The employee side
Consider a service company experiencing a growth phase. Initially, things appear to go well. The startup is adding clients and deploying staff to service those clients. Eventually, though, the company reaches a point where staff is 100 percent utilized. At this critical juncture, how do you handle your next new client if your staff is fully booked?
One alternative is to ask your staff to work overtime. This approach works initially, but it eventually produces diminishing returns. A second alternative is to turn clients away. However, no entrepreneur ever wants to be in that position. The last alternative is to add staff, but that is easier said than done because many growing startups can’t afford to add staff. Let’s see why.
The financial side
One advantage of working with retail clients, rather than business clients, is that retail clients usually pay for the work as soon as it is completed. For example, if you hire a plumber, you pay for the work as soon as the job is done. This arrangement makes for great cash flow.
However, business clients seldom pay as soon as the work is delivered. They often ask for net 30- to 60-day payment terms, giving them one to two months to pay your invoice. This scenario is where financial problems begin. Few startups can afford to deliver work, pay employees for two months and grow, before getting paid for their work. Eventually, the business depletes its cash reserves. Worse, if the business continues growing without solving this problem, real financial difficulties can occur.
Related: Why Payroll Matters to Your Startup
The solution: finance your payroll
The simple way to solve this problem is to get financing to cover payroll expenses until the client pays you. There are several business financing solutions in the market. However, not all solutions are well suited to solve this problem. The best solutions use a revolving line of financing.
Revolving lines of financing
A revolving line of financing is one that you can use and pay back as needed. For example, a credit card is considered revolving financing. You can draw funds up to the limit and then pay back as your income allows. Solutions that work well for payroll financing include:
- Business line of credit
A business line of credit operates much like a credit card. You use it only when you need it. It allows you to draw funds against a credit limit and provides you the flexibility that you can pay it as needed. A business line of credit is the cheapest and most flexible solution to finance payroll. Unfortunately, it is also the hardest to get.
Lenders are willing to provide these products only to companies that meet their strict qualification criteria. Unfortunately, few small businesses or startups can ever qualify. Lines of credit often require that your company show profitable operations for several years, solid assets and well-placed management controls.
- Asset-based loans
An asset-based loan is another solution you can use to finance your payroll. It works by financing slow-paying accounts receivable (i.e., net 30- to 60-day invoices). This solution improves your cash flow by eliminating the payment wait and provides the funds to meet payroll. Getting asset-based financing is easier than getting a line of credit. It is available to small businesses and startups that have been operating for a few years and have yearly revenues of $6 million or more.
- Invoice factoring
Invoice factoring operates much like an asset-based line against your receivables. It allows you to finance an invoice, thus improving the payment cash cycle, and provides the funds to meet payroll and grow. Factoring transactions have built-in controls; therefore, they are offered to startups that can’t qualify for other types of financing. Although invoice factoring is easier to obtain than other financing, it tends to be more expensive.
One word of warning
The decision to obtain financing is important and should be made carefully. Before doing so, speak to your CPA or financing team. Review your financial statements to identify bottlenecks and seek financing only when you have a clear understanding of how funding will help, and how much will it cost.
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