I'm considering starting a temporary staffing company. I'll have to bootstrap the startup period, as my credit is marginal and I don't own real estate. Industry standard is to pay employees every week or two, but even if I bill weekly, clients don't pay for at least 30 days. With the revenue and expense cycles so out of sync, how can I finance the business to best stretch my limited working capital?
--J.G., Los Angeles
Because of the fluctuations in cash flow that you described, financing is one of the trickiest aspects of setting up a new staffing company, experts say, particularly for startup businesses lacking real estate or certificates of deposit that can be counted as collateral. However, don't let that deter you if you've got some industry experience and are determined to succeed. With the outsourcing trend growing, both in the United States and abroad, staffing agencies are seeing double-digit annual growth.
"In order to make themselves more competitive, corporations have turned employee staffing into a variable instead of a fixed cost. Outsourcing is going to be more and more in demand in the next decade as additional companies adopt the practice of flex-hiring based on seasons and trends in their industries," says Chuck Miller, president of an independent staffing network based in Boca Raton, Fla., called People 2.0.
Because the industry has changed dramatically in recent years, small staffing agencies must occupy particular niches right from the start, Miller says. "The staffing industry has become more sophisticated and complex than it once was. You're no longer in a situation where you're sending somebody out to fill a vacation slot." Do some research to determine which niche -- office services, light industrial, high-tech, professional, health care -- takes best advantage of your background, industry contacts, and location.
NO CAPITAL. You'll also want to put together realistic budget projections -- week by week -- for your first 12 months of operation, he says. "Look up all the variables, such as payroll, local tax rates, and workers' compensation insurance, so you know ahead of time what starting this business is going to cost and how much capital you'll need to do it," he advises.
Staffing firms do not have tangible inventory or assets that bankers can measure in dollar value, which makes it particularly tough for startup staffing entrepreneurs to get loans, says James S. Rothman, president of Capital TempFunds, based in Ft. Lauderdale, Fla. "Staffing, especially at a young company, tends to have significant volatility in sales and can have heavily concentrated customer exposures," he notes. "Further, the drain on cash will get worse as a company is growing -- even if it is profitable. These are all things that banks don't typically like to see."
For these reasons, many specialty lenders have emerged over the past 20 years specifically aimed at the staffing industry. "A specialty lender will provide much higher lines of credit than a bank, and will rely on the receivables as its primary source of repayment," Rothman explains. "So as long as the staffing company is producing qualified accounts receivables, they will have a mechanism to borrow the money they need to hire the labor and pay the taxes that generated those same receivables."
FACTORED IN. Many of these lenders offer some combination of financing and back-office assistance. Rothman's firm provides a line of credit designed to smooth the cash flow fluctuations inherent in staffing, for instance, and offers optional software and other services.
These companies -- typically called "factors" -- originated in the apparel industry, and tend to charge dearly. With marginal credit and few assets, you can expect to pay between 4% and 6% of revenues, Miller says. They buy your accounts receivable at a discount (typically 80%, in order to cover disputes or defaults on invoices), then give you a check each week that you can use to cover your payroll, taxes, workers' compensation insurance, and other expenses.
Rothman offers this example of how factoring works: "Say a staffing company generated $10,000 of receivables. The payroll for those receivables may have been $6,500, the taxes $1,000, and the workers compensation insurance $500. If a lender lends 80% against the value of the receivables, that is sufficient to pay these expenses. When the receivable is collected, the remaining $2,000 -- minus fees and interest -- is given back to the staffing company," he says.
HANG TOUGH. Some factoring firms require their staffing agency clients to purchase a full-service package, which typically includes billing, payroll, doing background checks, and preparing W-2s, among many functions. Sometimes, debt collection is part of the package. Shelly Wilkinson, director of sales and marketing for Milwaukee-based Tricom Funding, says her firm emphasizes 30-day payment cycles for clients.
"When a staffing agency starts negotiating payment terms beyond 30 days, the likelihood of [their] being paid on time decreases. What we tell our clients is that they have to have the hard conversations, including going to clients and telling them that if they are consistently paying beyond 30 days, you'll have to pull your employees out," she says. Tricom charges 5% on gross invoices, which covers funding and the mandatory back-office functions they perform in house. If invoices are not paid 60 days out, the firm collects an additional 1%.
FRANCHISE OPTION. If factoring doesn't appeal to you, there are some additional options you might pursue. One is to finance your payroll through an asset-based lender or SBA-guarantee loan. Patty DeDominic, who has operated PDQ Careers since 1979, suggests that you consider taking on a partner who could help supply working capital, or that you concentrate on finding clients who will pay in advance or COD. "Consider making search part of your business plan," she suggests. "It is often customary to pay search fees in advance."
Finally, you might consider opening a staffing franchise rather than going it alone. While most of the large franchisers have fairly high investment requirements, there are some smaller franchises that might be options for you. Look for a franchisor who provides good support to new franchisees and has a good reputation within the industry. You can research them, as well as industry suppliers and vendors, through the American Staffing Association, a trade group that offers vendor directories along with a wealth of information and resources, and through Staffing Industry Analysts, Inc., which publishes a trade journal and a multitude of industry reports and analyses. Good luck!
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