Funding for recruitment agencies: payroll and invoice finance

A permanent placement is simple to fund. You find the candidate, they start, you send one invoice and wait to be paid. Temporary and contract work is different. The moment a temp starts, you're the one paying them, usually every week, along with the tax and other costs of employing them. Your client pays your invoice weeks later.

That's why growing temp agencies so often run short of cash while looking healthy on paper. This guide explains the gap, how agencies fund it, and what funders check.

The temp-staff cash gap

Here is the cycle most temp agencies live with:

1. Your temp works a week. The client approves a timesheet.
2. You pay the worker, usually the following week. On top of their gross pay you carry employer's National Insurance, pension contributions under auto-enrolment, and holiday pay that builds up as they work.
3. You invoice the client for the hours at your charge rate, which includes your margin.
4. The client pays, typically 30 to 60 days after the invoice, and sometimes later.

By the time the first invoice is paid, you may have paid five to ten weeks of wages for that worker. Every extra temp adds to the total. If a large client pays late, the hole gets deeper while the payroll keeps falling due every week.

You can't solve this by holding back wages. If you supply temps, you're legally an employment business, and the rules that govern employment businesses stop you withholding a temp's pay because the client hasn't paid you yet. National Minimum Wage, holiday pay and auto-enrolment duties apply whatever your cash position. GOV.UK has guidance on the rules for employment agencies and employment businesses.

Invoice finance for agencies

Invoice finance is the most common way temp agencies fund payroll. You raise an invoice to your client, the provider advances most of its value, usually within a day or two, and when the client pays, the provider takes back its advance and fees and releases the rest to you. Our guide to invoice finance vs a business loan covers the mechanics and costs in detail.

It fits recruitment well for three reasons:

• It grows with you. More temps mean more invoices, and more invoices mean more funding. A fixed loan doesn't do that.
• It's based on your clients. If you place staff with solid, creditworthy businesses, that counts for more than the age of your agency.
• It matches weekly payroll. Invoice every week and you can draw funding every week.

The two main forms are factoring, where the provider runs your sales ledger and chases clients for you, and invoice discounting, where you keep collecting and the arrangement is usually confidential. Newer agencies tend to start with factoring. Established agencies with good credit control often move to discounting, which usually costs less.

Payroll funding and back-office providers

Some providers go further than funding invoices. A payroll funding service combines invoice finance with payroll processing: you send approved timesheets, the provider pays the workers, raises the client invoices and collects the money.

A step beyond that is what the industry calls back-office funding. The provider takes on most of the administration of running temps: payroll, invoicing, credit control and often compliance support. You concentrate on winning clients and finding candidates. How the money flows depends on the model:

• Funding and admin for your agency. You stay the employer and the contracting party with your clients. The provider funds your invoices and does the paperwork, and charges fees for both.
• Margin-share models. In some arrangements, the provider contracts with the client and engages the workers itself, and you're paid a share of the margin on each placement. You keep the relationship, but the provider owns the contracts.

The difference matters. Under a margin-share model, the client contracts may not belong to your agency, which can affect what your business is worth and how easily you can leave. Ask who the client contracts with, who employs the workers, who owns the client relationship if you part ways, and what notice and exit fees apply.

Back-office services cost more than plain invoice finance, because you're paying for the work as well as the money. For a one- or two-person agency without its own payroll team, that can still work out cheaper overall.

What providers check

Agency funding is a specialist area, and providers look at things a general lender wouldn't.

Rules on worker status and on umbrella companies have tightened in recent years, and more of the responsibility for getting tax right now sits with agencies. Funders know this and may ask how your workers are engaged. Check GOV.UK for the current rules before you take on contractors through an umbrella company.

A worked example

An illustration, not a quote. Say you place ten temps with two clients, and your total weekly payroll cost, including employer's National Insurance, pension contributions and holiday pay, is £7,000. You invoice your clients weekly for £8,500 on 30-day terms, so your gross margin is £1,500 a week. Figures exclude VAT for simplicity.

