Payroll Loans: How to Use Them
Payroll loans are a type of short-term, small business financing used to help pay a business’ employees. If your small business is tight on cash, a payroll loan can help fund payroll costs, including wages and bonuses, benefits and tax obligations. We’ll cover your options and provide guidance to help you avoid borrowing in the future.
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Why a small business may need payroll loans
Business owners may find payroll loans useful when they’re experiencing cash flow issues. Payroll loans help to bridge gaps in funding for a variety of reasons, including:
- Unexpected expenses, such as necessary repairs
- Slow-paying clients or customers who don’t meet invoice deadlines
- Seasonal variations in business income
- Hiring new employees to expand operations
While it’s best to plan ahead and maintain cash reserves, there may be times when it’s necessary to borrow to pay your employees on time and keep your small business afloat. If you need an emergency business loan to cover your payroll expenses, there are a few options that can provide fast funding, even if you don’t have perfect credit.
Types of payroll loans
Payroll loans are similar to working capital loans because they help bridge cash-flow issues. Small business payroll loans can come in a variety of different flavors, depending on your business needs. Rates, terms and requirements vary depending on the loan type you choose.
| Payroll loan type | Maximum amount | Repayment time frame | Best for |
|---|---|---|---|
| Short-term loans | $1.4 million | 3 to 24 months | Emergency expenses |
| Line of credit | $750,000 | 12 weeks to 5 years | Ongoing hiring needs or seasonal fluctuations |
| Merchant cash advance | $1 million | 3 to 24 months or until repaid | Businesses with bad credit |
| Invoice factoring | Up to 90% of the value of your invoices | N/A | Businesses with slow-paying clients |
Short-term business loans
Short-term business loans provide a lump sum that is typically repaid in fixed daily or weekly installments over three to 24 months. They often come from online lenders, which have more lenient requirements than traditional brick-and-mortar banks, and you can get your funding as soon as the next day. They may also come with higher interest rates, ranging from about 7% to 50% or higher. Make sure to compare the total cost of borrowing when comparing lenders.
Business line of credit
A business line of credit is a revolving line of credit that your business can borrow from on an ongoing basis. It functions like a business credit card, but typically comes with higher borrowing limits. You only pay interest on the amount you use, and your line of credit replenishes as you make payments. Terms typically range from 12 weeks to five years, and lenders often charge higher rates for longer terms. You may pay an origination fee, maintenance fee, or draw fee in addition to interest, so pay attention to the total cost when comparing lenders.
Merchant cash advance
A merchant cash advance is a lump sum that is repaid as a percentage of your future sales. Merchant cash advance companies typically use a factor rate to express the cost of the advance, and collect daily or weekly over the course of three to 24 months, or until the loan is fully repaid, based on your credit card or debit card sales. These rates are typically higher than the interest rates on other forms of financing, but merchant cash advances are quick to obtain and easier to qualify for than other forms of credit.
Invoice factoring
With invoice factoring, businesses can sell their unpaid invoices to an invoice factoring company and receive up to 90% of the uncollected total. The invoice factoring company turns a profit by collecting payments for the invoices and keeping the difference. However, if a client fails to pay a disputed invoice, the invoice factoring company may require the business to repay the advance. One advantage of invoice factoring is that it doesn’t come with the same requirements as a business loan, so you can often get an advance on your unpaid invoices even if you have bad credit and no additional collateral.
THING TO KNOWThe Small Business Administration previously offered a type of payroll loan called the Paycheck Protection Program (PPP) during the coronavirus pandemic, but the program ended May 31, 2021. Existing PPP borrowers are eligible for loan forgiveness provided they maintained employee retention and compensation and spent the proceeds on eligible expenses, with at least 60% of the funds going toward payroll costs.
How to avoid payroll loans
Since payroll loans can be costly, it’s best to manage your business finances to avoid cash flow issues that might lead you to borrow. Follow best practices, including:
- Conduct a cash flow analysis to better time your expenses
- Maintain cash reserves to cover emergency expenses
- Request immediate payment terms and use automatic billing options if possible
- Follow up with customers and collect late-payment fees
- Use a business credit card for short-term, recurring expenses
- Forecast future cash flow to anticipate seasonal inconsistencies
- Don’t pay your bills early if there’s no advantage, in case you need the capital
If you’re still having cash flow issues, you may need to find ways to reduce your expenses or raise your prices. You may also need to evaluate your products and services and eliminate offerings that aren’t making money for your business. Identifying and correcting these issues may help you generate positive cash flow and reduce the likelihood you may need to take out short-term financing in the future.