Professional services funding: billable hours now, paid invoices later

A professional services firm sells time and expertise, and gets paid well after delivering both. The cash is locked in unbilled work and unpaid invoices. A line of credit sized to that gap is the right tool for most firms; expensive short-term money rarely is. One note first: our funding partner covers law firms, consultancies, architects and engineers, but not accounting, tax preparation, insurance or financial services firms.

The cash-flow shape of a professional firm

Follow a matter or project through the firm:

1. Work in progress. Staff spend hours on it. Salaries are paid as the hours are worked.
2. Billing. The work is invoiced monthly, on milestones, or at the end. Unbilled work in progress (WIP) is money you've earned but can't collect yet.
3. Collection. Clients pay on their terms, and larger clients can be slow.

Some firms add their own twists:

• Law firms on contingency fees may carry cases for a long time, paying costs along the way, before a settlement or judgment pays. Hourly practices have the ordinary WIP and receivables lag.
• Architects and engineers often bill by project phase, and fees can be held until drawings are approved or a phase signs off. Their clients' own construction funding can delay payment further.
• Consultancies win large engagements that require hiring or subcontracting before the first invoice.

Partner draws and distributions add another drain: profits paid out on paper while the cash is still sitting in receivables.

Which funding fits, and which doesn't

SBA 7(a) loans can be used for working capital, refinancing and changes of ownership, through a participating lender. For a partner buyout or merger, that's worth pricing.

A merchant cash advance is a weak fit: few card payments, invoice income, and a price built for higher-risk businesses.

What it costs: a worked example

Say the firm borrows $100,000 to cover a growing receivables balance, as a term loan at 18% APR over 24 months, paid monthly.

• The payment is $4,992.41 a month.
• You repay $119,817.84 in total.
• The interest is $19,817.84.

A line of credit that you draw for a few months and repay as clients pay would usually cost less in dollars, since interest runs only while the balance is out. For contrast, $100,000 as a cash advance at a 1.25 factor over 6 months, paid daily, is $125,000 back in 126 payments of about $992.06, or about 92% APR. The borrowing calculator on this page shows what your deposits can support.

In California, commercial financing providers must disclose the total cost as an annualized rate when they make you a specific offer.

Sterling's take: before you borrow, chase your aged invoices. The cheapest money a firm has is what its clients already owe it.

What funders typically ask a professional firm for

• Business bank statements for recent months.
• An accounts receivable aging report, and a WIP report if you track it.
• Profit-and-loss statements and tax returns for larger amounts.
• Professional licenses and proof of ownership.
• Client concentration: what share of fees your top clients represent.
• A schedule of existing loans and advances.

Our funding partner's programs suit firms trading 12 months or more with about $80K a month in deposits, an owner credit score of 600+ and no more than two loans or advances running.

Red flags specific to professional firms

1. Borrowing to fund distributions. If partners draw profits the firm hasn't collected, a loan just postpones the shortfall. Tie draws to collections.
2. Treating case outcomes as collateral. General business funding shouldn't be sized on what a contingency case might pay. If a case goes the wrong way, the loan is still due.
3. Funding a billing problem. If WIP sits unbilled for months, the fix is billing discipline, not debt. Look at days from work done to invoice sent.

Before you sign

Add your unbilled WIP to your receivables and subtract what you owe suppliers. That's roughly the gap a line of credit has to cover.