Payroll Loan: A Guide for Small Business Owners

Ezra Cabrera | June 9, 2022


    Your employees expect to get paid on time. But when a pandemic, natural disaster, or even late-paying customers disrupt your cash flow, raising money to cover employee wages can be challenging. Payroll financing gives you the capital you need to pay your employees when cash is tight.

    Read on to learn more about how payroll loans work.

    What is a Payroll Loan?

    A payroll loan is an umbrella term referring to short-term business loans that companies use to cover payroll expenses. There are many forms of payroll loans, including short-term loans, lines of credit, invoice financing, and merchant cash advances. Generally, businesses consider payroll as a working capital expenditure. That said, payroll loans may be synonymous with working capital loans. 

    Note: Payroll loans and payday loans are different and, therefore, shouldn’t be confused with one another. The difference between the two is that small businesses use payroll financing to pay their staff, while payday loans are consumer loans granted to individual employees. 

    How Does a Payroll Loan Work?

    Once approved of a payroll loan, the proceeds can then go towards paying your staff, their employment benefits, and payroll taxes. While other lenders may limit the use of the loans, others may allow flexibility. In other words, you may use the loan for other business expenses – not just payroll. Be sure to ask the lender before signing the contract to avoid mishaps in the future.

    Payroll business loans typically have to be repaid within a year or less, with lenders requiring daily or weekly repayments. Since they have a shorter term and faster approval time, the interest rate tends to be higher than long-term loans.

    The way payroll loans work will depend mainly on the type of loan you choose and the lender you work with. In general, these loans are only offered by alternative online lenders, so approval and funding times tend to be faster than loans offered by banks.

    3 Types of Payroll Loans for Small Businesses

    Companies usually have four options when it comes to financing payroll. Short-term loans, invoice financing, business lines of credit, and merchant cash advances can give you easy access to additional capital that you can use for payroll. It’s worth noting that each loan option has its advantages and disadvantages. It’s essential to be aware of these to make a more informed decision.

    Here’s how each payroll financing option works:

    1. Short-Term Loan

    Short-term loans are the best fix for dealing with unforeseen cash flow gaps. Short-term financing are term loans with a shorter repayment period – usually less than a year or 18 months for some. You’ll receive a lump sum of cash upfront, which you’ll then pay within an agreed-upon loan term. Usually, short-term loans come with a fixed repayment schedule.

    With short-term financing, eligible businesses can get between $2,500 to $250,000 in funding, depending on the lender they work with. The loan’s interest rate may be higher than medium-term or long-term loans, and it’s usually fixed. Although it can be expensive, that doesn’t necessarily imply that you should totally eliminate it from your options. 

    Short-term business loans are generally easier to qualify for. The approval time can be as quick as 24 hours after application. Once approved, the lenders can wire the funds within the next business day. 

    The qualifications for short-term financing vary from one lender to the next. However, having good credit and financial background significantly increases your chances of approval. When applying, aim for the following:

    • A credit score above 600
    • At least one year of business history
    • Solid financial track record

    Note that the qualifications above are not a hard-fast rule among lenders, and some may work with businesses with less stellar credit and financial backgrounds. 

    2. Invoice Financing

    If the root cause of your cash flow gap is slow-paying customers, invoice financing might be a viable choice for you. Invoice financing allows you to leverage your customer’s unpaid invoices in exchange for upfront cash.

    You’ll be able to advance anywhere between 80% to 95% of the total value of your invoices. The lenders will hold 5% to 20% of the invoice value until your customers settle their balances. Once the invoices are paid in full, the lenders will deduct the advanced amount plus the interest on the principal amount. Whatever remains of the 5% to 20% will be wired back to your business account.

    One of the biggest advantages of invoice financing is that it’s open to both new and established businesses. Even if you have less than stellar credit and financial background, the lenders are more likely to approve your loan application as long as you work with reputable customers. Plus, the invoices will serve as collateral for the loan, which adds another layer of protection for the lenders.

    But like other loan options, invoice financing has its downsides. The rates can be expensive – even more costly than short-term financing. Some may charge a starting rate of 3% per week until the invoices have been paid. The rate could go higher if the lenders perceive a higher risk of lending to you.

