What is Invoice Factoring for Staffing Agencies?

Many staffing agencies in the US experience the same problem: late invoice payments. Nearly 55% of invoices in the US are paid late, which can pose a significant problem for staffing agencies as it’s customary for them to pay their contract workforce weekly.

Staffing agencies can take several actions to prevent delayed invoice payments. For example, they could make their invoices due on receipt or follow up aggressively. However, it’s worth noting that a vast majority of invoices are paid late due to cash-flow issues for the company themselves, so this can often be ineffective. Moreover, setting up harsh invoice deadlines and aggressively chasing clients can harm client relationships and even lead to them refusing to pay altogether. The reality is that Days Sales Outstanding ("DSO")—the number of days it takes on average for your clients to pay invoices—will be greater than 30 days for the staffing industry, regardless of what your contractual invoice payment net terms are.

So what is the solution? 

Many staffing agencies turn to invoice factoring.

What Is Invoice Factoring? 

Invoice factoring refers to the concept of selling your unpaid invoices to a third party. A factoring company will pay you an advance for each invoice and then collect the invoice from your client directly before paying you the remaining amount. This allows staffing agencies to rapidly increase their cash flow to keep their placements paid.

How Does Invoice Factoring Work?

Invoice Factoring is the process of selling your client’s invoices to a factoring company for a fee. Factoring differs from traditional lending as the factoring company technically "buys" the invoice from you. As a result, this process is much less regulated.

However, that’s not to say that the factoring company will not do due diligence. Once a staffing agency finds an invoice factoring company they would like to work with, the first step is to clear their eligibility standards. This means an invoice factoring company will do due diligence to ensure the staffing agency is creditworthy.

As a staffing agency, it is worth it to get all the information together before applying. Factoring companies will look at your bank statements, financial statements, and company legal documents such as your Articles of Incorporation or Certificate of Formation. Most factoring companies will also look at your personal credit history.

Once the invoice factoring company approves your staffing agency, the next step is to sign a contract. This will outline all the terms of the relationship and how much of the invoice is paid upfront. In this agreement, you can also expect to receive the agreed-upon advance from each invoice, which ranges from 80%-90% (called the "Advance Rate").

Furthermore, the contract will outline any additional fees or processes your staffing agency will be expected to perform. Factoring companies often have complicated late fees, collateral monitoring fees, or origination fees in addition to their headline fees, so watch out for these in your contract.

After your contract is signed, the next step is selecting the invoices you’d like to be paid. Once the factoring company receives these, they’ll deliver your advance and begin collecting from your client. Typically, you will do this weekly by uploading invoices to the factoring company's online portal.

It’s important to remember that the Invoice Factoring company will alert your clients that payments now need to be made to them (this is called "Notice Factoring"). Given that it's relatively common for staffing companies to factor their invoices, your client's accounts payable department will not think this notice is too unusual.

When the factoring company receives the payment, it will release the rest of the invoice to you (the remainder that wasn't included in the original advance when they "bought" the invoice). Factoring companies will always receive funds directly from your client, and they will charge high fees if you redirect funds to your staffing company. They may also cancel your facility if they believe it was done intentionally.

How is Factoring Priced? 

Factoring fees are structured in several different ways. They can be priced as a fixed percentage of an invoice, normally about 2-3%. However, additional fees are often charged, including collateral monitoring and origination fees, which can be up to 1%. 

One thing to look out for is the complexity of an invoice factoring company’s pricing structure, as this can make it much more difficult to compare rates. Each factoring company can have its strong points. For example, they may offer a very low advance rate and a lower fee rate, or conversely, they may have a 100% advance rate but very high fees to accompany it as they have a higher amount of risk. 

Drawbacks of Invoice Factoring

While invoice factoring companies are a common option for staffing agencies, they do have some drawbacks. 

Unlike traditional lenders, factoring companies are often happy to work with smaller and new companies as they are underwriting your client’s credit rather than your business's. Consequently, factoring companies will often set credit limits depending on your client’s creditworthiness. This credit limit can vary greatly, with problematic clients only having $0-$2000 worth of credit per invoice. 

When engaging with invoice factoring, staffing agencies have to manage which invoices have been posted to the factoring firm, which increases back-office complexity. Since factoring firms rely on underlying invoices, you must upload invoices weekly through an in-house portal, and you will need to request funds to ensure you can cover payroll. Often, this can create liquidity issues if you do not process your invoices on time to cover payroll.

Another common problem with invoice factoring is invoices “aging out.” Typically, invoice factoring companies set limits on when an invoice is eligible for factoring, which is normally 60-90 days from the due date. If an invoice is past this window, it will be considered “aged out” and illegible for factoring. An invoice “aging out” will also result in the amount being removed from the eligible funds that an invoice factoring company is willing to give you. For example, if you are eligible for $100,000 worth of invoices and a $10,000 invoice ages out, your pool will be reduced to $90,000. If you have a large client that goes over 90 days past due, this could trigger a liquidity issue as your borrowing capacity evaporates quickly.

Moreover, you’ll need to look out for the process of “cross-aging.” This means when a certain percentage of a client’s invoices, normally 50%, age out, an invoice factoring company will consider that client completely ineligible for future borrowing.  Consequently, the amount of advances you can get decreases significantly. 

Another condition that can catch staffing agencies out is the enforcement of maximum client concentrations. An invoice factoring company will usually not fund a client over 15% of your total receivable balance.

Invoice Factoring companies often include a “sole discretion” clause in their contracts. This means they don’t have to be open about age limits or maximum client concentrations in their agreements but can enforce these rules given they have sole discretion to update credit limits and rules. As a result, invoice factoring companies can retroactively add criteria if they feel the risk has become too high.

Perhaps the worst part about invoice factoring is that all invoice factoring companies in the US will rely on some form of personal guarantee when signing with staffing companies. If a staffing agency’s clients don’t pay, the owners of the staffing agency are held personally responsible for the money. This means if your clients consistently don’t pay, the invoice factoring company can come after your personal assets, like your house.

Employer of Record Payroll Funding

Another option to get payroll funding for your staffing company is to use an Employer of Record like Ascen. Ascen functions similarly to a factoring company but does not rely on personal guarantees, concentration limits, or other fees that are typical of invoice factoring. Ascen covers your staffing payroll each week, and when clients pay 30-60 days later, Ascen releases the invoice gross profit to you. Functionally, you get the same benefits of invoice factoring but without the cash management and other risks involved in factoring.

EOR payroll funding is not for everyone, so companies like Ascen have the option for you to use an invoice factoring company if you prefer. Either way, you should be aware of the options available to fund your staffing agency.

If you’d like to see Ascen in action, please book a demo here.