Payroll funding represents financing for your payroll expenses when you can’t make payments with available cash. It’s typically needed to fund an upcoming busy season, when you grow too fast, or if you have slow paying customers. Funding speed is the most important aspect of choosing the right payroll financing option to meet your needs.
If you need to make payroll quickly you need a lender that can make loan decisions fast. OnDeck, who sponsored this article, can make a credit decision in minutes and have you funded in as little as 1 day. If you have $100K+ in annual business revenue, a 500+ credit score, and you’ve been in business for at least 1 year, you may prequalify for up to $500k.
Payroll Funding Options for Small Businesses
There are no specific loans classified as payroll financing. Instead, payroll funding typically comes in the form of either short term loans or lines of credit offered by alternative lenders that can fund within a few days. Long term loans, like SBA loans, won’t work for payroll financing because they routinely take 45-120+ days to fund.
There are typically 2 payroll funding options:
1. Short Term Business Loans
A short term business loan is a lump sum loan typically paid back within one year. The APR ranges from 30-50% and loan payments are typically amortized monthly payments based on principal and interest. You can typically get financing with a short term loan in as quick as 1 day.
Short term business loans are typically easier to qualify for and can fund faster than a line of credit. You can also typically borrow more money when compared to a line of credit. That makes a short term business loan ideal for a small business that needs to make payroll within a week, or if you don’t have an ongoing payroll problem that you’ll repeatedly need financing for.
For example, a business who has a cash flow shortage at the same time every month will find a line of credit a better fit because you won’t have to reapply every time funds are needed. However, a business owner needing to bring on seasonal employees to prepare for their busy season will likely find the larger, one-time sum of a short term loan the better choice.
2. Small Business Lines of Credit
A business line of credit (LOC) gives you a maximum credit line that you can draw against as many times as you want until you hit your limit. For example, if your maximum borrowing limit was $10K, then you could borrow $3K, $5K, and $2K at different periods of time. You can make draws continuously as long as you repay the amount you use.
Terms for a business line of credit vary greatly by lender. It’s common to see rates from 6%-40% and repayment terms from a few months up to 5 years. Keep in mind that some LOC providers treat each draw like it’s own loan with fixed monthly payments, which could cost you more money during repayment.
A business line of credit for payroll financing will likely come from an online lender who can finance your payroll needs as fast as 1-3 days. This is because while you could also finance your payroll needs with a business LOC from a traditional bank with lower interest rates and longer repayment terms, they’re difficult to qualify for. Plus, these loans could take a month or more to fund.
A small business line of credit can be a good option for those businesses who have a recurring problem making payroll because you can pay it off and borrow again without reapplying. It’s also a good fit for businesses that are unsure of how much they need in a given week like seasonal businesses needing to increase inventory quickly during their busy season.
Regardless of your needs, OnDeck, a popular small business financing option, offers both a short term loan and a line of credit product. Let’s take a look at the basic terms of both of these options.
OnDeck Short Term Loan vs Business Line of Credit
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How to Choose Between a Term Loan and Line of Credit
For most small business owners, the choice between a short term loan or a business line of credit is going to come down to two questions you need to ask yourself:
- How much money do you need?
- Is this need going to be recurring?
Luckily, there are lenders that offer both types of financing, which you the chance to consider both. With OnDeck, for example, you can get up to $500K in a lump sum payment, but you’ll have to reapply after you repay the loan if you need more funding. Alternatively, you could get a business line of credit for up to $100K and use it over and over again without reapplying.
There are many traditional lenders who offer term loans and lines of credit to small businesses. However, they often have high minimum requirements, hefty application processes, and can take a long time to fund your loan. If you’re facing a payroll emergency, it’s generally easier and quicker to work with an alternative loan provider.
Alternative lenders like OnDeck offer the fastest funding speeds for payroll financing. They can fund your payroll needs within 1-3 days whether you’re getting a business line of credit or a short term loan. You’ll meet their minimum qualifications if you have 1+ year in business, $100K+ in annual business revenue, and a 500+ credit score. You can prequalify online in minutes.
How Payroll Funding Works
Small businesses typically need payroll funding due to late customer payments, an unexpected drop in sales, or a lack of planning. Businesses in these scenarios will need to plug payroll funding gaps with a loan. Any form of financing used to meet this need is referred to as “payroll funding.”
However, when you don’t have the necessary funds to make payroll, it’s likely that you’ll need financing in less than 1 week. This limits your options to short-term financing that will likely carry higher interest rates than what you’re used to seeing with traditional loans from your bank.
While you’ll have an APR in the 30-50% range with short term financing, you will also likely repay your loan within one year or less. This is why the total cost of capital is more important than the interest rate in determining what your total costs will be for payroll financing.
