It happens. Business is chugging right along — until it isn’t. You might have a slow month or two when you find it difficult to cover business expenses, including payroll. What then? How can you ensure your staff gets paid as your business gets back to normal?
Fortunately, there are business loans you can use to cover such expenses at times like these. In fact, there are even specific payroll loans to help.
To clarify your options, here’s a closer look at small business loans that cover payroll.
Key Points
• Payroll loans provide quick funding for wages and benefits.
• Options include short-term loans, lines of credit, invoice factoring, and cash advances.
• Fast approval and funding, often within days, are typical.
• Higher interest rates and short repayment terms are common.
• By allowing workers to be paid on time, payroll loans can also help businesses avert staff.
What Are Payroll Loans?
“Payroll loans” is an umbrella term for any type of short-term financing that small businesses can use to cover payroll and related expenses, such as staff health insurance premiums.
Many different loan types are under this umbrella, including short-term business loans, business lines of credit, invoice factoring, cash advances, and working capital loans.
Because payroll loans have to be funded fast, they’re frequently offered by online, alternative lenders, though you may be able to get one through a bank or credit union as well. Qualification requirements, interest rates, and repayment terms for a payroll loan will vary by the lender and the amount of the loan.
How Do Payroll Loans Work?
As noted above, payroll loans fund quickly (sometimes in just a few days) and generally have a repayment term of one year or less. Specifics about how your payroll loan works will depend on the type of loan you choose.
For these short-term loans, you may be required to make weekly — or even daily — payments to the lender throughout the life of the loan. Payments usually contain principal and interest.
Common Uses for Payroll Loans
Payroll loans can typically be used to cover payroll, payroll taxes, and employee benefits. Before applying for any kind of business loan, however, it’s wise to research any rules about what that loan can be used for, so you can be sure to stay within those parameters.
Depending on the type of loan you choose, you may also be able to use a payroll loan to cover other business expenses such as inventory and office supplies.
4 Types of Payroll Loans
Payroll financing is generally offered via these four types of small business loans.
1. Invoice Factoring
If you have unpaid customer invoices, you may be able to borrow money against those invoices with invoice factoring.
With this type of financing, you sell your invoices to a factoring company, which then forwards you up to 90% of their value right away. The factoring company then owns the invoices and gets paid when it collects from your customers. Once the factoring company gets paid, you get the remaining value of those invoices, minus a fee. Keep in mind, though, that invoice factoring can cost more than other forms of business financing.
2. Short-Term Loans
If you need to make employee payroll right away, a short-term business loan could come in handy. These loans are typically offered to small businesses by online lenders. Once you get approved, you can access the funds quickly — sometimes on the same day. However, the repayment terms are short (often three to 18 months), and interest rates tend to be higher than longer-term small business loans.
3. Cash Advances
Instead of getting a loan to cover payroll, you may be able to get a cash advance based on the volume of your credit card receipts. With this type of financing, called a merchant cash advance, the funding provider gets paid back by taking a portion of your future credit card sales each day.
You can usually get approved fast (often within a day or two) with minimal paperwork. But you’ll likely pay for this convenience in the form of higher interest rates.
4. Lines of Credit
Another option to consider is a business line of credit. Rather than getting all your money at once, you can borrow against the line of credit whenever you need cash. You can borrow a little, pay it back, and then borrow again. Terms will vary by lender, but interest on lines of credit can be lower than credit card rates.
Advantages and Disadvantages of Payroll Loans
If you’re considering a small business payroll loan, weigh the pros and cons.
| Pros of Payroll Loans | Cons of Payroll Loans |
|---|---|
| Provide fast funding | May have a short repayment period |
| Easy to qualify for | May have higher interest rates |
Pros of Small Business Payroll Loans
Some payroll loans require minimal paperwork, vs. others like bank loans or Small Business Administration (SBA) loans. That means you may be able to apply and get approved within minutes. Many lenders will deposit funds in your bank account the next business day, so you can get the cash when you need it.
Certain payroll loans for small business are easier to qualify for than others. Some business loans don’t do credit checks; others consider qualifications other than your credit scores.
And finally, you could lower your risk of staff turnover. Rather than struggling to pay staff, being able to keep payroll smooth and steady can help you keep those great hires you’ve invested time and money in.
Cons of Small Business Payroll Loans
Depending on the type of loan, you may need to repay it within a year or so. The payments may be large and could cut into your profit margins. It can be a good idea to plan out how you’ll pay your loan back as part of your monthly budget.
