Payroll Loans for Small Business: The Good, the Bad, and the Necessary

Running a small business can be like riding a rollercoaster—thrilling, but terrifying—especially when payday rolls around. One of the biggest challenges a small business can face is making sure your team gets paid on time. That’s where payroll loans for small business come in handy. These lifesavers provide the funds a business needs to cover payroll when cash flow is tight. 

Small business loans happen more often than you think. A Forbes Advisor Survey found that 21.8% of respondents used small business loans to help offset payroll costs.

In this article, we’ll explore what payroll loans are and how they work, as well as give you some steps to avoid them and some alternatives to think about. We’re here to make sure small business owners like you know everything you need to know about payroll loans so you can make the right decisions for your business.

What is a payroll loan?

A payroll loan is a short-term financing option designed specifically to help businesses cover their payroll expenses. Think of it as a financial Band-Aid. These loans are important for businesses facing a cash crunch but needing to keep the lights on and employees paid.

Unlike start-up loans or other business loans, payroll loans are meant for short-term use and usually come with shorter repayment terms and higher interest rates. They became particularly popular during economic downturns when businesses struggled to maintain steady revenue streams.

How do payroll loans work?

Small business payroll loans aren’t your typical loans. They often have shorter repayment terms, meaning you’ll need to pay them back within a few months. The interest rates can also be higher because of the urgent nature of the loan.

While regular loans might be used for buying new equipment or special projects like transitioning from a pop-up shop to permanent location, payroll loans are laser-focused on covering wages. They’re the financial equivalent of calling in the cavalry when your back’s against the wall.

Types of payroll funding for small business.

Even though these loans are specifically to finance payroll, you’ve still got options. You can choose between different types of payroll loans for your small business depending on your needs and what type of interest you can handle. Here are some of the most common types of payroll loans:

1. Short-term business loan.

A short-term business loan gives you a lump sum of cash that you pay back over a short period, typically within a year. These loans are great for quick fixes and immediate payroll needs. The only ‘but’ is that they often come with higher interest rates and fees—and those can add up quickly. They’re not for the faint of heart.

2. Business line of credit.

A business line of credit is like having a financial safety net. You can borrow up to a certain limit and only pay interest on the amount you use. A payroll line of credit loan is perfect for fluctuating payroll needs. The downside? Variable interest rates and they usually require a strong credit history to qualify.

3. Invoice factoring.

Invoice factoring involves selling your outstanding invoices to a factoring company at a discount for immediate cash. It’s a quick way to get funds without taking on more debt, but you do lose a chunk of your revenue to the factoring company. It’s like paying for express shipping—fast, but not cheap. If you’re already having cash flow struggles, this isn’t the best option for most businesses.

4. Working capital loans.

Working capital loans cover everyday expenses—including payroll. They can be short-term or long-term, depending on who the lender is. These loans provide a quick cash infusion but usually come with higher interest rates and strict repayment terms. It’s like getting a caffeine boost during your mid-day slump—great in a pinch, but not a long-term solution.

Where do you find payroll loans?

Now that you know what types of payroll loans for small businesses are out there, it’s just a matter of applying. But where do you get a payroll loan?

Banks and credit unions.

Traditional banks and credit unions offer payroll loans with competitive interest rates and favorable terms. They’re reliable and often come with lower interest rates. The catch? The application process can be super slow and the requirements are pretty narrow.

Small Business Administration loans.

Small Business Administration (SBA) loans are government-backed. They offer favorable terms and lower interest rates. Government-backed loans are great because they’re flexible and supportive of small businesses, but the application process can be time-consuming, and approval’s not guaranteed. It’s worth it if you can wait.

Online lenders.

Online lenders are the fastest lenders in the loan world. They offer fast and convenient access to payroll funding for small business with minimal paperwork. But, like other small business payroll loans, they often come with higher interest rates and fees. Quick and easy, but not always the healthiest option for your business’ bottom line.

Factoring companies.

Factoring companies can offer immediate cash by purchasing your outstanding invoices. Quick cash without adding debt to your balance sheet is the perk for these loans. The disadvantage is the cost because you lose a portion of your revenue. These loans give you money fast, but they take away future income—which can create a bad cash flow cycle.

What are the alternatives to payroll loans?

If learning about payroll loans for small business is making you rethink that payroll loan application, we’ve got you covered. Here are some alternatives you can look into instead of payroll loans:

Collect overdue bills.

Chasing down overdue invoices is a surefire way to improve cash flow without taking on debt. Implement a clear collections process and offer incentives for early payments. Strike a balance of being persistent but polite.

Offer discounts or throw a sale.

Offering discounts for early payments can encourage customers to pay their invoices sooner, improving your cash flow. Depending on your business, you could also run a sale to run through some inventory at a faster pace. This can be a great way to speed up incoming cash without needing a loan. After all, everyone loves a good deal.

Take out a personal loan.

If you’ve got a solid personal credit history, taking out a personal loan can be an option to cover payroll. Quick and flexible—but remember, your credit is on the line. Think of it as borrowing from your future self. If you feel confident that this cash flow issue is temporary, this could be the way to go.

Liquidate assets.

Selling off non-essential business assets can bring in immediate cash. This might include old equipment, overstock inventory, or real estate. It’s like a garage sale for your business—out with the old, in with the cash.

Research grants and special financing.

There are grants and special financing options available all over the internet—you just have to know where to look. These types of financing are especially for specific industries or underrepresented groups and can provide funding without the need for repayment. If you have a business in a specific industry or are part of an underrepresented group, pull up a search engine and take a look around.

Ask yourself these questions before filling out a payroll loan application.

