Guide to US Payroll Funding for Staffing Firms

Guide to US Payroll Funding for Staffing Firms
April 21, 2024

If you have successfully launched a contract staffing firm in the US, congratulations, you now have a funding problem. Payroll for temporary employees in the US generally runs biweekly or weekly as required by law, but the vast majority of US staffing clients expect to pay in 30 to 60 days, with larger clients paying in 90 to 120 days. Here is some simple math: if you are spending $100,000 a week in payroll and clients pay in six weeks, you will need at least $600,000 in funding to cover payroll, not including internal team salaries and other costs. At any reasonable level of growth, you will need substantial working capital.

In this guide, we will cover the top three ways staffing companies fund payroll in the US: invoice factoring, employer of record, and asset-based lending. There are other methods, such as equity capital or ordinary term loans, but these will not apply to most staffing firms.

Invoice Factoring

Many recruitment firms that start out in the US will use invoice factoring. In the UK, invoice factoring might be called “invoice funding” or “invoice discounting.” Factoring companies are usually standalone firms, not banks, although some banks will have a capital finance division that does factoring for larger firms. Some factoring firms will focus on the staffing market, but others are more generic and serve industries like trucking, consulting, construction, and government contracting. Staffing makes up more than a third of the entire factoring market, so finding a factoring company with staffing experience will not be a problem.

How Factoring Works

Factoring works similarly to regular lending. You have assets (your client invoices, or “accounts receivable”), and the factoring company will advance you money on those invoices for a small fee. Technically, the factoring company is “buying” the invoice from you, hence why most factors are not regulated as lenders. Practically, the process works like this: You run payroll and invoice your client. The client agrees to pay in 30 days (“net 30”). The factoring company agrees to buy the invoice for a fee. The factor will then advance you part of the money for the invoice (usually 80-90%, which is called the “advance rate”). The remainder of the money will be held back until the client pays. Once the client pays, the factor will release the held-back amount less their fee.

Factoring companies control their risk by making sure your clients know the factor owns your invoices by sending them notification of assignment at the beginning of your engagement with a new client. They also mandate that the clients pay funds directly to the factoring company’s bank. Clients in the US are used to this arrangement, so it will not seem strange to them.

Factoring Pricing

Factoring fees can be structured in several ways. Sometimes, it will be fixed based on a percentage of the invoice (2-3% is common). Other times it will be based on a daily percentage fee (“daily rate”) on the outstanding advanced funds (approximating 2-3% of the invoice value if clients pay in 30 days). There may be other fees such as a “collateral monitoring” fee or an “origination” fee when the invoice is first sold (usually .5% to 1% of invoices). Each rung of the factoring market will have different pricing and different facility sizes. At the low end of the market, you could be paying prime rate + 15%, and at the upper end, close to prime + 5%, not counting other fees. [the “Prime Rate” is the current rate in the US that lenders lend to the most creditworthy corporate borrowers and is generally a few percentage points higher than the central bank interest rate, the fed funds rate].

The key thing to note is that the more complicated the fee structure is, the harder it will be for you to compare their rates with others. They may have a low daily rate but a high origination fee. Or, they may have a very low advance rate but a low fee rate on the invoice. A low advance rate effectively increases the factor's return, because they have less capital at risk (due to the remaining, non-advanced invoice amount that acts as a safeguard). Conversely, some factors may have a “100%” advance rate (more common in the UK), but there are often very high fees to go along with this teaser rate, along with extremely strict client credit limits and other non-obvious costs.

Factoring Company Practices

Factoring firms will generally work with very small and new firms, and the reason they can do this is because they are underwriting the credit risk of your clients, not your firm. This has some pretty big implications. Generally, they will run credit on every client and set a credit limit for each client. These will be strict, and they will not buy invoices after the credit limit is hit. Sometimes they will raise these amounts if you are able to get trade credit insurance with higher limits than their credit limit, but generally, their limits will be on par with the insurance agencies. Since factoring runs on the underlying invoices, factoring firms will need a copy of every invoice you generate, and you will need to upload them weekly to a portal the factoring firm will have.

Factoring firms will often let you receive up to $3,000,000 in total funding, but this varies across firms. Remember this is the total balance advanced, but each client will have defined, sometimes very low limits ($5,000 or lower).To put the $3M limit in perspective, under normal conditions, $3M in accounts receivable might be $12M in sales, depending on how quickly your clients pay.

There are some important considerations when using a factoring company that are not obvious to first-time users. Factoring companies will remove invoices from your eligible invoice base if they become older than 60-90 days past due (this is sometimes called “Aging Out”). For example, if you have $100,000 in invoices and can borrow $90,000 (90% of the $100,000), if a $10,000 invoice goes over 60 days past due, your eligible invoices would go down to $90,000, and your funding availability would go down to $81,000 (90% of $90,000). You will need to keep track of your invoice aging to manage this risk.

Related to aging out is something called “cross aging”. This means that if a certain percentage (usually 50%) of a client’s invoices go past 60-90 days overdue, then all of that client’s invoices will become ineligible (even the non-overdue invoices). This means your borrowing availability can evaporate extremely quickly. Invoice factors will also generally enforce maximum client concentrations below 15%. That means that they will not fund a client who becomes more than 15% of your total accounts receivable balance.

The worst part about these funding terms and conditions: they may not (and likely will not) be in your contract. Typically, factoring companies will have “sole discretion” terms built into their contracts, which means they can retroactively add cross-aging and other criteria, or worse, they can outright refuse to continue funding you if they feel the risk is too high.

