Of all the nightmare scenarios associated with operating a small business, perhaps nothing is more unsettling than being unable to cover payroll expenses.
For business owners who lack a traditional emergency fund—cash set aside to alleviate financial difficulties—or already exhausted their reserves, the only viable solution may be alternative lending from an online institution. Since anyone seeking a payroll loan is doing so out of immediate necessity, loans featuring shorter repayment periods and quick financing are ideal.
The truth is most business owners never want to be in this position, but a significant number of them do end up at this unfortunate juncture, regardless. Whether business has precipitously declined or you’re a victim of broader financial upheaval, there are critical decisions that need to be made to pay employees.
Being unable to cover payroll is not only important to maintain moral and good standing among your employees, but failing to do so could violate state and federal regulations.
If you’re considering using emergency funding to cover payroll, it’s important to take a hard look at your finances, your company's trajectory, and the state of your credit. Depending on your situation, loans may be available, but you just need to know where to look and decide what’s best for you.
Let’s break down the financial resources that may be at your disposal.
Before you begin cold-calling banks and researching lenders, you should consider drawing from your emergency fund to cover payroll expenses. Also known as a “rainy day” fund, this is cash you hopefully set aside to provide temporary relief during an unexpected downturn. The general rule is to save enough to afford three months’ worth of expenses, which may give you enough time to consider other options.
Depleting long-saved cash reserves may be a bitter pill to swallow, but unfortunately, circumstances often dictate how you should act. If this isn't viable, then it’s likely time to research other forms of payroll-related emergency funding.
Merchant Cash Advance For Payroll
A merchant cash advance (MCA) is a debt tied to future profits. Let’s be clear: A merchant cash advance is technically not a loan, but rather a lump-sum transfer typically obtained within days.
Instead of paying a monthly balance, the lender automatically absorbs a percentage of your daily profits through Automatic Clearing House (ACH) payments. This is particularly important to understand, because you need to ensure you’re earning enough to cover daily debits and payroll expenses.
While the thought of near-immediate funding may sound attractive, it’s crucial to consider what else a merchant cash advance entails. MCAs feature exceptionally high annual percentage rates (APRs) that sometimes reach three figures—which you may consider excessive. Additionally, defaulting can cause extensive damage to your credit score, potentially risking any chance at future funding.
As the steward of your company, you need to decide whether accepting a potentially risky lump sum of money to meet payroll demands is feasible. However, if you’re seeking funds from an alternative lender rather than a traditional bank, your credit has likely taken a hit, and you’re out of options. Before signing on the proverbial dotted line, scrutinize the terms of the agreement and make sure you can satisfy daily payments.
Invoice Factoring For Payroll
Invoice factoring, as with MCAs, is not a loan. Lenders offering this type of financing provide businesses with a percentage of their outstanding invoices—typically around 80 to 90 percent—to help with immediate needs, such as payroll expenses.
In theory, receiving this type of funding enables businesses to continue operations and pay employees. No business owner wants to lose employees because they can’t afford to pay them, for whatever reason, and invoice factoring can alleviate financial stress, even if it’s only temporary. It is especially beneficial to new businesses or those with so-so credit unable to obtain conventional loans.
Think of it like this: Say a client owes your company $20,000 but they’re not scheduled to pay you for 30 days or longer. If your finances are thin and you’re unable to satisfy next week’s payroll, you can sell the invoice to a factoring company, which will purchase it at a fee and then pay you a lump-sum amount—around 80 percent of the entire invoice, for example. You can then use those funds to cover payroll expenses.
Since this is considered short-term financing, APRs on invoice factoring are usually high. There also may be other fees (application and processing fees, for example) associated with invoice factoring, so do your due diligence to avoid any surprises. On the other hand, if you need fast cash and can’t rely on a traditional bank loan, this could benefit your business.
Other Emergency Options To Cover Payroll
Short-term loans can be used to finance a range of business-related expenses, such as gaining new inventory, or, in your case, paying employees.
As with any loan, it’s a potentially risky proposition. And as we mentioned previously, short-term financing measures are characterized by relatively steep APRs.
Short-term loans are common among small businesses in need of emergency relief. Among the reasons such funding is attractive: a relatively simple application process, quick access to funds, and a short repayment period.
Revolving Business Line Of Credit
A revolving line of credit provides business owners with near-immediate access to capital—which is why it’s used widely for payroll expenses.
It’s similar to a traditional line of credit, but once the amount you borrowed is repaid, the account is reloaded, for future use. Of course, you don’t have to use the entire balance available to you, but whatever you do spend you’ll have to pay off, plus interest. If you’re approved for $75,000, for example, you can use any amount necessary up to the maximum credit line to take care of employees.
Friends & Family
Business owners are a prideful bunch, and it may be hard to turn to friends and family and ask them for money to support your employees. If you’re not amenable to loans or alternative funding opportunities, be open with the people who love you the most and see if they’re willing to assist. But be realistic: You can’t rely on personal relationships indefinitely, so financing may be your only answer.
In short, there’s nothing wrong with using emergency funding to cover payroll, as long as you’re mindful of terms and have a plan for repayment and moving your business forward.