Debt Collection for Small Business

Debt Collection for Small Business

9 min read • May 02, 2022 • Seychelle Thomas

When you go into business you’re bound to have some customers or even other businesses fail to pay their invoices on time. It might be a matter of forgetfulness or financial hardship preventing them from paying. 

Either way, it can severely impact your daily operations, cash flow, and take up valuable time chasing down late payments. In this article, we will explore the different methods of debt collection for small businesses and a few alternatives to hiring a collections agency.

How Do Small Businesses Collect Debt?

So you have a contract that outlines the payment terms of your agreement, and a dated invoice requesting payment for goods or services delivered to your client. They’re well past the due date for payment, so how do you get what’s owed to you? 

Small businesses collect debt in many ways. It can range from a friendly reminder to hiring legal representation, plus a few things in between. 

Overall, the way debt is collected is based on how long the overdue debt has been there and what type of customer you’re dealing with. Small business debt collection practices include: 

  • Reminder emails/ letters
  • Phone calls
  • Demand letters
  • Negotiating bad debts
  • Hiring a debt collection agency
  • Filing with small claims court
  • Filing a lawsuit

To know which action to take, you have to know your customer. Is it another small business or an individual? Different debt collection laws apply to each. 

Does this client usually pay late or do they try to avoid paying altogether? Perhaps a firm reminder or demand letter will work best. If that doesn’t do the trick, you may have to send their debt to a debt collection agency. 

For a customer who’s typically on time, you’ll need a lighter touch. They may have run into financial issues that affected their ability to keep up with payments. A friendly reminder or phone call is the best option here. 

When Should One Hire a Debt Collection Agency?

Hiring a debt collection agency isn’t an easy choice to make, but it can save you the hassle of chasing down individual customers with outstanding debt. 

As a general practice, most business owners send business debt to collection agencies once it reaches 90 to 120 days past due

However, the time frame isn’t the only factor to pay attention to. When you’re looking to collect on a business debt, you should look out for any one of these situations: 

  • A customer making unfounded claims about the product or services they received from your business. 
  • A debtor completely denies that they owe any outstanding debt without proof of payment. 
  • A customer who agreed to a payment plan for their overdue accounts but hasn’t made any of their new payments. 
  • New clients with no payment history who don’t respond to your initial attempt at debt collection. 
  • Small businesses or individuals who have a history of defaulting on debts. 

These are all red flags that you’ve taken on bad debt. Of course, you’ll want to provide several chances for the debtors to resolve the payment issue. Emails, letters, and phone calls are your first line of defense. If those attempts don’t work, you could send them a demand letter. 

You’ll want to keep a copy of each demand letter sent. Each one should be professional, firm, and direct about any legal action or reporting to a debt collection agency.

How Collection Agencies Work

Debt collections for small businesses don’t typically work on a retainer or subscription basis. They work off of a contingency business model most times. This means they take a portion of the consumer debt they collect for you. The price of debt recovery doesn’t come cheap. 

On average, debt collection agencies charge 20% to 50% of the debt they recover. But since they only get paid when they successfully collect a debt, it incentivizes them to use legal tactics at their disposal to get your money. Plus, getting something back is better than nothing.

When you hire a debt collection service, they’ll need to get all the information available about each debtor you have an unpaid invoice with. This includes information like: 

  • Customer name, any nicknames, and maiden names
  • Addresses, phone numbers, and emails
  • Purchase details, transaction dates, amounts, and any contracts 
  • What you’ve done in your debt collection process so far 

From there, the collection agency acts as an extension of your business by contacting your customers to recover the business debt. In some cases, debt collectors may negotiate with the customer to pay a smaller amount than what they owe. This is usually the case with older debts. 

Working with a good debt collection agency can also protect you from getting into any trouble with consumer debt collection laws. 

Reputable collection specialists abide by the Fair Debt Collection Practices Act (FDCPA), which prohibits small business owners, debt collectors, and their employees from using harassment or unfair tactics when collecting on a past due account. 

