Assessing Startup Staffing Agencies for Invoice Factoring: Key Factors to Consider
Factoring for any startup firm comes with a slew of challenges, but doing so for startup staffing agencies presents even more complications and potential pitfalls. Raul Esqueda of 1st Commercial Credit outlines how to navigate these types of factoring relationships to ensure success for all parties.
BY RAUL ESQUEDA, PRESIDENT, 1ST COMMERCIAL CREDIT
The demand for staffing services often entices new entrepreneurs to enter the market, seeking to capitalize on the opportunities such demand presents. These startup staffing agencies are further drawn to the potential to provide businesses with flexible and skilled talent. However, these new ventures can encounter challenges as they navigate their way into the market, including establishing a client base, effectively managing cash flow and ensuring compliance with industry regulations.
Should you be the owner or operator of a factoring company in search of a fresh financing niche, startup staffing agencies could be worth considering. Factoring companies can significantly aid these emerging staffing firms by offering immediate liquidity, enabling the startups to navigate the cash flow gap that exists between disbursing wages to their workforce and obtaining client payments, thereby enhancing their cash flow management capabilities.
There is a significant difference when it comes to factoring receivables for startup staffing agencies compared to established staffing agencies. The distinction lies in various factors that need to be considered when evaluating and engaging in factoring arrangements with each type of agency.
For startup staffing agencies, factoring companies need to carefully assess the viability and potential of the business. Factors such as the strength of the company’s business plan, the industry experience of its management team, financial projections and growth potential should play a crucial role. Startups may have limited financial history, making it essential for factoring companies to conduct thorough due diligence to understand each agency's ability to generate revenue and meet financial obligations.
In contrast, established staffing agencies usually have a track record, financial history and proven client base. Factoring companies can rely on historical data, payment trends and client relationships to assess creditworthiness and evaluate this type of agency's stability. This allows factoring companies to make more informed decisions about the risk involved and the terms of the factoring agreement.
Underwriting Hurdles in Startup Staffing Agencies
When you embark on underwriting a factoring facility for a startup staffing agency, you will likely face an increased deal flow volume and numerous "false starts" that never come to fruition. Potential clients are typically individuals currently employed at a staffing agency who are considering starting their own business, seeking a fresh start following a failed partnership, or opting for a name change to avoid liabilities associated with another company. Engaging in open and transparent discussions during the initial stages is crucial in understanding each applicant's objectives and the potential challenges that may arise during the factoring relationship.
Challenges associated with newly established startup staffing agencies may include:
Setting up initial credit for account debtors without existing agreements or transaction history
Initial concentration ramp-ups with no payment history
Existing or future merchant cash advance debt
Ensuring compliance with receivable financing and operational requirements, which may include:
o Fulfilling insurance prerequisites
o Maintaining approved timesheets to invoice
o Coordinating with a payroll company and regulatory compliance
o Determining if 1099 contractors will be allowed
o Having sufficient cash reserves for operating expenses
o Establishing corporate status for the business and maintaining good standing
o Utilizing invoicing software that accurately converts time into decimal format, mitigating the risk of errors
o Staying current with all federal and state mandated taxes
Ability to access vendor management systems for verification
The Crucial Importance of the Billing Cycle
It is crucial for staffing agencies to recognize that financing receivables, whether through a bank line of credit or a factoring company, relies on the presence of invoice assets, as they serve as the basis for securing the necessary funds. An invoice is classified as an asset when the services have been rendered, duly acknowledged by an authorized party and recognized as a payable by the accounts payable department. This definition holds significant importance in terms of credit protection and impacts the eligibility for a factoring company's bank line of credit.
In addition to solidifying invoice assets, an equally important step to factoring with a startup staffing agency is negotiating a master service agreement that enables the agency to invoice on a weekly basis. This arrangement ensures the timely replenishment of cash to meet weekly payroll obligations.
While the standard payment terms in the factoring industry typically operate on a net 30-day cycle, complications may arise when clients (debtors) request monthly invoicing along with extended payment terms of 45, 60 or 90 days. These circumstances may arise with startup staffing agencies, as they can frequently encounter a cash crunch, which makes meeting their weekly payroll commitments for a full month challenging before they can issue invoices and procure financing. Invoice factoring, on its own, often falls short when the agency is mandated to invoice monthly and concurrently requires access to extra funds for payroll within the same month.
