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What to Do if You Can’t Make Payroll

Yancy Lassiter
Published Nov 17, 2023

In an ideal world, you’d always have the money to make payroll, but the reality of business is that not everything works out and the unexpected can have detrimental effects on your company’s cash flow.

As soon as you know or even think you can’t make payroll, you need to start getting backup options in place. Even better, it’s good to know your options and prepare yourself before you’re down to the wire.

There are a few ways you can fund payroll if you are in a bind:

  • Get a credit line through a bank.
  • Get a personal loan from friends or family who you can repay.
  • Sell a portion of your business to help with immediate and future funding.Take a loan out against an asset you own.
  • Get a loan on your accounts receivable.

Remember, any type of debt you take on can be detrimental to your business long term if you do not understand the ramifications of the method and if you do not have a plan to repay it. Let’s walk through each of these options, how they work, and the pros and cons of each.

Key Takeaways

  • There are ways to get funding for your business on short notice.
  • It is key to understand the risks in each method of funding so you can avoid losing your business.
  • the more foresight you have into your finances, the more funding options you’ll have available.

Credit Line

Credit lines are a debt product generally offered through banks and credit unions to an owner of a business that they can use when they need funds for a short term cash crunch. Obtaining a credit line (also referred to as a revolving line), is a formalized process that usually takes  around a month to complete, assuming all the information is readily available.

The bank will ask you for personal and business financial information to figure out how much they would be willing to offer to your business as a line of credit. This figure will vary depending on a number of factors, including:

  • how long the business has been in business,
  • previous success of the business
  • the financial state of the business
  • the owner/s financial situation
  • the current state of the economy, and many other factors.

How a Credit Line Works

First, the bank or credit union will ask for a personal guarantee by the owner/s of the business on the credit line, should the business not be able to pay it back. There would be documentation drawn up and signed by all the parties involved. Then, once the documents have been authorized, the bank would charge an origination fee, or fee to establish the line of credit. This amount can vary depending on the bank or credit union, but could be a percentage of the total approved credit line amount or a flat fee.

The bank will have established a rate to charge when the credit line is used which is a fluctuating rate normally associated with the prime rate. The prime rate is the amount banks overall charge customers for a line. This rate is determined by the Federal Funds rate plus an amount for them to make money off of. The rate on your credit line will fluctuate over as the prime rate fluctuates.

Personal Loans from Friends or Family

Another way to find short term funding would be to ask friends or family for a loan to cover money you need for payroll. This is possibly the fastest way to fund a payroll shortfall and can be as informal or formal as you want it to be. The risk here is the possibility of creating a dynamic in your personal relationships which one or both parties do not handle well over time. If you are going to borrow money for friends or family, I would suggest using a formalized process. This allows all those involved to understand what the funds will be used for and when they will be paid back. This will help to alleviate issues of uncertainty which are normally what strains the personal relationships involved.

A formalized process could look like this: Write up the amount of money, rate you are going to pay, and when you expect to repay the loan to the other party. You don’t need to have something like this notarized, but have all the parties sign it. This is also good because it will have your substantiation when it is time to file taxes for any interest you would have paid.

The benefit to this type of loan is that it normally doesn’t take long to get the funds and you’re not going to pay an origination fee to the other party. The structure is also flexible, so you can do it in whatever way works best for both of you.

Sell a Portion of the Business

Selling a portion of the business can open the door to a lot of different venues.

  • As an owner, you can get financing you need for both long and short term needs.
  • You can get value out of the business you have put time and effort into building.
  • You can decrease the risk you are taking by diversifying your ownership in the business, and use those funds for other ventures.

On the other hand, selling also can be a risk because you own less of the business, and have others to answer to. If you were to sell more than the majority ownership in the business you could lose the ability to determine the long term vision of where you want it to go.

If you are going to go down this path you need to have a reasonable idea of how much your business is worth is so you can assign a value to the portion you want to sell. There are a few methods to determine the value of your business, and you can use this valuation tool to get an idea of the amount.

When considering this option, you want to balance all the aspects of what you are trying to accomplish in your business, personally what you are trying to achieve, risk in the business, financing needs, the investors needs and any other implications. This method may take longer than obtaining a credit line to get at the money you need, so be thinking well ahead of time if you see a cash crunch coming and are going to sell a portion of your business.

Take a Loan Against Assets you Own

If you have been in operation for a while as a construction company you most likely have assets that are paid off or that you have equity in. With these as collateral, you can go out and find a lender who will offer a secured loan against one of the assets you have to meet your temporary payroll needs. This can be a very fast method to fund your payroll needs — often within a day or two, depending on the collateral you are using. If you have more foresight into the shortage coming, you can use large assets like a building or large equipment that is paid off. It takes longer to get loans against these but you can obtain more funds.

We’d suggest you try to go through a bank or credit union for this type of loan first before you seek out other lenders, because the rate you would pay from them could put you in a position where you are more likely to lose the asset.

The biggest risk in this method is losing the asset which might be critical to the success of your business.

Get a Loan on Your Receivables

Another method of getting funds quickly is to sell part or all of your receivables to a company. This is called factoring your receivables. 

For example, you have an account receivable for a bill you have with your customer that is due in 15 days for $100,000. You contact the factoring company and they would offer to pay $97,000 — a discount from the full amount of what you are owed.

You would no longer have a right to collect the $100,000 when you agree to sell to them. They would make $3,000 off of you in 15 days and give you the cash you need to fund your business now.

Factoring companies offer a quick cash infusion but end up making large margins off of a business. In the example above the factoring company would be making over a 70% annual return in this transaction.

Factoring can be a good solution if done on a very limited basis, but if overused it will end up killing the profitability of most companies.

All is Not Lost

Many businesses will face the pressure of making payroll on a short term basis and there are options to solve for the cash crunch in these situations. But, we’d be remiss if we didn’t mention that knowing about upcoming shortfalls as far in advance as you can is key for coming out the other side and continuing to grow your business. Keep a steady eye on three month projections and you’ll be able to see these types of situations well in advance. That opens up more funding options that will serve you better in the long term.

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Yancy Lassiter

Yancy Lassiter, a CPA with a degree from the University of Texas, has 12 years under his belt as a Controller and CFO in the construction industry; he’s your go-to guy for finance in the building industry.

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