Payroll Funding: A Guide for Small Businesses

Running payroll is one of the biggest responsibilities and stressors for any small business owner. Profitable businesses may also sometimes face short-term cash flow gaps that make covering payroll challenging. That’s where payroll funding can help. Let's break down what payroll funding is, how it works for small businesses, the solutions available, and what to keep in mind when deciding if it’s right for your company.

What is Payroll Funding?

Payroll funding is a short-term financing solution that helps businesses cover employee wages when cash flow is tight. Instead of waiting for client payments or invoices to clear, a business uses payroll funding to access immediate working capital to pay their team on time. This is also often called payroll financing, especially when it includes options such as invoice factoring or lines of credit.

Here’s how payroll funding solutions typically work: A funding company advances the money needed for payroll based on your outstanding invoices or verified revenue streams. You then repay the advance, plus any fees or interest, once your clients pay you. This type of funding can be especially helpful for small businesses with varying income streams or seasonal demand. It can also be beneficial for businesses that face long payment cycles from clients.

Types of Payroll Funding Solutions

Small businesses have several options for funding payroll, with short-term financing solutions tailored to their specific cash flow needs and operational demands. Here are some of the common options.

Invoice Factoring

With invoice factoring, a business sells its unpaid invoices to a third-party company (called a factor) at a discount. The factor gives you a percentage of the invoice value upfront and pays the remaining amount (minus fees) once your client pays the invoice.

Business Line of Credit

This is a revolving line of credit, which works like a flexible loan. You can draw what you need to cover payroll and repay it as you go. When necessary, you can borrow again, up to a set credit limit. This can be an ideal fit for businesses with ongoing but unpredictable cash flow needs.

Payroll Loans

Some lenders provide short-term business loans, often called payroll loans, that are specifically designed to help cover payroll expenses. These loans usually have quick approval processes but can come with higher interest rates, so it’s important to understand the terms before committing.

Merchant Cash Advances

This option provides an upfront sum that is repaid through a percentage of your future daily sales. Businesses with high credit card sales volume, such as retail shops or restaurants, often use it.

How to Choose the Right Payroll Funding Option

Selecting the best payroll funding solution starts with understanding your business’s specific needs.

• Evaluate Your Cash Flow: Look at your cash flow patterns. Do you struggle during certain seasons or only when a large client payment is delayed?

• Assess Costs and Terms: Compare interest rates, fees, and repayment terms. Do you understand the total cost of borrowing and any impact on your margins?

• Check Lender Requirements: Some funding options require a minimum monthly revenue or a certain number of years in business. Does your business qualify?

• Plan for Repayment: Make sure you have a realistic plan for repaying the advance or loan without straining your finances. What is your set plan for repayment?

• Get Expert Advice: If you’re unsure, talk to your accountant or a small business advisor to weigh your options and choose what’s best for your situation.

Pros and Cons of Payroll Funding

Payroll funding can be a valuable safety net for small businesses, but it’s important to weigh the trade-offs before you decide. Here are some factors to consider:

Benefits

• Improves Cash Flow: Access working capital for funding payroll when you need it most, so you don’t have to wait for outstanding invoices to clear.

• Keeps Payroll on Track: Make sure your employees are paid accurately and on time, which helps maintain trust and retention.

• Flexible Options: From invoice factoring to lines of credit, you can choose a funding solution that fits your business’s cash flow cycles and growth stage.

Potential Pitfalls

• Fees and Interest: Borrowing costs can add up, especially if you use funding frequently or for extended periods.

• Dependency Risk: Relying too much on short-term funding can mask deeper financial or operational challenges.

• Client Perception: Some invoice factoring arrangements involve clients paying the funder directly, which can affect how customers perceive your business.

Payroll Funding for Growing Small Businesses

Growing small businesses often turn to payroll funding as a short-term solution. It can be especially helpful for covering payroll when you’re onboarding new hires or managing seasonal spikes in demand. It’s also useful when you're waiting on large invoices to be paid.

The key is to use payroll funding strategically. Consider it a short-term tool to stabilize cash flow and ensure your team gets paid on time, rather than a long-term fix for ongoing cash flow issues. By pairing payroll funding with payroll automation, smart budgeting, strong invoicing practices, and other financing tools, small businesses can grow confidently without putting payroll at risk.

Keep Your Payroll Running Smoothly with Justworks

Managing cash flow and payroll doesn’t have to be stressful. While payroll funding can be a helpful backup, having the right payroll system in place is just as important. Justworks helps small businesses by providing payroll software and expert support for worry-free compliance, along with access to our 24/7 customer support team. Want to keep your payroll on track as you expand your team? Get started with Justworks today.