Total Cost of Capital
When borrowing to meet an immediate payroll shortfall, you want to make sure your total cost of capital (the amount you’re paying for the borrowed money) is affordable. High interest rates aren’t the only thing that can make a loan expensive. Repayment terms can also add to the costs of a loan.
Loans with higher interest rates and shorter terms often end up being more affordable in dollar-terms than longer term loans because of how long you’re making payments. That’s why it’s important to determine your total cost of capital before you agree to take a loan.
For example, if you repay a $50K loan with a 6% interest rate over 5 years, your total cost of capital will be $57,998.40. However, if you repay the same $50K loan with a 30% rate over 6 months your total cost of capital will be $54,464.99.
“If you are borrowing to meet payroll then I would borrow with the shortest term possible,” said Ty Kiisel, Editor at OnDeck.
The traditional loan process can be cumbersome, requiring a lot of documentation that takes up a lot of your time. Most payroll funding options are not that way. You’ll typically provide very little personal and business information during the application process.
Instead, you’ll likely be asked to connect your bank account or accounting software to your online loan provider. This will help them determine your eligibility for a loan and speeds up the process so you can get funded in as quick as 1 day.
Traditional business loans often require you to be a prime borrower and collateral in order to qualify for a loan. Payroll funding loan providers typically only require 3 things for you to qualify, though the actual numbers will vary by lender:
- A 500+ Credit Score
- $100K+ In Annual Business Revenue
- 1+ Years in Business
If you meet the above qualifications you could qualify for up to $500K with OnDeck. You can apply by filling out an online application that takes less than 10 minutes, and you can be fully funded to meet your payroll in as quick as 1 day.
4 Ways to Avoid General Payroll Issues
If you’re consistently running into a payroll shortfall, there’s a good chance you need to do an audit of your entire payroll and hiring processes. There are many ways to identify problems in your business that revolve around payroll, which can all be done without getting financing. While payroll funding will help you fill your short term needs, this audit can improve your long term sustainability.
Here are 4 ways to audit your payroll to increase your cash flow:
1. Run Payroll Yourself
If you’re consistently running into payroll problems, finding a solution to the problem can be easier if you start by working backward. The first thing you should ask yourself is when you actually need the payroll funds available in your account. The answer might not be as obvious as you think.
For example, many small businesses utilize the services of a payroll company. While a payroll company can relieve you of a lot of administrative burdens, it can also mean you need funds available for payroll 3-4 days prior to the actual payday.
If you’re not using a payroll company you won’t need the funds available until the day before payday. You won’t have to worry about the payroll company’s processing time, which gets you a couple of days float in your cash flow. So, depending on the size and complexity of your payroll needs it might be worth the added administrative work to gain a little more flexibility.
2. Use Physical Checks
The primary reasons small businesses pay their employees via direct deposit are the convenience for employees and reduced administrative tasks for the small business owner. But if you’re regularly facing uncertainty about being able to make payroll on time there may be some benefits to using physical checks.
Shifting to a physical check system has the ability to create a little wiggle room for you as an employer. While you can’t rely on it 100%, the time it takes for the bank to clear the check may create another day before funds are actually withdrawn from your account.
Additionally, some employees may not deposit your check right away. Keep in mind, with the ability to deposit checks at ATM or via their smartphone, the wiggle room created by a paper check is much less than it used to be.
3. Delay Paying Other Expenses
Being late on your payroll will create significant problems between you and your employees. Untimely payroll problems can create temporary inconveniences for employees which can usually be rectified, but they can also harm employee trust and satisfaction, which can be much more difficult to resolve.
For that reason, consider what other bills you might be able to put off before missing payroll. While your vendors, suppliers, utilities, and landlord certainly will not be thrilled to receive a payment late, it’s also less likely to create lasting damage to your relationship if it’s not a common occurrence.
Another expense to consider is owner’s salary. If you have to send a paycheck out late, yours is the one that creates the fewest problems. Not only that, but you can also customize how you pay yourself if irregular revenue makes it challenging to meet payroll during certain times of the month or year.
If, after reviewing your payroll schedule, you’re still not able to make payroll work, you may have a larger cash flow problem that can’t be easily solved with financing.
4. Check Recurring Cash Flow Problems
If your small business is finding that it’s having trouble not only meeting payroll, but also meeting other regular expenses, it might point to a larger working capital problem.
“No small business owner wants to reign in growth, but sometimes unexpected costs of growth can exacerbate cash flow issues and make payroll problematic,” said Ty Kiisle of OnDeck. “As a business owner, I personally experienced the cash flow challenges associated with slow-paying customers when I had already committed to meeting other important obligations. That’s why it’s so important to always be aware of your current cash flow and try to anticipate those times that could be challenging.”