Potentially the riskiest part of invoice factoring is that you will be required to sign a personal guaranty if you are a significant owner of your staffing firm (over 25% ownership). This means that if, for some reason, your clients refuse to pay and the factoring company does not receive their funds back, they will ultimately come after your personal assets. The likelihood of this is low in staffing (credit loss is below 1% of staffing market sales), but it’s a real, albeit small, risk.

Employer of Record Funding

An alternative to invoicing factoring is to use an Employer of Record (EOR) that offers payroll funding. An Employer of Record is a company that becomes the legal employer of your staffing workers, handling payroll, onboarding, and other compliance matters. Most EORs only handle payroll and employment, and you are responsible for covering the payroll costs as they come due.  Some EORs focusing on the staffing industry, such as Ascen, will front the payroll costs for you, before your client pays. Practically, this arrangement works the same as invoice factoring. You will be able to meet payroll plus costs each week, and clients will send money directly to the EOR. Structurally, it’s different, however, since the EOR is not advancing funds to your bank and is instead covering payroll from its own account.

Like a factoring company, the EOR will have a credit limit for each client, and your end client will know about the relationship. Generally, funding EORs do not have cross-aging or concentration limits in the way factoring companies do.

Using an EOR for funding has some advantages since it will ensure payroll rules are being followed, and you will not need to handle invoice posting and cash flow management the same way you would with an invoice factoring company. Since the EOR is not technically a lender, they will not have a lien on your assets and will not require a personal guaranty. If you are worried about losing your house or other assets due to business failure, you should use an EOR, and not a factoring company.

Asset-based Lending

At around $4-5M in accounts receivable and sometimes lower, you will graduate to Asset-Based Lending (ABL). Here, you will start to see banks more in the mix of providers, but there will still be standalone firms. The standalone firms will typically allow lower balances, especially if they are focused on the staffing industry. Access Capital is an example of one of those firms.

Generally, Asset-Based Lending is better in every way versus factoring (pricing, structure, notification, logistics), but ABLs will have much stricter underwriting standards. They will often require “reviewed” financial statements, which are similar to audited financials but without the transfer of liability to the accounting firm. Reviewed financials are expensive to prepare ($25,000 to $50,000 from an accounting firm). ABLs will also look into the background and operations of the business in greater detail than a factoring company during their due diligence investigation.

Asset-based lending is similar to invoice factoring in that the lender will advance usually up to 90% of the invoice value. However, ABLs will have more freedom to work with non-standard situations compared to factoring firms. They may be willing to fund more than 90% of invoices in certain situations, or they may fund permanent recruitment fee (“direct hire”) invoices. The reason they can do this is that they are taking a more holistic view of your company and assets. The downside is that you will likely have financial covenants, such as profitability ratios and other lending ratios, that would never exist in a factoring relationship. Aging limits, credit concentration limits, and cross-aging limits will still apply in an ABL facility.

Another benefit of an ABL facility is that typically client funds will be directed to your own bank. The ABL firm will have what’s called a “Deposit Account Control Agreement” or “DACA” on your bank account, so you won’t be able to access these funds, but this is better than having your clients send money to another entity’s bank account. Unlike factoring companies, the ABL will not contact your clients to notify them about the lending relationship. They may occasionally verify collateral values through an accounting firm, but this is meant to be non-invasive in a way that is opposite to the practices of typical “full notification factoring”.

ABLs will not need a copy of every invoice but rely on reporting when advances are requested. The tradeoff is that you will need more financial expertise and will likely need an internal or external controller to maintain your books. You will also be required to do monthly financial reporting.

ABL Pricing

ABL fees are substantially cheaper than factoring. Typically, ABLs will price below prime plus 4%, but sometimes they will price based on SOFR (the rate that replaced LIBOR). There may be a collateral monitoring fee, but these will be low (.25% to .5% of invoice values). ABL facilities can become very large. $25 million in funding is a common upper limit for standalone ABL firms, but money center banks can go much larger. Note, though, that a $25M borrowing base will put you over $100M in sales and within the top 200 staffing firms in the US. One thing to note about borrowing limits is that ABL firms will start out with a funding limit that fits your medium-term growth, but they will raise the limit as you grow. Remember, they are in the business of lending money, so they want to increase the limit. This just requires a small amendment to your contract, so do not let it hold up negotiations at the onset due to what looks like a low limit. Factoring firms will also raise your total limit, but they will have fundamental size limitations that ABLs will not.

Where to start

Financing is a never-ending process for companies, so where you start is not where you will end up if you are growing. Asset-based lenders will be your best bet once you approach $5M in receivables. At the onset, however, choosing between a factoring company and an employer of record comes down to several considerations. If you are a new firm without much compliance and financial team in the US, an employer of record funder will likely be the smartest option due to the efficiencies you will receive by using one firm for back office, employment, and funding, with financing costs that are comparable to factoring companies. Factoring companies may be a good choice if you are confident in your ability to manage risk and you have other structural reasons for wanting to be the underlying employer. The key to remember is that it’s not all about price. Deal structure, your company’s internal capabilities, and fundamental risks are key considerations on your funding journey in the US staffing market. Either way, the goal is to get your mind off money and back on your candidates and clients.

Guide to US Payroll Funding for Staffing Firms

Guide to US Payroll Funding for Staffing Firms


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