Likewise, some loans come with higher interest rates, particularly short-term business loans. If you can’t qualify for a bank loan or an SBA loan, your interest rate may rise into the double digits.
And while a payroll loan can solve short-term cash crunches, it won’t be much help if you have bigger financial issues. Consider it a Band-Aid, not a long-term solution.
How to Apply for a Payroll Loan
Once you’ve explored your options for payroll loans, it’s time to choose the one that’s the best fit for you.
The better your credit, the better the terms you are likely to qualify for. This is generally the case for loans.
If you have a high credit score, consider a long-term loan from a bank or the SBA.
If your credit’s less than stellar, there are options that may cost more. Look to merchant cash advances, short-term loans, and lines of credit.
Recommended: Equipment Financing
What Are the Requirements for a Payroll Loan?
Once you’ve landed on the best fit, review the requirements to make sure you meet them. These may include the following:
Business Credit Score
If you have a business credit card and have established a credit history through your business, then your company has a business credit score that is separate from your personal credit score. The higher your business credit score, the more likely you are to get a bank business loan with attractive rates and terms.
Business History
Banks typically want evidence that you’ve been in business for at least two years, since this indicates that you have a successful business model. Online and alternative lenders may have less stringent requirements for how long you’ve been in business.
Debt-to-Equity Ratio
This is the ratio of your existing debt to your business equity. It’s okay if you are carrying some debt, but to approve a loan, banks ordinarily like to see a healthy balance between debt and equity. Generally, a debt-to-equity ratio of around 1 or 1.5 is considered good, but that may vary depending on your industry.
Business Plan
Banks and other lenders will often want potential borrowers to submit a plan for how they will use the loaned funds. Even if you only plan to use the money for payroll, you may want to make a business plan. It demonstrates that you have fully thought through how much you need, how you will use the capital, and how you will pay it back.
Collateral
Some business loans require that you put up an asset to secure the loan. Known as collateral, the asset could be real estate, equipment, vehicles, or other tangible assets owned by you or your business. If your business can’t repay the loan in full, the lender can recoup its losses by seizing the collateral.
Alternative Small Business Loan Options
It’s a smart practice to be mindful of all your financing options, whether you need to cover payroll or another business expense.
Inventory Financing
If you buy and sell products, you likely spend a large portion of your money on inventory. Did you know that you can use the inventory you’re buying as collateral for a loan to purchase the inventory? Lenders will give you a percentage of the value of your inventory as a loan. Be aware that, should you not be able to pay it back, the lender can take the inventory to cover your debt.
Equipment Loans
Just as inventory financing uses inventory as the collateral, equipment loans use the equipment you’re buying as the collateral. Securing the loan in this way often helps you get a low interest rate. Equipment loans can be used to buy computers, heavy machinery, or company vehicles.
The Takeaway
Payroll loans are a type of short-term financing that small businesses can access quickly to cover wages and related expenses. Lenders will assess the business’s cash flow, history, debt-to-equity ratio, and credit score, among other criteria. Though rates on short-term loans tend to be high, you may be able to negotiate better terms by offering collateral, such as business inventory or equipment.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
Can SBA loans be used for payroll purposes?
Yes, the Small Business Administration (SBA) has several loans that you could use for payroll and related expenses. These include 7(a) loans and SBA Express loans.
What does it take to qualify for payroll loans?
That will depend on the type of payroll loan you plan to apply for. If you opt for a short-term business loan from an online lender, you will generally need to show a personal credit score in the 600s, have at least one year of business history, and provide proof of business income.
How exactly do payroll loans work?
The details of a payroll loan will depend on the type of loan you want. However, in general, payroll loans work like any other type of short-term business financing. A lender forwards you a lump sum of capital that you agree to pay back (plus interest) in installments — which may be daily, weekly, or monthly — during the loan’s term. In the case of a payroll loan, the money you borrow is used for the specific purpose of paying your employees.
What are the risks of using a payroll loan?
If you take out a secured payroll loan — that is, one involving collateral — the bank’s risk is reduced, but yours increases. That’s because, if you default, the bank can seize your collateral. Also, short-term loan payments can be hefty, potentially reducing your cash flow and prolonging the debt crunch.
Can payroll loans help businesses avoid layoffs?
Yes. A business may not need to resort to layoffs or reducing company benefits if it can borrow money to cover wages and employment expenses. Avoiding layoffs could also help keep both morale and productivity high, which may in turn boost company revenues.
Photo credit: iStock/sasirin pamai
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