    Moreover, the invoice financing companies may also require businesses to meet a specific volume of invoices before they approve you for financing. Be sure to clarify with the lender what the terms for the funding are.

    3. Business Lines of Credit (LOC)

    If your cash flow was disrupted by a large, unexpected expense, which could hinder you from making payments to your staff in the next few months, opening a business line of credit may help.

    Business lines of credit are revolving credit that features a credit line with a pre-established credit limit. Business owners can tap into the pool of funds on an as-needed basis. Unlike a typical business term loan, you won’t be obligated to max out your credit limit. Instead, you can draw the amount you need and pay the same amount back with interest.

    As you draw capital from the credit line, your maximum credit limit will decrease and go back up as you repay what you’ve drawn. You can keep drawing and repaying the cash as long as the credit line stays open.

    With a business line of credit, companies will be eligible for anywhere between $10,000 to $1 million. Depending on your qualifications and the lender you work with, the repayment terms can go as short as less than a year to five years.

    Lenders that offer business lines of credit may work with new businesses or those with less than stellar credit. However, you can expect the credit limit to lean on the lower side because of the risk you pose to the lenders. Making repayment towards your credit line on time and diligently gives you a chance to renegotiate the terms so that the lenders can increase your credit limit.

    What are the Pros and Cons of Payroll Business Loans?

    Like other small business financing options, payroll financing comes with pros and cons. Let’s explore both sides of the coin below.


    • Easier to qualify for

    Most payroll loan providers are not as stringent as banks regarding eligibility. Since the financing is usually short-term, there’s a lesser risk on the lender’s part. Plus, with other types of payroll loans like invoice financing and merchant cash advance, your customer’s outstanding invoices and your future credit card sales serve as collateral for the loan, providing another layer of protection. 

    They may be able to extend payroll loans more freely to startups and businesses with less stellar credit. 

    • Fast approval

    Alternative or online lenders are widely known for their fast approval time and less stringent requirements. Assuming that you’ve submitted the needed requirements on time, lenders can approve your payroll loan application within 24 hours after application. 

    • Quick funding

    In addition to fast approval, funding for payroll loans is relatively quick. Some lenders can fund your business within a few hours after approval. This is perfect for companies who need access to cash fast to pay their staff on time. 


    • It’s expensive

    Payroll loans offer a quick approval and funding process, but there’s a catch. The interest rates for these loans are usually higher than more traditional financing options. Additionally, the lenders could charge other fees like origination, administration, late payment, or termination fees, bringing the total loan cost up. Without proper repayment plans, you could end up with financial issues.  

    • Not available through banks

    Banks don’t usually offer these loans because payroll loans require fast approval and funding. Applying for payroll loans from alternative lenders means higher interest rates and more expensive loan fees. 

    • Shorter repayment periods

    As mentioned, the different payroll financing options have a repayment period of less than a year. That means that the weekly or monthly repayments could be higher. 

    How to Get a Payroll Loan

    The application process for payroll loans will vary, but the first step is to find a lender. Payroll business loans are usually offered by alternative online lenders, narrowing down your choices. Don’t limit yourself to one lender for better chances of getting flexible terms. Shop around and see which one best suits your business’ needs and current situation.

    Once you have a lender in mind, you’ll need to provide the necessary documents. The lenders will usually ask for the following:

    • Proof of identity
    • Business information
    • Business licenses and registration
    • Tax returns
    • Bank accounts

    The requirements will vary as well, so be sure to ask for a checklist of documents as much as possible. The faster you can submit the required documents, the faster the application process and decision will be.

    Once your application has been approved, carefully go through the loan agreement. Be sure to check your business information and double-check the spelling. More importantly, make sure that the loan terms reflect what you and the lender agreed on at the beginning. It’s best to go through the loan agreement with your lawyer to better understand the terms. 

    FAQs about Payroll Loans

    About the Author

    Ezra Neiel Cabrera has a bachelor’s degree in Business Administration with a major in Entrepreneurial Marketing. Over the last 3 years, she has been writing business-centric articles to help small business owners grow and expand. Ezra mainly writes for SMB Compass, but you can find some of her work in All Business, Small Biz Daily, LaunchHouse, Marketing2Business, and Clutch, among others. When she’s not writing, you’ll find her in bed eating cookies and binge-watching Netflix.