These laws don’t apply to B2B debt collections. If you’re a small business owner who needs B2B collections, there are specialized commercial debt collection agencies. 

Steps To Take Before Hiring A Debt Collection Agency

Hiring a small business debt collection agency is a big step and it’s a potentially expensive one. Before you hire a collection agency, there are some other actions you can take that are less costly.

Earlier we mentioned sending friendly reminder emails. This works for customers who are genuinely forgetful, unorganized with their payments or have run into financial difficulty. A polite reminder email or letter brings your unpaid invoice to the forefront without burning any bridges. 

With Lendio’s free small business accounting app, you can quickly see which invoices are unpaid and send email nudges to the clients sitting in your accounts receivable. It’s an easy way to handle customers who will make their payments without the threat of a debt collector. 

If reminders, phone calls, and letters aren’t working, then it’s time to change tactics. You might offer them the chance to repay their debt on a payment plan or negotiate the debt down to something they can handle. 

If they agree to a payment plan, the remaining payments must be made on time. The alternative is to send the account to collections.  

How to Hire a Good Agency

Hiring a good small business debt collection agency is similar to hiring for other services as a small business owner. You want to find a debt recovery agency that meets a few basic standards: 

  • They work with the types of customers you work with; commercial collections or consumer collections. 
  • They’re familiar with your industry and the rules that govern it. 
  • They’re a good representation of your company. Although you want to recover your small business debt, you don’t want to ruin your reputation in the process. The debt collector you choose should be professional and courteous with your customers. 
  • Make sure they’re licensed, bonded, and insured. 
  • Consider the reviews they’ve received through the Better Business Bureau.

How Much Does it Cost to Hire an Agency?

It’s rare to find a small business debt collection agency that has a fixed cost. The ones that do are usually only for accounts that are less than 90 days past due. There’s a higher chance of collecting on those. Agencies with a fixed cost typically charge $10 to $15 per account

Most other business debt collectors charge a contingency fee of 25% to 50% depending on the age of the accounts and how many there are. You typically won’t find pricing on their website though. Many times they’ll have you speak to an agent to determine the cost. 

As with any other service, you’ll want to focus on the quality behind it, not just the price. Going with the cheapest option could mean sacrificing customer service or return rates.

Alternatives to Hiring a Debt Collection Agency

If hiring a debt recovery agency isn’t the right move for you right now, you have a few other options at your disposal. They might be more of a pull on your time or resources. Either way, it’s worth a try to recoup some of the income lost. 

Collecting the Debt Yourself

We’ve mentioned a few tactics you can use to recover business debts on your own. Staying on top of your accounts receivable to quickly address any late payments is a key to improving your cash flow. 

Lendio’s free accounting software for small business is a great option for saving time on sending those email reminders. Sign up for free and see how they can help you improve your accounts receivable.

Selling the Debt

No luck with getting a response from the customer? You could try selling your debt to regain some of the funds. Depending on the type of debt it is, there may be companies interested in buying it and collecting it for themselves. 

You’ll likely be required to sell at a large discount, but something is better than nothing. 

Going to Small Claims Court

If you have a small unpaid debt, you might have some success with a small claims court as long as the customer is local and your claim meets small claims court guidelines.

With substantial proof that you provided goods or services and didn’t receive payment, the judge might grant a judgment in your favor,  requiring the client to pay you. This can come with plenty of court fees though. 

Hiring an Attorney

For larger amounts that have gone unpaid, you could hire an attorney. Some attorneys specialize in collecting debts and sending letters that get your client to send payment. However, their fees can be very high.

All in all, understanding how to collect debts is important for small business owners. It makes a difference in your ability to do business. While there are some actions you can take on your own, sometimes it helps to call in the professionals. 

Hiring a collection agency, selling your debt, or going to court are heavy hitters in getting your outstanding accounts paid.

*The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.

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Seychelle Thomas

Seychelle is a Maryland-based personal finance writer and business owner. She’s passionate about helping others out of financial pitfalls she’s already dug herself out of. Most of her finance knowledge stems from her career as a Financial Consultant and Branch Manager at the 7th largest US bank.