What is Payroll Funding?
Payroll Funding has emerged as an essential element of a smaller company's financial planning. Since the 2008 Great Recession there is very little liquidity in the economy for smaller companies. Individual owners can borrow on their net worth and invest the proceeds in their company but this simply drives down their FICO score and reduces their debt capacity.
Up until recently this has not been a problem because the economy has not experienced significant growth, but that is changing. The economy seems poised for growth, and smaller companies – the typical client of a PEO – do not have access to the working capital they will need to exploit this growth.
How Funding Works
Payroll Funding solves the working capital problem by letting a smaller company pay is payroll on credit. This largely solves the cash flow problem because it is payroll that drives cash flow – the payroll must be paid in a specific amount on a date certain, whereas cash collections are bumpy, uncertain, and unpredictable.
The end result is a cash flow problem that absorbs an out-of-proportion amount of management's time and effort – many managers spend more time managing their cash flow than they do managing the business. In part this is due to the nature of cash – it takes a senior member of management to get customers to pay faster (what do you offer them to do that?) or to get suppliers to accept slower payment (what do they want for that?). So a cash flow problem reduces the time to solve the problem as well as putting a limit on growth.
The key to Payroll Funding, however, is not just the dollars and cents aspect. In terms of non-economics, Payroll Funding does not require a personal guarantee (otherwise the owner's FICO score will be reduced), any collateral or lien (otherwise it will limit the company's ability to borrow on those assets), collection calls to clients, daily charges to a bank account, etc. The best Payroll Funding programs do not even require a written application (which, unless meticulously prepared in great detail offer a lender the opportunity to convert a standard non-payment case into a criminal case due to non-disclosure).
The bottom line is that by paying its payroll on credit a company can generate the working capital it needs to expand. This gives it a competitive advantage over other companies who, due to lack of working capital, must raise their prices or cut back their marketing efforts. And of course it enables a company to sell its products on credit but at a higher price, given that today credit is more important than price.
Great for Small Businesses
In terms of payroll servicers that service smaller companies: Payroll Funding keeps them from having to provide credit to many of its clients. And by referring a client to Payroll Funding the servicer can generate a steady stream of profit without taking any risk or cost. But the greatest appeal of Payroll Funding to a payroll servicer is that letting a client pay its payroll on credit shifts the sale pitch away from the servicers payroll services (basically a commodity) to the client's cash flow.
And the greatest problem a company has in regards to payroll is not administering it but paying it, so Payroll Funding resonates with a prospect in a critical way that simply selling commodity payroll services does not. For a payroll servicer, his sales cycle is shortened, his hit ratio goes up, and he get his price.
The Bottom Line on Payroll Funding
Essentially, virtually everything for sale in the United States can be bought on credit. Why not payroll? why can't a company buy its payroll on credit from a payroll servicer? It makes sense for both parties.