Without funding, you'd pay out around £35,000 to £42,000 of wages before the first invoice is paid, and you'd need that cash in the bank.

With an invoice finance facility advancing 85%, each weekly invoice releases about £7,225 within a day or two. That covers the week's payroll. When the clients pay, the provider takes its advance and fees, and passes you the rest of your margin.

The costs are a service fee and a discount charge on the money you've drawn, and they come out of your £1,500 a week. If they took, say, £300 to £400 a week, the agency would still be profitable, but you can see how quickly a thin margin or a late payer would squeeze it.

Real figures depend on your clients and the provider. Work out your margin after funding costs, not before.

Growing from perm into temp

Many agencies start with permanent placements and add temps later. The two need very different cash.

• Perm is fee income. You invoice once the candidate starts, often as a percentage of their salary, and there's no payroll to fund. The risk is the rebate period: if the candidate leaves early, you may have to refund part of the fee. Some invoice finance providers are cautious about funding perm invoices for that reason, or advance less against them.
• Temp gives you recurring margin every week, which is steadier and builds value in the business. The cost is working capital: every new temp needs funding before they earn you anything.

The trap is winning a big temp contract before the funding is in place. If a client asks for 30 workers from next Monday, you need to be able to pay 30 workers the Friday after. Set up funding before you need it, and build a simple cash flow forecast that shows payroll going out each week against client payments coming in.

The Agency Workers Regulations also matter as you grow. After 12 weeks in the same role, temps are generally entitled to the same basic pay and working conditions they'd have had if the client had recruited them directly. If your charge rate doesn't rise to match, your margin shrinks on longer assignments.

Other options alongside invoice finance

Invoice finance is usually the core facility, but it isn't the only tool:

• An overdraft or revolving credit facility can smooth small timing differences, such as a client paying a few days late.
• A short-term loan can fund one-off costs that invoices can't, such as new software, an office move or a quarterly VAT bill. See borrowing to pay a VAT or tax bill.
• Credit protection covers you if an approved client becomes insolvent. Some providers build it in, and some offer it as an extra. For an agency that relies on a few big clients, it can be worth the cost.

Common mistakes to avoid

• Pricing without the full cost of a worker. Employer's National Insurance, pension contributions, holiday pay, and the Apprenticeship Levy if your pay bill is large enough, all come out of your margin. So do funding fees.
• Agreeing long payment terms to win a client. Every extra 30 days on a client's terms adds another month of payroll you have to fund.
• Relying on one big client. It caps your funding, and if that client delays payment or leaves, the whole agency feels it.
• Invoicing unapproved hours. Invoices without approved timesheets get disputed, and providers won't fund disputed invoices.
• Signing without reading the exit terms. Whole-ledger and back-office contracts often have minimum terms, notice periods and exit fees. Check them before you sign.

Questions people ask

How do new recruitment agencies fund payroll?

Most use invoice finance or a back-office provider that funds payroll and runs invoicing for them. Because funding depends on the quality of your clients rather than your agency's history, a new agency with creditworthy clients and signed timesheets can often get funded from the start.

Can I delay paying temps until my client pays me?

No. If you supply temporary workers, the rules for employment businesses stop you withholding a temp's pay because the client hasn't paid you. That's why funding the gap matters. GOV.UK has guidance on the rules for employment businesses.

What is back-office funding in recruitment?

It's a service where a provider funds your temp payroll and handles the administration, such as payroll, invoicing and credit control. In some models the provider contracts with your clients and pays you a share of the margin. Check who owns the client contracts and what it costs to leave.

Can I use invoice finance for permanent placement fees?

Sometimes. Some providers will fund perm invoices, but rebate clauses make them riskier, so expect a lower advance or tighter terms. Temp invoices backed by approved timesheets are the easier case.

How much can a recruitment agency borrow against invoices?

It depends on your clients, your sector and your track record. Providers advance a percentage of each approved invoice and may set limits on how much they'll fund against any single client. Your total facility grows as your invoices grow.