MONEY

How to Pay Employees When You Can't Make Payroll

There may come a time when circumstances prevent you from being able to pay your employees. Here's how to make it though this trying time.
Running low on funds is a problem for entrepreneurs, especially when employees need to be paid.

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Running low on funds is a problem for entrepreneurs, especially when employees need to be paid.

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Only half of new small businesses survive beyond their fifth anniversary. According to research provided by the American Bankruptcy Institute, 43,546 small businesses filed for bankruptcy protection in 2008. When events like this occur, it is not only business owners who are left holding the metaphorical bag.

Employees of said businesses not only lose their jobs, but are often left in the dust when it comes to receiving funds owned to them in bankruptcy court. Short of going belly up, many businesses go through periods when they become short on cash, leaving business owners in the unfortunate position of being unable to make payroll for a given period.

Instances such as this occur for a variety of reasons including low seasons in certain industries, absent receivables, and a down economy. However, one thing is clear - employees and payroll taxes must be paid by any means necessary. When it comes to entrepreneurs in this predicament, "They have to scramble - family, friends, savings - whatever they can do," says John Seelinger, a management counselor with the Orange County, California branch of SCORE.

Granted, this is one of the more dire situations that a small business can find itself in. But there is hope. When it comes to paying employees in a hurry, there are several options that should be considered, including family, hard money loans, lines of credit, and discounts on receivables. But, more importantly, the business should be restructured in a way that prevents episodes such as this from recurring. If you have ever been unable to pay your employees or desire to understand how to negate the risk of this occurrence in the future, read on to discover ways to prevent or rectify this unfortunate scenario.

How to Pay Employees When You Can't Make Payroll: Notify Your Employees

Most employers know in advance that they will be unable to make a given payroll. However, it's usually embarrassment or pride that prevents entrepreneurs from being honest with themselves about the situation, and honest with employees in turn. "What I have found in my consulting business is that, more often than not, small business owners are embarrassed and worried about results, so they typically handle [the situation] emotionally," says Donald Todrin, founder of the Northhampton, MA-based Second Wind Consultants. "This usually means that they don't tell anybody until 10 minutes before they're supposed to get their checks." The best thing that an employer can do is to notify their employees of the potential problem as soon as they're aware of it themselves.

Mike Turner founded the luxury real estate firm Front Street Brokers in Boise, ID in 2005. In early 2008 and in late 2009, due to downturns in the real estate market, he was unable to pay his employees with existing revenue. "I tried to be upfront with them about it," says Turner. "I said, 'We're running out of time, running out of money, and here's what I'm going to do." This gave his employees the time and freedom to look for new employment in the interim before he resorted to layoffs.

When it comes to informing your employees of impending danger early on, Todrin recommends disseminating the news via a top down approach. "There's a natural hierarchy of leaders or there are specific leaders depending on the size of your business, whether they're managers or the people with the longest longevity - the go to men and women that are in your business," says Todrin. "What I would highly recommend is that you gain their cooperation in advance of dealing with the entire population." Todin explains that doing this softens the blow for the other employees, and that the news will not be as harsh as if it were to come from upper management.

Dig Deeper: Advise Employees of Possible Changes in Ownership


How to Pay Employees When You Can't Make Payroll: Find Methods of Financing

Once you are aware that you will be unable to make payroll from the profits of your business, swift, decisive, and possibly desperate action must be taken at once. Not paying your employees may not only result in lawsuits, but also serious federal and state tax liabilities. "The first thing to note is if you haven't paid your staff it means you probably haven't paid your payroll taxes or your sales taxes," says James Sinclair, the principal of the Los Angeles-based OnSite Consulting, a firm that offers business restructuring services to the restaurant industry.

Sinclair says that business owners in this situation have to make an abrupt decision that amounts to three choices - make swift business modifications that result in rapid liquidity, conduct massive layoffs, or close. If none of these options are seen though to fruition, the owner and or controlling parties of the business will be responsible for penalties and fines with regards to payroll taxes to the IRS that can equate to 50 percent of the total that is owed for the year. "[Those fees] will be with you for life until you pay them," says Sinclair.

How can you attain missing funds to pay employees in a crunch? "Beg, borrow, or sell whatever you need in order to come up with the funds," says Rod Jorgensen, the director of counseling at the Nevada Small Business Development Center. However, in light of recent restrictions on bank lending, gaining rapid access to cash via traditional bank loans, lines of credit, and mortgages is a thing of the past.

The first time Turner found himself unable to pay employees was in a down economy, causing the loss of many of his expected receivables to fall through. "For example, in that time period, we had 10 real estate transactions scheduled to close, and nine of them fell through for unforeseeable reasons," says Turner. "And all of a sudden, $100,000 worth of business income that we were dependent upon is gone." When Turner and his business partner - his wife - realized their predicament, they immediately tapped into their personal savings accounts and credit cards in order to keep the business afloat. When those sources of financing reached their limit, they suspended their own salaries. Finally, the Turners had to execute the layoffs of some of their employees. Still liable for their last couple of paychecks, Turner was forced to obtain funds from what is known as a hard money lender.

