of the day they will say that it's the people who are running the company, making it work, taking it to market, the management issue, that they put most credit into, along with a range of other things that you can see listed there.

So if you go into a deal with a venture capitalist and say, 'I've even done some animal trials. I know this stuff is going to work,' they are going to have a very different view of life from yours. And unfortunately, whether you consider it reasonable or not, what we are talking about here is dealing with the real-life marketplace and what is in the market. And it is not simply for you at a technology level. As a very quick example: one of the products that my company has on the market is assay kits. They are cellular pathway screening kits for high-throughput screening in cell culture. This has taken cell culture to a new height from when I used to do it. Those of you who do tissue culture, for example, would be using a tissue culture dish of a certain size. We would have 24 wells in that. The pharmaceutical industry uses cell culture but we now have tissue culture dishes with 1536 wells in them, so we're down to a couple of microlitres per well. If you grow cells in there you have to do entire cell-based screening assays in this – no washing steps possible. Anyway, that's what our assay kits do.

We sell those kits internationally to probably all major pharma companies now, and we do that through PerkinElmer, a company many of you would probably know. We do it on consignment, which means PerkinElmer never actually has to buy the kits. We just ship them over to Boston, they hold them there and they go out and sell them to their pharmaceutical clients. That may seem like, 'Well, they're not doing a lot. We've taken all the risks, developed all the technology, to produce a manufacture kit in Adelaide and ship it over to Boston, and they get such-and-such a percentage of every sale.' If they get that percentage for that bit, when you go back through the chain you can see why it is a tough ask when you go into these things. Understanding this is, I think, really important for you, because if you're not now you will increasingly be having negotiations with industry, and the more savvy you are about it, the more you can negotiate – as Moira would say – a good deal, a good win-win.

There are a number of traps when you are actually looking at finance sheets that you might want to consider. They are these big undefined items. For example, someone just puts 'Other' on some line. Well, what is an 'Other?' If 'Other' is a tiddly little amount of the expenditure, fine, but if 'Other' is 30 per cent of the expenditure you have got a bit of a worry. Or there may be this lovely item called 'Balancing item', which probably meant the accountant couldn't make it add up so they put something else in there to make it add up.

Sometimes people can hide things and not even have them in the formal finance sheets. There are all these 'Notes' to finance sheets, and you go to Note 360 and suddenly there is some whammy in there. So there are a lot of ways that the financial community can manipulate this. Probably a major example is Enron – you may remember the Enron disaster a while back. That happened because Enron chose to value these 'intangibles', and what they actually did was to say, 'We've got some potential sales. We are going to put them on the balance sheet or the profit/loss at the market value. We're going to value them in our balance sheet at the market value.' What they forgot to do when the market went down – assuming they really did forget – was to decrease their value. So it looked as if they were a lot healthier than they were, and even their own board appeared to be fooled by that.

So there are some real traps in finance sheets. I don't think that particularly concerns you. I think what you want to do is to find a way to learn the basics – you don't have to do a formal course but if you wish to, there are a number of short courses that you can do, offered by a range of organisations, that will give you the basics of it. Now that you are at that time of having to really plan your own finances and those of a group, it will probably be more relevant to you and perhaps you will actually find it not totally tedious.

It is also very important for you, if you are managing a research group, to establish some systems by which you can avoid that problem I showed on the first cash flow sheet. That is, you know what your group is doing in ordering, well before it ever appears on an actual formal statement back from your institution, because that can take months. I can assure you that the slowest people that we have who are sending us bills are universities. They sometimes haven't invoiced us for a year. So there is a reasonable chance that your finance system is not invoicing the things that you have actually committed to, and you won't know about it. You have to do that internally: within your own group have a system to monitor what you have actually committed to. That is perhaps the most crucial message I can give today.

Also, it may be impossible, but you should press your organisation to find you the necessary information. Don't accept not having it, just say, 'I've got to have some useful information financially that I can use to manage my research and my future planning.'

And, as I said, learn these basics of valuation.

Discussion

Sue Serjeantson: Thank you very much for that, Leanna. One of the things I'd like to mention as a hint to those present is that they also need to watch the possibility of the finance department charging for depreciation of major equipment. I have reviewed faculties that have said that they can't afford another ARC major equipment grant, because all of a sudden on their balance sheet the depreciation of that major piece of equipment is appearing as a cost. Some institutions write off the equipment, the minute it comes through the door, so there is no reason – if this is happening to you – for you not to go to your finance department and argue the case for it to be written off from day one.

