Should Your Business Consider Payroll Loans?
If you find yourself in a situation like this and need quick cash to cover payroll, you might benefit from a payroll loan.
Payroll loans are short-term loans or advances that allow you to borrow a small amount of money to pay employees. If you take out a payroll loan, you’ll typically have financing in your bank account within one business day.
Still, as you might expect, payroll loans can be expensive, and the payroll funding company will want to be repaid as soon as possible. In addition, payroll loans shouldn’t be confused with payday loans, which are short-term consumer loans that charge borrowers an average interest rate of 400 percent. In fact, payday loans aren’t even legal in some states, unlike payroll loans.
In this post, we’ll explain what payroll financing is, and how utilizing it can help you pay your employees and in turn grow your business.
Everything You Need to Know About Payroll Loans:
The 3 Types of Payroll Loans:
To start, let’s explain how payroll funding works. A ‘payroll loan’ is a broad description for short-term financing designed to smooth a company’s cash flow.
If you can’t meet payroll, you’ll have more than just angry employees on your hands; in addition, you’ll also have to answer to government regulators. Payroll funding solutions typically come in one of the following forms:
1. Short-Term Loans:
This type of loan has short terms because they are meant to be repaid quickly. Many online lenders process short-term payroll loans in a single business day, but you’ll typically need to have the following:
- A personal credit score in the 600s
- Be operational for at least year
- Provide proof of business income
- Provide a postdated check for the full loan amount to ensure that the lender is repaid.
2. Cash Advances:
Instead of taking out of loan, you can sell a portion of your business’s future credit card sales in exchange for lump sum funding. Merchant cash advances can be more expensive than business loans in some cases, but they’re also easier to qualify for since your credit score isn’t considered. Instead, only your business’s credit card sales are examined.
3. Invoice Factoring:
Do you have customers’ unpaid invoices sitting on your desk? If so, you can borrow money against that invoice using a method called invoice factoring.
Through invoice factoring, you’ll get a cash advance of up to 85 percent of the invoice total. Then, once you receive funding, you can use the unpaid invoice as collateral. Since the invoice is considered the collateral, you won’t need to show business statements or credit history to qualify with a factoring company.
Who Benefits from Payroll Loans?
A payroll loan should only be used as a last line of defense against bad financial situations. Interest rates on payroll financing can be as high as 30 percent, so you should consider all options before pursuing a loan from a payroll financing company.
Below, you’ll find a few situations in which a payroll loan might make sense for your small business:
1. You’re facing a short-term cash shortage
When you run a small business, cash flow isn’t always a smooth cycle. Sometimes, paying for a big business expense (like an equipment repair) could leave you with a cash shortage. Then, when it comes time to manage payroll for the month, you won’t be able to afford to pay your employees.
If you know you’re getting paid by a customer in less than a month, a short-term loan that you can repay quickly could keep your business’s cash flow stable.
2. You’ve hired extra workers for an expected surge in sales
If you own a seasonal business, you might have funding fluctuations between your slow and busy times.
For example, if you run a coastal vacation business, you could benefit from paying a staffing agency to recruit employees for your summer season. However, before the busy season picks up, you might not have enough revenue to pay your new help. Luckily, a payroll loan can fill that gap, so all employees get paid prior to the summer rush.
3. You haven’t been approved for funding by traditional lenders
If you can’t get approved for traditional business loans but need to send paychecks out as soon as possible, a payroll loan could be your only option. Taking a hit on a 15-30 percent interest rate payroll loan is better than facing the consequences of not paying your employees on time!
Conclusion: Are Payroll Loans Right For Your Business?
Usually, payroll loans are quicker and easier to qualify for than SBA or bank loans. Plus, you’ll receive the funding almost immediately, making it possible for you to pay your employees on-time. Still, you should thoroughly examine the terms and conditions prior to applying.
Payroll loans should be a last resort for most businesses, not a long-term funding solution. You’ll pay handsomely for obtaining quick cash, and the penalties for missing payments can be steep. Make sure you’ve considered all other avenues, including lines of credit, traditional loans, and cash advances before pursuing payroll financing. However, know that payroll loans are available if you find yourself in a cash flow crunch.
Editor’s Note: This post was updated for accuracy and comprehensiveness in March 2021.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.