Using a business loan to hire team members is a smart financial move when the following criteria are true:
- Net-new profit of new hires is higher than the total cost of debt.
- The business has enough cash in the bank to survive the new hires’ ramp-up period.
- The company uses the right type of small business loan for the job.
By meeting these criteria, you’re making a smart investment to grow your business whether you need more staff for the busy season, you’re opening a new location, or you’re unable to meet customer demand with your current staff levels.
If meeting payroll ever keeps you up at night, you’re not alone as lots of small businesses struggle with uneven cash flows to pay the people they already have, according to the Federal Reserve. That’s why this guide shows you how to use a small business loan for hiring new team members to create growth instead of going into debt.
There are two main criteria to focus on: the profitability of the new hire and having the cash flow to cover it. From there, it is about matching other needs and your situation to the type of business loan.
New Hire Profitability
When new hires bring in more than they cost, it means they’re incrementally profitable, and using a loan for hiring them would be a good idea. To figure this out, you’ll need to estimate how much extra revenue they’ll bring in and how much they cost in total, including benefits, taxes, and administration costs.
The extra revenue they bring in could be direct from sales people or indirect like with extra factory workers that increase output levels. Their total cost includes salary plus any bonuses, their payroll taxes, benefit costs, tools, supplies, and administration fees.
Here’s an example if you hire a new sales team that opens a new location:
- You estimate they’ll bring in $1,000,000 in new sales.
- Base salary is $100K and they get 25% commission.
- Taxes, benefits, and other costs are 30% of gross income.
This formula tells you if they’re profitable:
- New hire incremental profit = New sales – (Salary + Bonus + Taxes/Benefits/Admin)
- $1,000,000 – ($100,000 + $250,000 + $105,000) = $545,000
The sales team you want to hire will add $545K incremental profit before factoring in the cost of a loan to hire them. That means the total costs from your loan, including interest and fees, needs to be less than the incremental profit.
If you borrow $205,000 to cover the base salary plus taxes etc., a 2-year small business loan at 15% would cost approximately $33.6K. Even if you borrowed $455,000 to cover everything that you would otherwise only pay after collecting revenue, the total cost of the loan would be $74,474 plus any fees.
This leaves more than $500K in gross profit from the new hires, so using the business loan to hire them would be a good idea as long as you have enough cash to cover their onboarding period.
Cash Flow to Cover the Ramp-Up
Having enough cash to cover the ramp-up period, or the period before a new hire becomes fully trained and productive, is important because payments on a business loan start right away, but it takes time for new employees to add value.
If the new hires from the previous section don’t make any sales until mid-year, you need enough cash flow to cover the $9,940 loan payments for the first 6 months. It’s best to plan for a longer ramp-up period than you think by matching future sales from the new hires to cash outflows.
Here’s one way to do this using a 4-step process:
- Start with the total cash balance including loan funds.
- List out incoming cash from new sales for each quarter (double the estimated time to first sale so there’s a safety buffer).
- Include all cash outflows for the quarter.
- Subtract outflows from new sales and add that amount to the remaining balance from the prior quarter.
| Q1 | Q2 | Q3 | Q4 | Q5 | Q6 | Q7 | Q8 | ||
| Starting Cash including Cash from Loan | $205,000 | ||||||||
| Sales | $0 | $0 | $0 | $0 | $250,000 | $250,000 | $250,000 | $250,000 | |
| Salary | $25,000 | $25,000 | $25,000 | $25,000 | $25,000 | $25,000 | $25,000 | $25,000 | |
| Commission | $0 | $0 | $0 | $0 | $62,500 | $62,500 | $62,500 | $62,500 | |
| Taxes, etc. | $7,500 | $7,500 | $7,500 | $7,500 | $26,250 | $26,250 | $26,250 | $26,250 | |
| Loan Payments | $29,820 | $29,820 | $29,820 | $29,820 | $29,820 | $29,820 | $29,820 | $29,820 | |
| Net Cash Flow | -$62,320 | -$62,320 | -$62,320 | -$62,320 | $106,430 | $106,430 | $106,430 | $106,430 | |
| Net Cash Balance including Funds from Loan | $142,680 | $80,360 | $18,040 | -$44,280 | $62,150 | $168,580 | $275,010 | $381,440 |
If the first sales come in quarter 5, the loan would not be enough to cover the cash flows in the first year, and you’d need an extra $44,280 to cover the negative cash balance in Q4.
If you’re short on cash, then here are two good options to get additional funding:
- Equity financing from an outside investor is good because they’ll like the future growth potential. You’ll have to share more of the total profits because equity investors are part owners of your business, but they also share the risk if it takes longer to start making sales.
- Revenue-based financing is another option where you get a lump sum of cash upfront in exchange for a percentage of your future sales. The total cost will be higher with this type of financing, but you don’t have to worry about payments until sales roll in.
If you have plenty of cash and the team is profitable, using a loan to hire new team members is a good investment. All you have to do is choose the right type of small business loan for your needs.
Types of Small Business Loans to Hire New People
The right type of small business loan to hire new people depends on how much you need, how much cash you have on hand, your lead time, and if you’ll use the funds for anything else.
SBA loans are where some business owners look first. If your hiring timeline allows for several weeks for approval, there are 3 types of SBA loans that may make sense:
- SBA microloans are faster than other SBA options and have low rates, but they cap the amount borrowed at $50K.
- SBA CAPlines are the SBA version of a line of credit and let you fund seasonal workers as long as you show evidence of a seasonal sales cycle with your application.
- SBA 7(a) loans are a third option when the first two won’t work. They offer low rates and higher dollar amounts of up to $5 million.
A working capital loan is another good option for hiring because it’s designed to pay for short-term items including payroll and supplies for the new hires. And shorter repayment terms mean lower total interest expense.
If you’re hiring for a new location and it will bring in profit quickly, a business expansion loan will be able to cover the costs of supplies, hiring and training staff, and costs like deposits on leases.
Whether you need to hire and train staff for a new location, add another team at the factory to meet growing customer demand, or put together a sales team to enter new markets, business loans to hire new workers can be a good idea. Just make sure the new hires will be profitable over the cost of the loan, that you have enough cash to cover the onboarding period, and that you use the right type of loan based on your needs.
SmallBusinessLoans does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
