Not having enough cash to pay employees can be consequential, not limited to losing talent. For a short-term gap in revenue, a payroll loan can provide the funding to pay your staff so you can keep your business running.
Many different business loans can help business owners make payroll. Explore loan options by comparing interest rates, terms and fees to help you decide the best way to borrow.
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What Is a Payroll Loan?
A payroll loan is a short-term funding option small businesses can use to cover employee payroll when working capital falls short. If, for instance, your clients are late paying invoices or your business experiences a seasonal decline in sales, you can use a payroll loan to cover those gaps.
Payroll loans may come in the form of small business loans, lines of credit or alternative financing options, like invoice factoring. Depending on the lender, you could be approved and receive funds within a few days.
Types of Payroll Loan Options
Several different financing options can provide the capital you need for payroll. Below are loans you can use to pay employees.
Short-Term Business Loans
Short-term business loans are loans that are typically repaid in less than two years. Both banks and online lenders may offer short-term business loans. However, bank loans may require strong business credit and high revenue to qualify, and the application and funding process can also take several weeks.
Online alternative lenders may offer faster loan funding processes and more flexible eligibility criteria than banks. However, rates on online loans may be high depending on your credit and other business credentials.
Annual percentage rates (APRs) for short-term business loans may range from 3% to 50% or higher. Your personal credit, business credit, business revenue and collateral pledged to back the loan are factors that can affect the interest rate on your business loan.
Business Lines of Credit
Business lines of credit offer a revolving credit line you can use for business expenses, such as paying employees or buying supplies. Unlike loans that give you one lump sum payment, business lines of credit provide a credit limit you can borrow against on an ongoing basis.
Like credit cards, lines of credit may have an annual fee and a fixed or variable interest rate. You only pay interest on the amount you borrow, and the borrowing limit is based on the lender and your ability to repay debt.
Some major banks and online creditors offer credit line limits of $250,000 to $1 million, depending on the size of your business.
Invoice Factoring
Invoice factoring is the process of selling unpaid invoices to a company that fronts you a percentage of your outstanding invoices, which you can then use to cover payroll. Typically, the advance you receive is up to 95% of the amount of your unpaid invoices. For example, if your company has unpaid invoices of $20,000, you could get an advance of $19,000.
Before you get funding, invoice factoring companies verify your invoices and may look at the creditworthiness of the companies that owe you money to determine your eligibility. If your invoices are accepted, you get funds upfront and the invoice factoring company handles collecting payments from your clients.
Once invoices are paid, you receive a portion of the additional funds collected minus a fee. Since invoice factoring isn’t technically taking out a loan, it’s a way to bring cash into your business without debt payments.
Invoice Discounting
Invoice discounting is similar to invoice factoring, but instead of selling your unpaid invoices, you use your unpaid invoices as collateral to back a short-term loan. The invoice discounting company loans you money that you can use for payroll and other expenses. You handle the collections processes for invoices and use invoice payments to repay your loan, plus interest.
Pros and Cons of Payroll Loans
If you’re thinking about taking out a payroll loan, consider the pros and cons before taking on the debt.
Pros
- Quick funding. Some lenders offer fast approval and funding processes on short-term financing, giving you access to money within a few days.
- Custom payments. Lenders may work with you to set up daily, bi-weekly, weekly or monthly loan repayment terms that fit your budget.
- Maintain staffing. If you can’t pay employees on your own, borrowing money can help keep your business running during a slow season or when clients are slow to pay invoices.
Cons
- High fees and interest. Short-term small business financing may come with high fees and interest rates, especially if you have limited business credit and history.
- Unmanageable payments. If you borrow a large sum for a short period, the loan payment may be high and repayment can become a challenge if you’re already having trouble with cash flow.
- Excessive debt. If you have to borrow regularly to keep your business afloat, you could accumulate debt that’s difficult to pay off. Before taking on additional debt, make sure you have a plan to pay any outstanding loans.
Where To Find Payroll Loans
Banks, online lenders and alternative lenders may offer business loans, credit lines and invoice-backed financing options that can be used for payroll. Lenders also offer loans backed by the Small Business Administration, or SBA loans, with flexible eligibility criteria and capped interest rates.
However, SBA loans can have long application processes, and it could take several months to get cash. Online and alternative lenders may offer faster loan turnarounds to help you in an emergency situation.
Requirements for Payroll Loans
Requirements for payroll loans can vary by lender and loan type. Here is an overview of what lenders may consider when evaluating an application:
- Revenue. Lenders will look at your revenue to determine if you have the funds to repay the loan. Minimum revenue requirements vary widely, with some lenders requiring $100,000 in annual revenue and other lenders requiring at least $400,000 in annual revenue.
- Time in business. You may need to be in business for at least one to two years to get approved for a loan.
- Personal and business credit. Lenders may look at your personal and business credit scores to measure your credit risk. Some lenders offer bad credit business loans where you could get approved with a poor personal credit score, or below 580 on the FICO scale. However, interest rates may be higher when your credit is poor, and having a higher score can help you qualify for lower rates.
- Personal guarantee. In some cases, owners of the business may have to personally guarantee repayment of a loan if the business isn’t able to pay off the debt.
- Outstanding invoices. For invoice factoring, factoring companies may verify your invoices and check the creditworthiness of the clients who owe you money to decide whether to front you payments for invoices.
Alternatives To Payroll Loans for Small Business
Other types of small business financing can be used to cover payroll, including:
- SBA Express loans. If you have immediate working capital needs, SBA Express loans may have a faster application turnaround time than other SBA loan options. You can borrow up to $500,000, with loan terms of up to 10 years.
- Merchant cash advances. A merchant cash advance is a financing option that offers cash upfront if you commit to giving the lender a percentage of your future sales until the loan is repaid. Merchant cash advances can be a good solution for new businesses with limited credit history.
- Personal loans. If you’re unable to qualify for a business loan, personal loans are another way to raise capital. With very good credit (740 or higher on the FICO Score scale), you may qualify for the best personal loans with low interest rates.
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