There might come a time when you don’t have enough money to pay your employees. Cash flow might be slow, or a three-paycheck month may surprise you. To help your business make ends meet, you might consider taking out a payroll loan.
A payroll loan can be a lifeline. However, small business payroll loans also mean debt and potentially high interest rates.
Should you take out payroll loans? Read on for the information to help you decide.
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What is a payroll loan?
A payroll loan provides your business with financing that you can use to cover employee wages and other payroll expenses.
You can use a loan to cover payroll costs such as:
- Employee wages
- Benefits
- Social Security and Medicare taxes
- Federal and state unemployment taxes
You may need a payroll loan to pay your team during an emergency or slow season.
Payroll funding options include business loans, business lines of credit, and invoice factoring.
Did you know? The Paycheck Protection Program (PPP) is an example of a “payroll loan” available to businesses in 2020 and 2021 during the COVID-19 pandemic. Unlike typical payroll loans for small business, a PPP loan was forgivable money—aka you didn’t have to pay it back if you qualified.
Payroll loans for small business: What are your options?
So, what kind of financing can you take out for payroll, and where do you have to go to apply?
Types of financing options you can use as a “payroll loan” include:
| Type of Payroll Loan | What Is It? | Considerations | Where to Go |
|---|---|---|---|
| Small business loan | A traditional loan that provides a lump sum of money. | Requires strong credit | Banks and credit unions |
| SBA-guaranteed loan | A loan backed by the Small Business Administration, reducing risk and making it easier to get funding. | Slow approval | Small Business Administration |
| Business line of credit | A revolving line of credit, similar to a credit card, that you can access on an ongoing basis. | High interest rates | Banks and credit unions |
| Short-term loan | A lump sum of money that may come with a quicker repayment period and higher interest rate than traditional loans. | High interest rates | Online or alternative lenders |
| Merchant cash advance | A cash advance you receive in exchange for a percentage of your future debit and credit card sales. | Expensive in the long run | Merchant cash advance company |
| Invoice factoring | A cash advance you receive when you sell your unpaid invoices to a third-party company at a discount. | Lost revenue | Factoring companies |
To apply for payroll funding, you typically need information like your business financial statements, bank statements, and tax returns.
When might you need a payroll loan?
You might take out a payroll loan if you’re in a situation where you need money quickly to cover payroll expenses.
Examples of situations where you may need a payroll loan for small business include:
Three-paycheck months: If you use the biweekly pay frequency, there are two months in the year when employees receive three paychecks instead of two. Failing to budget for the third monthly paycheck could result in you scrambling to find tens or hundreds of thousands of dollars to pay your team!
Slowdowns: Is your busy season year-round? Most businesses have seasonal rather than consistent demand. You may also have slowdowns during a recession. Or, tariffs could impact your small business.
Emergencies: During a natural disaster or other emergency, you may need to close your business, preventing you from making money.
Unexpected expenses: The unexpected happens in business every day. But situations that require immediate action (e.g., needing new equipment to run your business) can throw your budget for a loop.
Late customer payments: Customers not paying you on time can make it difficult for you to cover expenses. You may need access to quick money if your cash flow takes a hit.
What happens if you can’t make payroll?
Failing to pay your employees on time can have significant consequences, like penalties, fees, and even lawsuits from your team.
The FLSA requires employers to pay non-exempt employees on their regularly scheduled payday.
There are also pay frequency requirements by state that mandate employers to pay employees within a certain time frame.
You might not like taking on business debt, but a payroll loan can help you make payroll and avoid penalties and legal headaches.
How does a payroll loan work?
When you take out a loan to cover payroll, you’ll need to consider things like repayment and interest and fees.
First, you’ll work with a lender and apply for a loan. They can review important terms and conditions with you, including:
- Loan amount: The amount you need to cover payroll (aka the principal)
- Interest rate: The additional money you’ll owe back to the lender
- Fees: Business loan fees can include origination and underwriting fees
- Repayment plan: How long you have to repay the loan, and when payments are due
- Secured or unsecured: Secured loans require collateral, unlike unsecured loans
Your terms and conditions will likely depend on your credit score, how long you’ve had your business, and the loan amount.
Pros and cons of small business payroll loans
Taking out a payroll loan can help your business in an emergency. However, the fast access to cash these loans provide isn’t without its drawbacks.
Compare the pros and cons of payroll loans below:
| Pros of Payroll Loans | Cons of Payroll Loans |
|---|---|
| Pay employees on time | High borrowing costs (e.g., interest) |
| Quick access to funding | Increases business debt |
| Avoid noncompliance penalties of late payday | Not a permanent solution to cash flow issues |
How to avoid payroll loans
Sometimes, a payroll loan is your only option. But you can avoid payroll loans by making a few changes in your business.
Here are a few ways you might be able to avoid taking out a loan to cover payroll:
- Collect overdue bills: Apply late fees to unpaid and overdue customer invoices. Consider offering an early payment discount to encourage early payments, too.
- Improve budgeting: Are you struggling to make payroll because of a three-paycheck month? Did you overspend last month? Whatever the case, improving your budgeting can help make sure you have enough cash on hand to pay your team.
- Have an emergency cash reserve: A cash reserve can help you meet short-term financial needs, like paying your team when you’ve been hit with unexpected cash flow issues.
- Increase cash flow through discounts: You might consider offering a sale ahead of time during slow seasons to increase your cash flow.
Should you take out a payroll loan?
Paying employees is a responsibility you can’t delay. Otherwise, you may face penalties (and an unhappy team!). Payroll loans provide a short-term financing solution if your business is struggling to pay your employees.
Like any new debt, taking out a payroll loan depends on your business situation. They aren’t a long-term solution to cash flow problems, but they can help in a pinch—especially if you’ve exhausted all other options (e.g., collecting late payments).
Consider the pros (e.g., access to cash quickly) and cons (e.g., interest rates) of taking out a payroll loan before making your decision.
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This is not intended as legal advice; for more information, please click here.