Loans for payroll purposes are a short-term solution. Before you put pen to paper—or fingers to keyboard—take a moment to really think through what your business needs. Here are some key questions to ask:

How much capital do I really need?

Be honest with yourself and calculate the exact amount needed to cover payroll and any other urgent expenses. A poor guess or overestimation could put you on the hook for more interest than you need to pay.

What’s my underfunding number?

How low can you go before it seriously impacts your operations? Figure out the minimum amount you need to keep things running smoothly.

What’s my overfunding number?

What’s the maximum amount you need without taking on any unnecessary debt? Try to avoid borrowing more than you can handle or truly need.

Did I see this cash flow issue coming or was it a surprise?

Did you see this coming, or is it an unexpected shortfall? Understanding the cause can help you plan better for the future.

Will enough revenue return sooner or later?

What’s the forecast for your business revenue? Really assess whether this is a temporary hiccup or a longer-term issue that needs more strategic planning.

What type of repayment plan am I looking for?

What works best for your cash flow situation? Look at all of the repayment terms and choose one that lines up with your revenue cycles.

What loan terms am I looking for?

Think strategically about the loan terms, including interest rates, repayment schedules, and any potential fees, to make sure they fit your business goals.

How quickly can I repay the loan?

Be realistic about your repayment ability. Consider your current and future cash flow to avoid overcommitting yourself.

How can I avoid needing payroll loans in the future?

Plan ahead by setting aside emergency funds, improving your cash flow management, and exploring other financing options that might offer more stability.

What happens if a business doesn’t make payroll?

Missing payroll isn’t just a financial hiccup—it’s a serious issue with legal and financial repercussions. We aren’t writing this all out just to scare you. We just want you to have all of the information you need. If your business fails to meet state payday requirements or other employee payment laws, it’s considered wage theft.

Here’s what could happen:

1. Paying your employees’ wages with added interest or additional fees.

When you miss payroll, you could be required to pay not only the owed wages, but the interest or fixed additional fees as penalties.

2. Penalties and prosecution under the Fair Labor Standards Act.

Wage theft can lead to severe penalties, or even criminal prosecution for violating the Fair Labor Standards Act (FLSA). These violations are taken very seriously, and consequences can be harsh.

3. IRS penalties and liens for late payroll taxes.

If you fail to pay payroll taxes on time, it can lead to IRS penalties, interest charges, and even property liens. The IRS doesn’t take noncompliance lightly, and their penalties can add up—quickly.

4. Civil and criminal prosecution by the IRS.

Noncompliance with employment tax laws can lead to both civil and criminal prosecution by the IRS. This could mean big fines, legal battles, and even jail time in extreme cases.

5. Private lawsuits from employees or independent contractors.

Everyone’s got bills to pay. Employees or independent contractors who aren’t paid on time could file private lawsuits for back pay. These lawsuits usually include claims for attorney fees, adding to the financial burden.

Again, we don’t want to scare you. Some penalties and fines might be waived if your nonpayment is found to be unintentional and due to a “good faith legal justification”. You’re still responsible for the wages owed. Missing payroll is something you want to avoid at all costs. So, how do you do that?

How to avoid cash flow issues.

Avoiding cash flow problems is the most important thing you can do to keep your business financially healthy. Here are some ways to do just that:

  • Only offer credit terms to customers who’ve proven their creditworthiness. This helps reduce the risk of unpaid invoices and improves cash flow reliability.
  • Accept credit cards, electronic, and online payment options. If you offer multiple payment options you can speed up the receivables process and make it easier for customers to pay.
  • Offer a discount to customers who pay their bills early. Encouraging early payments for things like bulk orders can improve cash flow and reduce the time spent on collections.
  • Ask your suppliers to extend your payment period, if possible. Negotiating longer payment terms with suppliers can help line up your outgoing payments with your incoming cash.
  • Set money aside in a cash reserve account for emergencies. We know that margins can be tight in small businesses. Having a cash reserve can give you a safety net during periods of low cash flow.
  • Budget for seasonal fluctuations in revenue and expenses. Anticipate and plan for seasonal changes to help you manage cash flow more effectively.
  • Consult an accountant or other financial professional. Getting expert advice can help you create a cash flow management strategy and see any potential issues before they become a big problem.

Payroll loans for small business: Should you take one?

Payroll loans can be a lifesaver for small businesses facing cash flow issues, but they’re not without their challenges. By understanding your options, asking the right questions, and planning ahead, you can swim these financial waters like a pro. 

You don’t have to swim it alone.

Homebase is here to help with payroll solutions designed to make your life easier. With built-in time tracking and automatic tax calculations, you’ll always have a clear idea of your upcoming payroll costs. That way, you can plan ahead to avoid or mitigate your payroll loans, and focus your attention on building your business.


Payroll loans for small business FAQs

Can payroll loans be used for other expenses?

Typically, payroll loans are specifically designed to cover payroll expenses, but some lenders may allow you to use the funds for other urgent business needs. Always check the loan terms.

What’s the difference between a payroll loan and a regular business loan?

Payroll loans are short-term and focused on covering employee wages, usually with quicker repayment terms and higher interest rates. On the other hand, regular business loans can be used for a variety of business expenses and usually have longer repayment periods.

How quickly can I get a payroll loan?

Approval and funding times vary by lender, but online lenders can typically provide funds within a few days. Traditional banks may take longer.

Are payroll loans expensive?

Payroll funding for small business can be expensive because of higher interest rates and fees. It’s important to compare options and understand the total cost of borrowing before deciding which loan you’re going to go with.

What are some alternatives to payroll loans?

Alternatives to using loans to finance payroll include collecting overdue bills, offering discounts for early payments, taking out a personal loan, liquidating assets, and researching grants or special financing options.

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