Payroll loans for small businesses: 6 options (plus helpful tips)

Sometimes as a small business owner, payday approaches and you realize you are short on the cash you need to pay your employees. This doesn’t automatically mean your business is struggling - it happens in periods of high growth as well. However, it’s a problem that payroll loans for a small business can solve. Read on to learn more about these loans and find some tips for making payroll.

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What is a payroll loan?

A payroll loan is an umbrella term that includes the many types of small business loans, including private short-term loans and government-backed long-term loans that can be used to cover payroll.

How do payroll loans work?

The way payroll loans work varies by loan type. For example, if you’re using a merchant cash advance to cover your payroll expenses, you might repay your loan in daily increments. That’s a very different model than if you were to use SBA 7(a) loans for payroll financing where you’ll repay your loan in predictable monthly installments over a longer period of time.

Another thing to consider: With payroll loans, you might need funding sooner than later to pay your team. If that’s the case, your options might be limited to loans that offer rapid funding – and these loans often have terms that are unfavorable. You might get saddled with high interest rates and short repayment periods, resulting in higher monthly payments compounded by those high interest rates. If possible, it's generally best to get a borrower-favorable loan, even if you have to wait longer for your funding.

6 payroll loan options for your small business

Whether you need to pay your employees tomorrow or you’re putting a fallback plan in place for future potential cash flow issues, you may have options. The below financing options may work wonders as payroll loans for your small business.

1. SBA 7(a) loans

SBA 7(a) loans are often considered the gold standard by small business funding experts. These government-backed loans come with long repayment periods, low interest rates, and high potential loan amounts. With SBA 7(a) working capital loans, you can cover payroll without generating a mountain of extra debt that needs to be repaid quickly.

Speaking of quick, SBA 7(a) loans have one considerable drawback when it comes to payroll loans. Namely, if you desperately need to pay your employees now, you can’t quite do that with SBA 7(a) loans. Completing, filing, and hearing back on your loan application can take a month – sometimes more. That said, if you qualify for SBA 7(a) loans, they’re a fit in every other way. And if you can wait to cover your expenses, you’ll be grateful you didn’t incur short repayment terms and high interest rates.

Below are some quick facts about SBA 7(a) loans.

  • Loan amount: $30,000 to $350,000
  • Repayment period: 10 years
  • Repayment schedule: Monthly
  • How long you’ll wait for funding: Typically at least 1 month

2. Bank term loans

Bank term loans could cost you slightly more, but otherwise, their benefits are roughly the same. They can give you a large lump sum of money you can use to cover payroll. You’ll repay this loan over several years, whereas online alternative payroll loans typically require repayment within a year. Your interest rates would generally be reasonable and will likely not change over time like SBA 7(a) loans.

That said, you’ll likely wait a while for bank loan funding too. Although you can get bank funding a bit quicker than SBA 7(a) loans, they’re nowhere close to same-day funding. But patience is generally worth it if you have the time.

The basics of bank term loans are below:

  • Loan amount: $30,000 to $500,000
  • Repayment period: 2 to 5 years
  • Repayment schedule: Monthly
  • How long you’ll wait for funding: Approximately 1 month
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3. Short-term loans

Short-term loans are any type of loan you’ll repay within one year of funding. At first, this short repayment period may seem beneficial – you likely won’t have business debt hanging over your head for years. In reality, this short repayment period can needlessly inflate your loan payments by cramming the repayment schedule into a short period. Adding insult to injury, these loans are typically available primarily through alternative online lenders that tend to charge exorbitant interest rates and fees.

So, then, why do so many small business owners cover payroll with expensive short-term alternative online loans? The main reason is that these loans can make funding available within 24 hours. That can be a big deal – payroll gaps can increase turnover rates. From that perspective, maybe the high cost of these loans is worth keeping your employees around. Just be certain you can repay the loan before you sign the dotted line.

Here are the key terms and conditions of your average short-term loan:

  • Loan amount: Varies widely among lenders
  • Repayment period: Up to 1 year
  • Repayment schedule: Daily, monthly, or weekly
  • How long you’ll wait for funding: As little as 1 day, and rarely longer than 1 week

4. Business line of credit

Most payroll loans are installment loans, meaning you’ll repay the entire loan amount in monthly installments. That’s true even if you don’t use the whole loan. Business lines of credit present an alternative to this model since they’re revolving loans, not installment loans. That means you can use any amount of money up to your maximum credit limit, and you’ll only pay for what you use. And since business credit lines’ interest rates can be quite high, this repayment flexibility is a huge plus.