As Ty points out, cash flow problems don’t always mean your business isn’t successful. But those problems will need to be addressed if the business is going to be able to grow. Read our article on solutions to cash flow problems for more information.
4 Common Payroll Problems Solved Without Payroll Funding
Whether you decide to meet your payroll financing needs with a short term small business loan or with a small business line of credit, borrowing to meet payroll should not become a regular occurrence. Payroll funding can solve many problems, but the need for it can be somewhat mitigated by properly planning ahead of time.
“There are a lot of moving parts to running a successful small business. Questioning an otherwise healthy business’ profitability because they occasionally struggle to make payroll is an oversimplification,” said Ty Kiisel, Editor at OnDeck. “It’s not uncommon for seasonal cash flow issues to throw a wrench in the works or for other unexpected cash flow issues to create a bump in the road.”
Four common payroll problems you can solve before you get payroll funding are:
1. Need for Hiring Outpaces Revenues
When your business starts to do well you can feel pressure to maintain growth by hiring more staff. Often times, a business owner will put the cart before the horse and expand their payroll or other expenses quicker than their revenue can keep up. Even if you’re anticipating increases in revenue that justify the new positions, your revenue may take awhile to materialize.
If you’re wanting to increase your headcount faster than you earn revenue, you need to have the cash available to float the increased payroll expenses. If you do not have the cash savings to cover the increase in payroll, you’ll want to either hold off on hiring more employees or make sure you have a financing option available to you. Otherwise your business runs the risk of growing to death.
2. Hiring Seasonal or Temporary Workers
If you do a majority of your business during a particular season, your payroll expenses likely increase during that time to keep up with demand. This is common for landscapers, restaurants in resort towns, retailers, and businesses in college and university communities. Businesses with seasonality are typically cyclical and predictable.
Since you’ll need to hire seasonal employees before the busy season starts, you should prepare in advance by having funds available. You’ll either need to set money aside from the last season to afford the increases in payroll expenses or you’ll need to obtain an affordable financing option.
Small business owners have many jobs to juggle at once. It can leave you with very little time to think about operations and processes. Occasionally, small business owners fall into the bad habit of simply throwing another body at problems or tasks as they arise. If business slows, this can create a huge payroll funding problem.
“It can seem easier to increase your headcount than to solve an underlying problem,” said Bryan Clayton, CEO of GreenPal. “Hiring a new employee should be the last case scenario for every small business. Before taking on another team member explore other options such as reorganizing shifts, outsourcing contractors, repurposing current staff, or find ways to automate mundane tasks.”
Payroll funding can help if you have a need for employees but can’t afford them all the time. It can help you overcome the bumps of paying their salaries when your business is slower in order to retain them for the busy periods. However, another solution is just not hiring these employees and getting by with less workers during your busy time.
4. Miscalculating Payroll Taxes
If you make a mistake calculating your payroll taxes, the IRS is going to send you notice that you owe them money. Unfortunately, this notice will come after the money for these taxes has likely been spent. There are ways to limit a potentially large IRS bill and the impact it could have on your ability to make payroll.
“There are a number of ways a business can work with the IRS to settle outstanding payroll tax liabilities” according to T. Joshua Wu, Partner at Greaves Wu. “These range from installment agreements to offers in compromise to currently not collectible. Installment agreements allow taxpayers to enter into a payment plan to settle outstanding payroll taxes. These are typically done in equal monthly installments. With an offer in compromise the taxpayer can ask the IRS to settle payroll taxes for less than the full amount.”
While payroll funding or working with the IRS can help with this problem, the better scenario is to eliminate potential risk by having your payroll team work with your accounting team to verify all payroll payments. Too many accounting teams just pay the tax numbers given to them by the payroll processors instead of auditing payroll and making sure everything is calculated correctly.
Payroll Funding for Staffing Agencies
Payroll funding is also a term used frequently in the staffing industry when describing the need to finance payroll for temporary workers. Agencies typically carry the expenses of placing workers for 2-4 weeks before they get paid. Staffing factoring, or payroll factoring, helps these staffing agencies convert unpaid invoices into immediate working capital.
You can read our staffing factoring guide to learn more.
The best solution to solving your payroll problems quickly is to borrow a short term loan or line of credit from an alternative lender. A short term loan is best if you if you view your payroll shortage as a one-time thing. If you have consistent problems meeting payroll, then a line of credit is the right choice.
OnDeck offers both a short term loan and a business line of credit. Either one can help you meet your payroll demands quickly. You can qualify for up to $500,000 with a short term loan or $100,000 with a business line of credit. To apply you can fill out an online application that takes less than 10 minutes, and you can be funded in as quick as 1 day.