The Payroll Challenge in Staffing

Staffing companies often find themselves in need of payroll funding because of a cash flow gap. Staffing agencies must pay employees weekly or biweekly, but customers often take 30, 60, or even 90 days to pay invoices. This creates a gap between revenue and expenses, making it difficult for staffing agencies to grow and operate effectively.

What is Payroll Funding?

Payroll funding is a commercial financing solution that provides staffing firms with immediate working capital to meet payroll obligations and while waiting for customer payments. 

Payroll funding is not necessarily a product in itself, but a use case for various other products (or combination of products). Payroll funding often takes the form of invoice factoring, accounts receivable lending, or other payroll-specific lending. Some payroll funding providers offer other back-office services and human resource management, becoming one stop shop for staffing agencies. But this comes with premiums, and a staffing agency can achieve the same level of service by leveraging a Professional Employer Organization (PEO) and a financing company. It is not a one stop shop, but it is often more flexible and cost effective. We will focus on this arrangement throughout this article, specifically focusing on the factoring variation.

Additional reading: Invoice Factoring for Staffing Agencies

Who Needs Payroll Funding?

The most common reason staffing companies need payroll funding is when they service slow-paying customers. As mentioned, this creates a cash flow gap in the ordinary operations of the business, causing financial stress. A staffing agency may not have the power to negotiate with their customers for shorter payment terms, and so they are stuck carrying receivables for one to three months.

Startups and fast-growing staffing agencies could also experience a need for payroll funding, when rapid growth outstrips cash reserves. A temp agency expanding into new markets or industries, or from taking on larger clients, could result in this level of growth. The cash constraints caused by rapid growth are further exacerbated by slow-paying customers.

A staffing firm may also require payroll funding if their customers have seasonal needs. Similar to the problems faced by startups and fast-growing agencies, seasonal staffing agencies that serve fluctuating markets such as agriculture, tax preparation, or hospitality, may find the quick upswings and downswings difficult to navigate without payroll funding.

Lastly, because many temporary staffing agencies maintain lean operations, they may find it difficult to secure traditional loans, which often require hard assets, such as real estate. Rising interest rates heighten this challenge, as an agency depends almost entirely on the strength of their DSCR (Debt Service Coverage Ratio) to secure financing. These factors make payroll funding through invoice factoring one of the few options.

How Payroll Funding Works

Step-by-Step Process

Payroll funding through invoice factoring works in the following steps:

1. The staffing agency completes the work and invoices their customer.
2. The staffing agency submits the invoice to the payroll funding provider.
3. The payroll funding provider advances cash to the staffing agency (typically 80-95% of the invoice’s value).
4. The funding provider waits for customer payment, then remits the remaining balance (5-20%) to the staffing agency, minus fees (which typically fall between 1-3%).

Types of Payroll Funding

As mentioned above, payroll funding can take various forms for staffing companies:

• Invoice Factoring (Accounts Receivable Factoring): This involves selling your accounts receivable (outstanding invoices) to a factoring company for immediate cash.
• Asset-Based Lending (Invoice Financing): Asset-based lending uses accounts receivable, similar to factoring, but differs in that the lender uses the AR as collateral for a line of credit.
• Payroll Loans: Some banks will offer short-term loans to be used specifically for payroll.
• Business Lines of Credit: Some staffing firms can qualify for revolving credit to cover short-term payroll needs.

Benefits of Payroll Funding for Staffing Companies

Ensures On-Time Payroll: Payroll funding helps temporary staffing companies prevent payroll delays, which saves on costs associated with employee turnover. Further, failing to pay employees on time is a good way to damage your reputation in the industry, which can cripple your business.

Eliminates the Stress of Slow Payments: As already covered, payroll funding bridges cash flow gaps, so staffing companies no longer need to wait 30-90 days for clients to pay. Peace of mind, knowing you can meet your current obligations, can allow you to focus on growing your business, which leads to the following point.

Supports Growth and Expansion: Payroll funding allows agencies to take on more clients and contracts without cash flow constraints. AR-based payroll funding (such as factoring and asset-based lending) is flexible and scalable, growing in proportion to sales—the more invoices you generate, the more funding you are eligible to receive.

No Traditional Debt (For Factoring): With using invoice factoring for payroll funding, staffing companies don’t take on traditional debt, since factoring is not lending, but selling an asset (accounts receivable). This can help preserve balance sheet health, while providing the funding.

How to Qualify for Payroll Funding

To qualify for payroll funding (invoice factoring or asset-based lending), temp staffing agencies must ensure that their customers are creditworthy. Since many payroll funding providers advance and collect on receivables, the creditworthiness of the customer is paramount. The funding provider needs to be sure that the receivable won’t turn into bad debt.

In a similar vein, most payroll funding providers won’t fund invoices over 90 days old. If your customer’s payment terms exceed 90 days, the payroll funding provider may allow for negotiation. For example, some companies such as Honeywell and Anheuser-Busch require payment terms of 120+ days. Payroll funding providers may make exceptions for these arrangements.

For invoice factoring, the payroll funding provider will probably focus more on your customer’s credit worthiness when negotiating the deal. However, with asset-based lending, you, as the staffing agency, will need to meet higher credit standards from the payroll funding provider. If your agency had a recent loss, or balance sheet restructure, factoring may be your best option.

Choosing the Right Payroll Funding Partner

What to Look For:

• Fast Funding Process: Look for a payroll funding provider who will, on average, advance same-day or within a 24-hour period.
• High Advance Rates: 80-95% of invoice value is the general range, with 90% being standard for many funding providers.
• Competitive Rates: The rate structure depends on the type of payroll funding. If receivables factoring, a staffing agency can expect to pay 1-3% per invoice. For asset-based lending, you can expect to pay a daily rate with a prime plus APR.
• Industry Experience: Ensure your payroll funding provider is well versed in the staffing industry and understands your business model.
• Transparency: Transparency should characterize any financial partnership. You don’t want to sign up, only to be surprised by junk fees.
• Reputation: When looking for payroll funding options, it’s important to establish that the company is reputable. Working with a bank owned providers offers more safety and soundness, and is sometimes more cost effective.

Questions to Ask a Potential Payroll Funding Provider:

• Is this a factoring or lending agreement?
• If factoring, is it recourse or non-recourse factoring?
• How fast can you fund?
• What are your advance rates?
• What is the fee rate?
• Are there minimum volume requirements?
• What are the total costs including any other fees (such as wire fees, monthly minimums, and per invoice fees)?

Steps to Get Started with Payroll Funding

1. Assess your cash flow needs: How much funding do you require? Will funding your outstanding receivables meet your needs, or will you need another form of financing?
2. Research and compare providers: Find the best payroll funding partner. Submit inquiries and have conversations. Consider their reputation, pricing, experience, and transparency.
3. Choose a provider and submit your application: Once you’ve chosen a provider, submit your application and any required documentation to get approved by their underwriting team.
4. Submit invoices for approval: Once approved, submit your invoices, providing customer details.
5. Receive funding: Get an advance on approved invoices to meet your payroll.
6. Continue operations smoothly: Keep growing your business with predictable cash flow.

Further Reading: How to Start Invoice Factoring

Conclusion: Is Payroll Funding Right for Your Staffing Business?

If cash flow shortages are leading you to pass up on new contracts, or payroll shortages are leading to employee complaints and turnover, payroll funding may be the right solution. Invoice factoring is the most common form of payroll funding for staffing companies, but asset-based lending and other solutions may also be viable options. The key to success is choosing the right funding partner with transparent terms, fast approvals, and industry expertise.