Bob Williamson: Thanks, Leanna. When I got a chair, over 30 years ago, at Imperial College, the first piece of advice I got from one of my best mentors, Peter Richards, who was dean, was that the only committee you should go to in a university is the finance committee. And I went to the chief finance officer before each finance committee meeting and said, 'Philip, teach me: what should I know to understand this?' I would imagine that the majority of the career development awardees here probably will finish up in a university type of institution, and the universities are very adept at concealing all sorts of things on finance. Often you are told there is no money – what that really means is that the money has been spent on someone else and not on you, and if you master just enough finance you will be able to deal with that.

I want to follow on from Sue's point, though. One of the problems I had when I was director of the Murdoch was that I was told by one or two of the finance people on my board that we were not allowed to go against the Australian accounting norms and do exactly what you have said. I argued that it was ridiculous to do accrual accounting for depreciation of major equipment, because it didn't actually fit with a biomedical research institute. What is the position on this, Leanna? Are you allowed to do something sensible, provided you are up front about it, if it doesn't quite meet the sort of thing you would be expected to do? You can wear both hats, in a sense, having been in both sectors.

Leanna Read: I am not sure. I think things are different in a not-for-profit organisation versus a company. And there are private companies and public companies. So it is all a bit different, and I am not actually sure of the rules on that. Also, different research organisations have different charters. I remember when we were implementing the NCRIS program [National Collaborative Research Infrastructure Strategy] there were some particular problems that related to this. This goes back to the point that Sue was making, that it really did cause some problems. So it does vary by organisation, not simply by sector, but I think what Bob and Sue are saying is absolutely right: understand these things and make sure that what you are getting is sensible information, and that it is fair on what you are doing.

But I would say to you, if you were a research group you would still want to realise that depreciation is real to you, in that you do still have to replace that equipment somehow. Maybe it's because you apply for a new equipment grant, but in your planning you don't want the equipment falling down around you. In your planning for how you spend your money and what you are going to do in future, it is very important to work out how you are going to replace that infrastructure that is vital for you to do good research, whether it is your institution providing it or you are getting it through a grant.

Question (Sally Gras): As someone who has been involved in moving from academia to a biotech-type company, what sort of tips do you have for younger scientists who would like to be involved in helping Australia develop biotechnology?

Leanna Read: I actually have a whole talk I give on that, which some of my slides are a part of. It is a bit daunting to be asked how you jump from running a research group to suddenly being CEO of a company. Generally, you don't, because you wouldn't really have credibility or have learned the skills along the way. In the context of possibly moving in that direction, I guess I've always had an applied bent, I like applying research. I am in biotechnology, so clearly I started to work in it. I did a collaboration: I stuck my neck out and I went to Chiron and I asked them for some growth factors – this is a long time ago – and I thought they would give me hell and just tell me where to go, but they were wonderful. They ended up funding my research a bit, and so forth. So it was a progressive thing.

Then I was involved with a CRC, and I learnt a lot of those skills then and progressively moved along that way.

So I think it is a matter of starting to get some links with industry, whichever is the appropriate sector, and then progressively moving a little bit that way. The best thing is the power of learning by observation. You watch other people around you and you learn these things. So you don't have to go and do formal courses for business-type skills.

Graham Farquhar: It must depend on the conditions, I suppose, but what are the normal recommendations about how much you keep in reserve? You mentioned cash that you could do anything with, in various forms, versus annual expenditure.

Leanna Read: In a company, ideally we would say it would be nice to actually have two years of funding available. That's a nice rule of thumb, because it gives you enough time to regroup and think of some alternative strategies if something goes wrong. If you've only got a couple of months' funding, you are not going to be able to do that.

In fact, Bioshares, in the biotech sector, publishes a thing called the Survival Index every few months – it is the amount of cash that companies have available divided by their cash burn over the last few years. So it is virtually asking, 'How much cash do you need, and how much have you got left?' If you have got a survival index of 2, meaning two years, you are considered to be doing pretty well.

I guess what you want to do is to look at who you have to fund, particularly the staff that have to come from your funding, and think ahead. But you would certainly be trying to aim to have enough in reserve, I'd suggest, getting up to six months a year. But it is really a matter of where it fits into your funding cycles, and how you can respond, if something goes wrong, to get through that – and what other possibilities you have with your institution.

There is no particular answer. The more the merrier, basically, I guess – and particularly untied funding, so that you have the flexibility then to use it and to prop up things as needed, rather than everything being tied to a particular grant, which clearly you don't have much flexibility on.

Kurt Lambeck: But the danger of untied funding is that your superiors will see that as unused money and they will try and grab it. You have to have a reason for having it untied; you have to have it tied to a particular project, just to justify keeping it there.

Leanna Read: Yes, and that is hard. It's not always under your own control. So if you learn more about finance, you can also work out how to hide your own money!

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