Payroll Loans: How to Use Them

A payroll loan is a short-term financing option business owners can use to pay their employees when there isn’t adequate cash to cover payroll costs. Term loans and lines of credit are some types of payroll loans that can be used to cover costs such as salaries, hourly wages, commissions, bonuses, payroll taxes and employee benefits.

Although a payroll loan can help ensure your employees receive their paychecks on time, there are steps you can take to minimize the cash flow issues that put funding your payroll in danger.

When a business may need a payroll loan

If a business doesn’t have enough money to make payroll, it’s typically experiencing an issue with cash flow — the money coming into and going out of the business. Some situations that can disrupt cash flow include:

• Not receiving timely payment from customers.

• Encountering unexpected expenses.

• Offseason reduction in revenue.

• Holding too much inventory.

• Natural disasters or other disruptions to regular business.

» MORE: Best small-business loans

Types of payroll loans

Compensating employees and paying associated payroll taxes needs to be a business priority because not meeting payroll obligations can result in fines and legal action. Here are some options to consider when you need funds for payroll:

Short-term business loan

Short-term business loans are commonly offered by lenders and provide a one-time lump sum of money. Depending on the lender, you can find loan amounts anywhere from $5,000 to $500,000 or more. Repayment periods could be as short as six months or extend to 24 months, or possibly more. When talking to the lender, ask if there is a prepayment penalty if you pay the loan off early.

Business line of credit

A line of credit is another financing option to get cash to meet your payroll obligations. However, unlike a term loan, you won’t receive a lump sum of cash. Instead, with a line of credit you have the option to draw out money when it’s needed, up to a set limit. Business lines of credit may range from $5,000 to $1,000,000, or more, depending on the lender. One advantage of a line of credit is that you pay interest only on the amount you withdraw. Like short-term loans, you’ll typically get the best loan terms from a traditional bank, but you can expect faster processing time from an online lender. In fact, a line of credit may be your quickest option, with some lenders promising a decision in as little as five minutes.

Invoice factoring

Invoice factoring involves selling your invoices at a discount to a factoring company and receiving cash for them. When you sell your invoices, you typically receive a percentage of the invoice amount upfront. After your customer pays the factoring company, you’ll receive the remaining amount, less a service fee. The service fee is to compensate the factoring company. The percentage you’re paid upfront and the amount of the service fee will be spelled out in the agreement you sign.

Invoice factoring can be a quick option to obtain funds for payroll. However, it can be expensive depending on the fee you’re charged. Also, it’s not an option for businesses that don’t invoice their customers.

Where to find payroll loans

While some lenders may not specifically advertise “payroll loans,” you can find financing options for working capital that can help you meet the payroll requirements of your business. Here are some lenders that may be a good option when you need funds to meet your payroll:

Banks and credit unions

Typically not your fastest funding option, traditional banks and credit unions typically offer short-term business loans as well as lines of credit that can provide cash for payroll as well as a variety of other purposes. Payroll loans from banks will generally have the best interest rates and terms. However, bank loans often require you to have an established business with excellent credit.

SBA loans

SBA loans can be a long-term solution to payroll issues and a good alternative if you don’t meet the requirements of a traditional bank loan or line of credit. They offer low interest rates and competitive terms, but still often require good credit and can be slow to fund. Although some SBA loans can’t be used to pay delinquent payroll taxes, funds from the SBA 7(a) program can be used for short-term working capital to meet expenses such as paying bills, purchasing inventory and meeting payroll. An SBA Express Loan may be the best choice for a payroll loan, with faster funding than other options under this government-guaranteed program.

Online lenders

If time is important, as is often the case with a payroll issue, then financing from an online lender will be one of your quickest options. Online lenders offer term loans and lines of credit and some can provide decisions within 24 hours and funding within a day or two. Generally, online loans are easier to qualify for, but often have higher interest rates and shorter repayment periods than bank loans. And it's not uncommon to have online lenders ask you to make weekly payments instead of monthly, and the repayment period could be as short as six to 12 months.

» MORE: Best online business loans

Factoring companies

Like online lenders, factoring companies can provide cash quickly so you can meet upcoming payroll needs. However, they may not be the best long-term fix because their fees can be expensive when compared to bank loans. Factoring companies can be subsidiaries of banks or private companies. For example, AltLINE, which offers payroll funding, is a division of The Southern Bank, a community bank. In contrast, ECapital, another company that offers invoice factoring, is a private firm.

Ways to avoid cash flow issues

Addressing cash flow issues can help you avoid payroll emergencies and the additional costs associated with financing the funds you need. Creating a cash flow forecast to estimate the amount of money flowing into and out of your business can be helpful in budgeting for payroll costs.

While raising prices, reducing expenses and eliminating waste may be the most common ways to increase the cash you have on hand, here are some other things you can consider:

• Only offer credit terms to customers who have proven their creditworthiness.

• Accept credit cards, electronic and online payment options.

• Offer a discount to customers who pay their bills early.

• Ask your suppliers to extend your payment period, if possible.

• Set money aside in a cash reserve account for emergencies.

• Budget for seasonal fluctuations in revenue and expenses.

• Consult an accountant or other financial professional.