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We often regard professional services businesses as being easier to manage than a product based business and in a lot of ways they are; they can be set up by one person at very little cost, there’s no stock to hold or supply chain issues to contend with and overheads are minimal and generally, a great deal simpler to trim when necessary.
Financing a professional services business can prove more complex than in a product-based company however, as the advantages can quickly become disadvantages when it comes to securing business funding for growth and expansion.
Service based companies are selling the expertise of the people they employ so it goes without saying that without the people who bring this specialist knowledge to the organization, clients would be hard to attract and retain. Whereas a manufacturer concentrates on keeping equipment current and can replace a piece of failing machinery with a more advanced model, management is not so easy for a services business, which needs to maintain a highly skilled and motivated workforce that can perform and bill enough hours month after month.
Poor management within a services business can lead to average costs rising when employees are not performing to potential as this results in a disconnect between input and what is able to be billed.
It’s feasible for a manufacturing plant to achieve economies of scale through buying in bulk for example which allows them to take advantage of volume discounts and take on bigger orders. Scaling a services business is not as easy as building another facility, services can’t be ‘mass-produced’ nor standardized as different clients have differing needs.
There’s also only so many hours in a day that an employee can complete billable work, limiting the amount of profit that can be made. It’s difficult to sell more of a service without additional capital expenditure – labor costs, which are already the single biggest cost for a services business can put a big strain on cash flow, especially in businesses such as staffing that aren’t paid for 60-90 days but have to cover payroll weekly.
Successfully scaling services involves being able to replicate specialized knowledge that clients recognize to achieve consistency in the level of services provided and quite often growth can be restricted by geographic location too. Many service company founders struggle with the idea of relinquishing responsibility to new employees but without this level of trust, the business can be suppressed from achieving its full potential.
There are minimal barriers to entry to the service industry, particularly financial and this keeps competition high. New innovative companies enter the market quickly and existing businesses must continuously adapt and add value to their services to set themselves apart. Investment in new automation and digital technologies will be a focus for professional services providers that want to add efficiencies to back office operations and transition towards an advisory business model which differentiates them and allows a more premium price to be established.
These are just some of the scenarios when a services business may face cash flow challenges and need additional funding to make key hires, acquire another complementary business or invest in new technologies.
When assessing eligibility for finance, lenders will assess a similar set of factors for services businesses as they do for any other including capital situation, management structure and expertise, cash flow, market position and potential for growth.
A services business can come up against rejection because there are specific traits to them and even intricacies within different sectors that deem them riskier to lend to.
There are few, if any, tangible assets in a services business that can be valued for collateral against a loan. Much of the companies’ value is tied up in people and paper which is much harder to put a number on. This is where the quality of record-keeping becomes imperative to securing finance as there’s likely a lot of value sitting in your accounts receivable and future growth projections, however it needs to be clearly documented. Proving that you have safeguarded access to specialist knowledge or technology that your competitor’s don’t have (through patents and trademarks for example), is another way to demonstrate the value of your knowledge going forward and these things can have significant saleable value in their own right.
Moving into the ‘breakthrough’ stage of business is a crucial point for any organization. Traditional bank financing can be harder to secure for a younger, growing service business because it requires a longer history of revenue and collateral which just isn’t available. The finance will often hinge on the quality of a companies’ current and anticipated client base, however in an early-stage professional services business, there may not be the diversification in accounts receivables that a bank wants to see. A diversified customer base with a lower concentration rate will generally be more appealing to a prospective lender.
Especially in the initial years of a service business, founders usually look to minimize costs by having non-dedicated operations teams, instead favoring client-facing roles to maximize sales. Key roles from a financial perspective are undertaken by the owners themselves or by a part-time team which can be perceived negatively by a lender as not having enough control over finances and not making it a priority.
There’s huge diversity within the service sector with different sectors having very different cash flow situations. An accountant may be able to demand payment on completion of services rendered but conversely, it can be months before a staffing agency, consultant or creative agency receives payment for their involvement in a project.
Many businesses struggle with sales cycles and seasonality that impair cash flow and the amount of working capital available to sustain operations is often limited to internal sources and the personal finances of partners or owners. In these situations a short-term cash injection can help the business meet their operating expenses and move past a temporary situation to thrive.
Sallyport has a long history and experience in providing tailored finance to service-based businesses of all kinds. Whether you’re looking for help with day-to-day cash flow to make payroll, need to fund the purchase of another firm or make larger investments, flexible finance from Sallyport could be the solution.
The professional services industry is poised for big growth in North America, particularly in technology and computer systems design and related services. Those companies with the right financial partnerships are taking advantage of this growth opportunity, such as this professional technology services company who we recently equipped with the working capital required to advance their business into six different countries.
Reach out to discuss your alternatives to traditional bank lending for financing your services business.
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