Hard money lenders operate with more lenient lending requirements than traditional banks, and the loans are often backed with real estate as collateral. Unfortunately, due to high interest rates and fees, they are also likened to payday loans for businesses. "It's one of those things you want to look at as a last resort," says Turner. There still exist companies that, while not defined as hard money lenders, offer quick cash solutions to small businesses. Paramount Merchant Funding based in New York City offers merchant advances and small business loans for businesses that have operated for at least six months and have no less than $10,000 in gross sales. A lump sum payment can be issued to a qualifying business within five days, and the terms of repayment run anywhere from four months to one year. While there is no traditional interest on the loan, Paramount Merchant Funding operates via a "fixed cost to capital." For instance, a $10,000 loan comes with a flat fee attached that would require the business owner to pay back anywhere from $11,800-$14,500 on the loan.

Dig Deeper: How to Get Financing When Banks Won't Lend


How to Pay Employees When You Can't Make Payroll: Utilize Available Resources

Another method of raising capital in a hurry is through the discount of existing receivables and liquidation of existing inventory. Todrin recommends taking as much as a 50 percent hit on your outstanding receivables as long as it means that you'll be able to cover your payroll. "If I've got $25,000 out on the street that I'm owed, I'd slash it down to $10,000 on a promise [that vendors] wire me the money today," he says. "Pay me half [of what you owe me] and I'll wipe [the debt] out. And you raise cash instantly and overnight. Now you pay a price for that because that's your overhead money, but you cover your payroll. You got to play for another day," he says.

Dig Deeper: Factoring Receivables: A Bright Spot in the Credit Crunch?


How to Pay Employees When You Can't Make Payroll: Avoid Staggering the Payroll

Though you may be tempted to pay employees a fraction of their paychecks in lieu of nothing at all, staggering payments is a tricky process and, in general, is unadvisable. "Payroll is a state by state issue, and it usually is not legal to do that," warns Todrin. "Once you start owing your employees payroll, the employee is unsatisfied, will not put in his whole effort typically, and you're sowing the seeds for further erosion."

There is a way to broach the process effectively. Todrin recommends asking the highest paid, top-level staff members of your company to electively forgo their paychecks for a few days so that lower level employees can receive on-time payments. "If you're using the top two or three employees including yourself to not be paid at all, and you're spreading the rest out to everyone else, this is the type of spirit that gains confidence and a following," explains Todrin.

Dig Deeper: How to Plan for Hiring and Payroll in 2011

 

How to Pay Employees When You Can't Make Payroll: Pay Tipped Employees What They're Owed

Sinclair estimates that the restaurant industry, or the tipped employee industry, experiences this scenario more frequently that any other. This is because, while employees may not be receiving their usual paychecks, they still receive daily payments in the form of cash tips. "If you're asking your employees to be delayed a week or you're asking your employees to not deposit your checks today but to deposit them in phases over the next ten days, many employees will buy into it, especially tipped employees who the check is just a percentage of their total income," says Sinclair.

Not paying employees their earned paycheck will not only land the operator of the business in hot water with the IRS, it can result in action being taken by the Department of Labor as well. The U.S. Department of Labor mandates that an employer must pay covered non-exempt employees the full minimum wage, along with any accrued statutory overtime for a given workweek. Failure to do so is a direct violation of the Fair Labor Standards Act and will result in severe monetary penalties.

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How to Pay Employees When You Can't Make Payroll: Restructure Your Business

Once the dust has settled and you've found a way to not only pay your employees but to remain in business, your main priority should be to restructure your operations in order to reduce the risk of this happening again. The best way to do this is to lower your overhead expenses. "A lot of times I think businesses wait too long to really see what they can dig and cut from," says Turner.

If you manage to survive this downturn both personally and professionally, Sinclair stresses that making a change means heavily altering your business model and curbing expenses. It also means showing the staff that you're in the gutter along with them, bearing the financial burden and helping to get the business back on track. "This is not a matter of us sipping champagne while you're cleaning the toilets. We are working hand in hand, rolling up our sleeves with you to resolve this," says Sinclair. He also warns business owners that, while a clear message needs to be sent to employees that the owners are shouldering the burdens right along with them, this does not give employees the right to slack off. "It's a very tight line to walk and one has to be conscious of that," he says.

It is the nightmare of employers to be unable to afford their most valuable assets, their employees. However, employers should remain empathetic to the situations of their employees. Before resulting to layoffs or shutting the business down completely, Seelinger suggests attempting the negotiation of a furlough or a reduction in hours for employees.

While you look for a way to pay your employees the remainder of what they're owed, Todrin recommends giving them whatever you can scrape up - maybe $50 per employee for gas money - as a gesture of good faith. It may be a catastrophe on your end as the proprietor of the business, but it can be a nightmare for employees who rely on their paychecks for their livelihood and sustenance. Be loathe to neglect the fact that your loyal employees are also due to have their hard work and humility reciprocated, even in hard times.

Dig Deeper: A Surprising Way to Re-energize Your Business

Last updated: Apr 1, 2011




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