Payroll Business Loans: The Top Pros and Cons

Matthew Gillman

Updated: March 23, 2022
payroll-business-loans

Payroll is often the most substantial monthly expense for many smaller businesses. Inability to make payroll or bouncing a payroll check can have severe repercussions for your organization. Employees may resign, you may face sanctions or litigation, and the tarnished reputation could damage employee, customer, and client relationships.

If you are unsure about your capacity to fulfill payroll responsibilities, taking out a payroll loan could be a wise decision.

What is a Payroll Loan, and How Does It Work?

A payroll loan refers to a category of loans that helps organizations pay their workforce. Numerous types of financing, including invoice financing and lines of credit, can be utilized as payroll loans since they finance swiftly enough to meet your payroll obligations. Most lenders regard payroll as a typical working capital expenditure. Thus, these small business loans are considered as working capital loans occasionally.

Online, alternative lenders typically offer payroll loans as they require quick financing. The type of loan requested dictates the working fashion of payroll loans. Generally, such loans have a duration of one year or less with variable interest rates. Payroll loans feature higher interest rates than other business loans due to their short-term status and requirement for quick financing. Lenders extending payroll loans seek daily or weekly payments rather than a longer-term monthly payback schedule.

Top 3 Types of Payroll Loan Options

Short-term loans, invoice financing, and business lines of credit are three forms of payroll loans that can fund you instantly and with no constraints on how you utilize those funds.

1. Short-Term Loan

Since these loans are intended to be repaid soon, they have short terms, usually less than a year. Online lenders can rapidly approve qualifying short-term loan borrowers and provide them with the funds they require in as little as one day in some cases. You should have a credit score in the 600s, and your business must be operational for at least a year to borrow money. 

2. Business Line of Credit

Due to the evolving nature of business lines of credit, you can access these funds whenever you need them, and you’ll only be charged interest on the money you spend. Once you’ve paid off everything you’ve borrowed, your credit line will revert to its previous balance. After you’ve taken care of your payroll, you can leverage your line of credit to order stock, generate cash flow, invest in new promotional tactics, etc., as long as it’s within the spectrum of your allocated loan balance and you’re confident of paying back within your loan terms.

Also, if you are starting an LLC in Florida, business lines may be helpful if you’re expanding your operations. 

3. Invoice Financing

A lender provides you capital in the amount of 85% of the value of your outstanding invoices via invoice financing. The lender withholds the remaining 15% until your client repays you, and meanwhile, they will charge on that proportion. Then, once you’ve received the money, you can use the outstanding invoice as collateral. Because the invoice is recognized collateral, you will not need to provide financial statements or credit history to qualify with a finance company.

What are the Pros of Payroll Business Loans?

Here are several cases in which obtaining a payroll loan would be advantageous to your firm.

Employee retention

Employees rely on their earnings to cover monthly rent payments, car down payments, EMIs, and other expenditures. If you fail to pay them on time or at all, they will most likely look for a job elsewhere. You can borrow instantly and minimize payroll delays with a payroll business loan. Several payroll loans get funded within 24 hours. So, if you don’t expect to be able to make payroll today, you’ll receive the money by tomorrow’s paycheck run.

A convenient loan approval process

A conventional bank loan application can take several months between documentation requirements, paperwork, and processing. On the other hand, a payroll loan requires less underwriting and can get funded quickly. A simple approval procedure implies you’ll spend a little less time negotiating with banks and far more time running your company.

Get away from a situation of cost-cutting

While witnessing the possibility of missing payroll, many businesses choose to cut expenditures elsewhere. While this is preferable to failing to pay your workforce, it is not optimal. If you don’t have the required products and services on offer at a particular point in time, you will lose sales, or clients may move their operations elsewhere.

With a payroll business loan, you can avoid missing payroll without diverting funds from other obligations like rent, inventory, or bill payments. You can keep your staff engaged and continue to invest in your firm by borrowing the money.

Deal with capital shortage with access to additional cash flow

You might run out of funds for working capital requirements due to uncontrollable situations. A customer fails to make payments in time, their check bounces, or your costs have unexpectedly increased more than you anticipated. Whatever the cause, payroll loans are perfect for dealing with a short-term liquidity crunch due to their speedy funding.

What are the Cons of Payroll Business Loans?

High-interest rates

When you require money urgently, you’ll have to pay more to borrow it. This is because lenders do not have as much time to investigate your firm thoroughly. They’re taking on greater risk with your loan, and they’ll compensate by imposing a higher cost of capital. Expect to pay a premium ranging from 15% to 45% for a payroll loan.

Shorter repayment terms

Lenders prefer to be paid back quickly, so anticipate a short repayment time. Indeed, most payroll lenders will need you to present a post-dated check for the whole loan amount. If you fail to repay your loan by the due date, you will be charged costs by both your bank and your online lender.

Payroll loans could cultivate a debt cycle

Sliding into a debt cycle might prove to be detrimental to your organization’s future. When you sign out a payroll loan, be sure you have a strategy to repay it. Otherwise, you risk falling into a cycle of debt to meet payroll responsibilities.

Conclusion

Most enterprises should not consider payroll business loans as a long-term financial solution. You’ll pay a high price for quick fundraising, and the consequences of missing payments might be severe. Before seeking payroll finance, be sure you’ve exhausted all other options such as lines of credit, standard business loans, and cash advances. Yet, if you find yourself in a cash flow crunch, payroll loans are indeed an alternative.

However, the benefits of a payroll loan frequently outweigh the disadvantages, mainly if your company relies on highly skilled and qualified professionals. So the best piece of advice is to invest in your employee training and relations.

Matthew Gillman
Matthew Gillman is the founder and CEO of SMB Compass, a bespoke business financing company focused on providing financing and education to small businesses across the U.S. The company has provided over $250 million to more than 1,250 businesses. Coming from a family of small business owners sparked Matthew’s passion to not only become an entrepreneur, but also to work with his fellow entrepreneurs to build long-lasting relationships.

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