Another potential issue that startup staffing agencies may face is the credibility of account debtors, particularly when extended payment terms are involved. It is crucial to assess the creditworthiness of account debtors to avoid situations where the staffing agency must withdraw employees due to credit limit issues.
Catalyzing Payroll Funding Solutions
As a factoring company, it is vital to be able and ready to provide staffing clients with additional funding programs beyond conventional invoice factoring, often through payroll funding. Numerous factoring companies decline such requests or face limitations due to agreements with their bank lines, preventing them from funding anything other than invoice assets.
What is the difference between payroll funding and invoice factoring? Payroll funding is specifically designed to address payroll and tax obligations of staffing agencies. In these types of arrangements, the staffing agency provides the necessary payroll information to the payroll funding company, which then advances the funds to cover the payroll and tax expenses.
Payroll funding is often used in conjunction with invoice factoring. Once the staffing agency generates invoices for the services provided to clients, the factoring company purchases those invoices at a discounted rate, providing immediate funds. The funds obtained from invoice factoring are then used to repay the advance provided for payroll and taxes by the payroll funding company.
To ensure clear accounting and prevent any confusion, it is recommended to maintain separate entities for payroll funding and invoice factoring. This separation helps to clearly distinguish between the advances made for payroll and the funds obtained from invoice factoring. By maintaining separation, it becomes easier to track and manage the funds allocated for each purpose, reducing the risk of confusion or misallocation.
Certain factoring companies have devised workarounds by providing funding for proforma invoices, which essentially serve as prebilling statements outlining the work completed up to a specific stage or the end of each week, depending on the circumstances. This approach allows for financing based on the anticipated invoices, enabling staffing agencies to access funds before the official billing is generated.
Funding proforma invoices carries risks for the factoring company, as there are various potential complications involved. Firstly, a proforma invoice lacks recognition as a formal asset and may not have obtained approval for payment. This absence of official approval introduces uncertainties regarding the ultimate collectability of the invoice. Additionally, since a proforma invoice does not fit the traditional definition of an asset, it may not meet the criteria for financing and should not be included in the portfolio drawing on the bank line if it fails to meet eligibility requirements. These factors underscore the potential risks and challenges associated with funding proforma invoices.
Additionally, funding pre-invoiced receivables can be considered an over-advance or loan to the client, potentially resulting in the factoring company being classified as a lender rather than a factor in the event of bankruptcy. This distinction is important, as it may have implications for the legal and financial standing of the factoring company. It is essential to carefully navigate these circumstances to ensure compliance with applicable regulations and mitigate any associated risks.
Industry Segments Dictate the Margins
The profit margin of a staffing agency heavily relies on the sectors it specializes in. Light industrial staffing agencies, which typically provide staffing solutions for roles such as warehouse workers, production line operators, or assembly line workers, tend to experience lower rates of return compared to other industry specializations. Additionally, they face the challenge of dealing with the highest workers' compensation insurance costs due to the nature of the work involved. In contrast, staffing agencies specializing in other sectors, such as healthcare, technology, or professional services, may enjoy higher profit margins. These sectors often command higher bill rates and require specialized skill sets, enabling agencies to charge premium fees for their services.
While industry specialization impacts profit margins, operational efficiency, cost management, client relationships and marketing strategies also contribute to overall profitability. These factors may not be proven in a startup staffing agency that is establishing its foundation and refining its practices.
Factoring companies must have a deep understanding of the dynamics, risks and requirements of the industries a startup staffing agency plans to work with to effectively serve the needs of these emerging staffing firms. By being knowledgeable and attentive to the unique challenges faced by startup staffing agencies, factoring companies can provide valuable support and help these businesses thrive in their early stages.
In conclusion, with more than 20 years of experience in providing factoring services to the staffing industry, I have successfully assisted numerous startup staffing agencies in their growth journey. Through our collaboration, we have addressed challenges, worked through difficulties and witnessed the long-term success of many of these agencies. It has been a fulfilling experience to support and nurture startups, and I look forward to continuing to serve and empower the staffing industry in the years to come.