Payroll Loans: How to Use Them
Janet Schaaf is a freelance writer, editor and proofreader who considers reader advocacy to be her calling. After taking a few roads less traveled, Janet completed a bachelor’s degree in English Literature from the University of Missouri-Kansas City, with English Department Honors. She has been correcting grammar and checking facts since she could string a sentence together. For the past three years, Janet has focused on making personal finance topics understandable and relatable. Loan terms and credit card agreements can look overwhelming, but understanding what you’re agreeing to is paramount in grasping the impact debt can have on your life.
If your small business is tight on cash, a payroll loan can help fund payroll costs, including wages and bonuses, benefits and tax obligations.
There are several types of loans available to cover payroll, and you’ll want to consider the amount you need, other expenses and your repayment timeline before deciding what option is best.
What is a payroll loan?
Payroll loans are a type of short-term, small business financing used to help pay a business’ employees. For example, you can use a payroll loan to fund employee paychecks or pay invoices received from independent contractors. In addition to wages and salaries, payroll loans can help with employee benefits, taxes, commissions and bonuses.
Can payroll loans be used for other expenses?
You can use several different types of business credit to finance payroll, including business term loans, lines of credit and merchant cash advances. Most business financing options offer business owners flexibility when spending the funds, with the exception of equipment loans and commercial real estate loans.
That means you can use a payroll loan for other business expenses in addition to employee wages. For example, you might use a short-term loan to cover payroll as well as buy inventory and cover marketing costs. However, most lenders won’t allow you to use the funds for personal expenses.
Types of payroll loans
| Payroll loan type | Maximum amount | Repayment time frame | Best for |
|---|---|---|---|
| Short-term loans | $1.5 million | 3 to 24 months | Emergency expenses |
| Working capital loans | $5 million | Varies by loan type | Smoothing out cash flow issues |
| Line of credit | $750,000 | 12 weeks to 5 years | Ongoing hiring needs or business expansion |
| Merchant cash advance | $1.5 million | Variable based on revenue | Businesses with bad credit |
| Invoice factoring | Up to 95% of accounts receivable | N/A | Businesses with slow-paying clients |
Short-term business loans
Short-term business loans provide a lump sum that is typically repaid in fixed daily or weekly installments over three to 24 months. They often come from online lenders, which have more lenient requirements than traditional brick-and-mortar banks, and you can get your funding as soon as the next day. They may also come with higher interest rates, ranging from about 7% to 50% or higher. Make sure to compare the total cost of borrowing when comparing lenders.
Working capital loan
A working capital loan is any form of business financing used to cover day-to-day operating costs, including payroll. While these loans are often short-term loans or lines of credit with terms of 24 months or less, some long-term loans can be used for working capital as well.
For example, the SBA 7(a) loan, which is available in amounts up to $5 million, can be used for long-term working capital and repaid over as many as 10 years.
If you have seasonal fluctuations in business revenue, an unexpected expense or other cash flow issues, a working capital loan can help.
Business line of credit
A business line of credit is a revolving line of credit that your business can borrow from on an ongoing basis. It functions like a business credit card, but typically comes with higher borrowing limits. You only pay interest on the amount you use, and your line of credit replenishes as you make payments.
Terms typically range from 12 weeks to five years, and lenders often charge higher rates for longer terms. You may pay an origination fee, maintenance fee or draw fee in addition to interest, so pay attention to the total cost when comparing lenders.
Merchant cash advance
A merchant cash advance is a lump sum that is repaid as a percentage of your future sales. Merchant cash advance companies typically use a factor rate to express the cost of the advance, and collect daily or weekly over the course of three to 24 months, or until the loan is fully repaid, based on your credit card or debit card sales. These rates are typically higher than the interest rates on other forms of financing, but merchant cash advances are quick to obtain and easier to qualify for than other forms of credit.
Invoice factoring
With invoice factoring, businesses can sell their unpaid invoices to an invoice factoring company and receive up to 90% of the uncollected total. The invoice factoring company turns a profit by collecting payments for the invoices and keeping the difference. However, if a client fails to pay a disputed invoice, the invoice factoring company may require the business to repay the advance.
One advantage of invoice factoring is that it doesn’t come with the same requirements as a business loan, so you can often get an advance on your unpaid invoices even if you have bad credit and no additional collateral.
Can I still get a PPP loan?
The Small Business Administration previously offered a type of payroll loan called the Paycheck Protection Program (PPP) during the coronavirus pandemic, but the program ended May 31, 2021. Existing PPP borrowers are eligible for loan forgiveness on the total balance used, provided they maintained employee retention and compensation and spent the proceeds on eligible expenses, with at least 60% of the funds going toward payroll costs. Borrowers may be eligible for partial loan forgiveness in other scenarios.
Borrowers can apply online using the SBA PPP Direct Forgiveness Portal.
Alternatives to payroll loans
The alternatives available to you will depend on the amount you need and how quickly you need the funds to cover payroll, but you can explore the following options:
- Collect overdue bills. Review your accounts receivable, starting with the most overdue invoices, and reach out to customers or clients by phone to remind them. You may offer a payment plan if they can’t pay all at once.
- Offer discounts. If your business frequently faces cash flow issues, try offering your customers an early payment discount. The U.S. Chamber of Commerce notes this can provide a competitive edge and help with customer retention.
- Take out a personal loan. Some lenders allow borrowers to use personal loan funds for business expenses. Personal loans are often easier to qualify for than traditional business loans, but loan limits may be lower, and you’ll be personally liable for repayment.
- Liquidate assets. Consider liquidating your investments to raise cash, especially if you can do so without penalty. You can also sell business equipment, land or vehicles. If those assets are essential to your operations, consider leasing them instead.
- Sell stocks or take on a partner. A public offering isn’t the only way to sell shares of ownership in your business — you can also use business crowdfunding, look for an angel investor or venture capital financing or start a partnership that may be mutually beneficial.
- Research grants and special financing. Check whether you’re eligible for any business grants, which don’t need to be repaid, or special loan programs. You’re more likely to find opportunities if your business innovates, benefits the public or is a woman- or minority-owned business.
- Pay your employees’ wages with interest or fixed additional fees.
- Pay other penalties or face criminal prosecution for violations of the Fair Labor Standards Act.
- Face IRS penalties, interest and even property liens for late payroll taxes.
- Face civil and criminal prosecution by the IRS for noncompliance with employment tax laws.
- Face private lawsuits brought by employees for back pay (plus attorney fees).
- Face private lawsuits from independent contractors for breach of contract and potentially pay double damages in some jurisdictions.
Note that you could be exempt from penalties and fines if your nonpayment is not found to be willful due to a “good faith legal justification.” But you’ll still be responsible for the employee wages owed, and you may lose the trust of your employees in the meantime.
How to avoid payroll loans
Since payroll loans can be costly, it’s best to manage your business finances to avoid cash flow issues that might lead you to borrow. Follow best practices, including:
- Conduct a business cash flow analysis to better time your expenses.
- Maintain cash reserves to cover emergency expenses.
- Request immediate payment terms and use automatic billing options if possible.
- Follow up with customers and collect late-payment fees.
- Use a business credit card for short-term, recurring expenses.
- Forecast future cash flow to anticipate seasonal inconsistencies.
- Don’t pay your bills early if there’s no advantage, in case you need the capital.
If you’re still having cash flow issues, you may need to find ways to reduce your expenses or raise your prices. You may also need to evaluate your products and services and eliminate offerings that aren’t making money for your business. Identifying and correcting these issues may help you generate positive cash flow and reduce the likelihood you may need to take out short-term financing in the future.