The revolving nature of business lines of credit introduces funding and cost flexibility atypical of most payroll loans. For example, let’s say you receive a $50,000 business line of credit when you only need $15,000 to cover your remaining payroll expenses. That’s great – you’ll only pay interest and fees on that $15,000 for as long as it takes you to repay it and, once you do, you can borrow it again, just like with a credit card.

Below are the basics of business lines of credit:

  • Loan amount: Varies by lender, but can reach into the six-figure range.
  • Repayment period: Flexible
  • Repayment schedule: Flexible
  • How long you’ll wait for funding: Approximately 2 weeks

5. Invoice financing

In business, things happen and one of the reasons you may be struggling to cover payroll is because your clients are behind on paying their invoices. In that case, invoice financing may be a great choice. It’s a type of funding based on the value of your accounts receivable (A/R) that may help fill the gap and allow you to cover payroll.

When you seek funding from an invoice financing company, you’ll share your total A/R value along with your outstanding invoices. The finance company will then lend you roughly 80 percent of your A/R value via an installment or revolving loan. You’ll then keep pursuing payment from your clients. After that, you’ll deduct your loan amount from what clients have paid you, and the lender will keep part of that difference.

Another type of payroll loan for small businesses, invoice factoring, is similar to invoice financing. There are several differences between invoice financing and invoice factoring. For starters, invoice factoring companies will take over your collection process. They also charge slightly higher fees – but with that extra cost comes a loan that’s 85 to 90 percent of your A/R value. Both options are powerful for rapidly obtaining the cash you need to pay your team.

Below are the fundamentals of invoice factoring and financing:

  • Loan amount: 80 to 90 percent of your accounts receivable
  • Repayment period: You’ll repay your loan as your A/R turns into cash.
  • Repayment schedule: You’ll repay your loan as your A/R turns into cash.
  • How long you’ll wait for funding: Typically just a few days

6. Merchant cash advance

Merchant cash advances (MCAs) are perhaps the most hands-off type of payroll loan. Once you’ve obtained the loan, the lender will automatically keep a portion of all your daily or weekly debit and credit card sales. On top of that, if you’re approved for a merchant cash advance, you can often get your funding 24 hours after you apply. That makes MCAs a great choice for immediate needs.

That said, MCAs come with a considerable drawback: They’re often the most expensive type of loan. You’ll likely pay a factor rate of 1.1 to 1.5 instead of an interest rate. This means that your fees will be between 10% and 50% of your loan’s total. The shorter your repayment period, the higher this factor rate makes your effective APR, which can exceed 100%. So while MCAs can be helpful for covering your payroll costs today, they could become very expensive very quickly.

Your MCA might look like this:

  • Loan amount: $2,500 to $500,000
  • Factor rates: 1.1 to 1.5
  • Repayment period: 3 months to 3 years
  • Repayment schedule: Daily or weekly
  • How long you’ll wait for funding: 1 to 7 days

Tips on making payroll in the future

Although payroll loans can help you cover your bases, they also introduce new expenses. To avoid the extra costs, consider the following:

  • Account for cash flow. At some points in the year, you’ll have more cash coming in than others. You should account for these shifts in your financial planning so you’re more likely to have the cash you need on hand for payroll.
  • Save money for possible future troubles. Periods of growth don’t guarantee a future clear of roadblocks. That’s why these periods are generally a great time to put aside some extra cash for any future emergencies, including an inability to pay payroll.
  • Be honest and transparent with your employees. It’s better to alert your employees to a payroll problem and explain how you’re solving it than to sweep it under the rug. Assuming you make good on your promise, this transparency can help humanize you to your team and allow them to plan their finances while the issue gets worked out.

Search for payroll loans with SmartBiz

Payroll loans include short-term options for urgent needs and long-term options for sustained payroll coverage. SmartBiz® can connect you with SBA and bank payroll loans. Check now whether you pre-qualify* for the funding you need to pay your team.

*We conduct a soft credit pull that will not affect your credit score. However, in processing your loan application, the lenders with whom we work will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and happens after your application is in the funding process and matched with a lender who is likely to fund your loan.

WHAT YOU NEED TO KNOW: The SmartBiz® Small Business Blog and other related communications from SmartBiz Loans® are intended to provide general information on relevant topics for managing small businesses. Be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed. Please consult legal and financial processionals for further information.

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