Dealing with nonpaying clients can lead to bad debt, a dent in cash flow and stress. There are several ways to get back to recoup what you're owed.
As a business owner, the last thing you can afford or want is a client who doesn't pay you. Receiving late payments, or no money at all, can push you into bad debt or severely cramp your cash flow. Luckily, there are resources available to you and steps you can take to help make things right.
While in business it is assumed you will be paid for the service you provided, things don't always go as planned. Unfortunately, there are occasions when clients simply don't pay. As uncomfortable or frustrating as it may be, approaching a nonpaying customer doesn't have to be difficult. You can combat this problem by seeking legal action, reviewing your contracts or contacting collections agencies, just to name a few solutions.
Chasing a nonpaying customer is often a messy process, so it's best to take the following precautions to avoid the issue altogether.
1. Research your client.
If you've never worked with a client before, take the time to research who you're dealing with. Google their name, ask your contacts if they know anything about your new prospect, and see if there are any complaints against them on sites like the Better Business Bureau (BBB).
"Most nonpayments can be prevented or severely minimized by screening the customers in advance," said Jocelyn R. Nager, president of Frank, Frank, Goldstein & Nager, a professional legal corporation. "Thanks to all [the] information available on the internet, especially the court records, notice of liens and more, most often, you can run a risk assessment on your own … and the possibility of nonpayment should be reflective of your tolerance for risk." [Looking for a collections agency? Read our recommendations and reviews on our best picks page.]
2. Have a contract.
Regardless if it's your best friend or one of the most respected business leaders in your industry, always have a written contract in place that lists all costs and payment terms. It should also address the following:
- Payment plan: e.g., 40% deposit, 40% milestone payment and 20% on completion
- Terms: e.g., payment either 30, 60 or 90 days after the invoice is sent
- Preferred payment method: e.g., checks, credit card or PayPal
- Scope: the exact work you are expected to complete
- Deadline: expected completion date
- Late payment policy: the amount charged if the invoice is not paid on time
It's important to put all the details in writing so you don't face issues down the road. For instance, if your client is aware they owe fees for overdue expenses, they'll be less likely to flake – and if they do, they'll be forced to pay interest. But if you fail to set up a contract, nothing is guaranteed.
"Often when assisting clients who are being charged interest, late fees or legal fees, I will ask the company for anything in writing and signed by my client that permits them to do so," said Thomas J. Simeone, trial attorney and managing partner at Simeone & Miller LLP. "When they cannot do so, I explain that interest and fees are not part of the contract and, therefore, are not allowed."
Don't set yourself up for problems that can be easily avoided. You can find service contracts for free and online. Here's one from LawDepot.
3. Ask for a deposit.
If you ask for a portion of the payment upfront, you'll absorb some of the hit. Asking for a deposit or retainer is common for freelancers when negotiating with clients and helps cover some of the expenses or time that you've already invested into a project.
According to Tina Willis, owner of Tina Willis Law, the amount you should ask for depends largely on the industry. If workers in your position do not typically charge retainers, consider installment fees, which are paid as you complete certain parts of the job.
"That way, you are less likely to do way too much work before getting paid, or realizing that you are never going to be paid," Willis said.
Approaching nonpaying clients
Sometimes, no matter what you do to prevent the issue, you're still left empty-handed. If you've taken all the precautions and a client still hasn't paid the invoice, you need to act fast. Here's how you should proceed.
1. Weigh your options.
Ask yourself if chasing down the client is really worth it. If the payment was only a small percentage of your yearly income, it may be better to let it go and write off the client for future business. You could end up spending more money and energy than what the invoice is worth.
"Best-case scenario, if you have a winnable case, and the defendant has the money to pay and doesn't declare bankruptcy, you usually will still have to pay your own attorney's fees to collect," said Willis. "And those can run in the tens or even hundreds of thousands, depending on the complexity of the case."
2. Follow up.
Don't hesitate to send out a letter or email if the invoice has not been paid by the agreed-upon date. There's always a possibility that the invoice was lost or misplaced. Maybe the client was on vacation or had a family emergency. You shouldn't instantly assume that the client is a deadbeat because they didn't pay on time.
Send them a friendly yet firm email reminding them that the invoice is past due, and you'd like to resolve the issue as soon as possible. Also ask if they have any concerns with the product or service that you provided, or if they need assistance with the payment process.
3. Talk to a lawyer.
If your client is resisting or ignoring your requests and the unpaid invoice is worth the trouble, consult a third party, someone who is not a friend or an individual whose help you sought out online. Seek legal advice from an actual attorney who will suggest which legal courses of action you can take against the customer.
According to Willis, once you've tried all else, it's best to hire a lawyer to write a demand letter.
"Many businesses and individuals do not understand the legal obstacles involved in collections," she said. "If they are a debtor and your lawyer contacts them, many will just pay without analyzing further."
4. Account for your bad debt.
Check if you can account for bad debt. Your company may be able to deduct it for tax reasons or add it to expenses. Debt can be written off after it's been unpaid for 90 days and the accounting department would add a bad debt expense to your income statement. This lowers the accounts receivable on the balance sheet by the same amount.
5. Hire a collection agency.
You could also hire an agency to collect the debt for you. You can find a reputable collection agency, like you would with other professionals, such as accountants or lawyers. Ask your network if they know of any collection agencies, or read online reviews to select one for yourself. If that doesn't work, check out member listings for the Commercial Collection Agency Association or BBB-certified collection agencies.
"A licensed collection agency is experienced, trained and skilled to pursue recovery while trying to maintain a good business relation with your debtor, should you want to keep doing business with them," said Federico Nuccio, an FCIB Certified International Credit Professional and founder and CEO of Recoupera. "Most agencies will offer you to collect on a contingent fee and on a 'no-win, no-fee' basis. This way, you can rely on their assistance while not incurring further costs and keep focusing on your business."
5. Hire a factoring service.
Factoring companies are designed to help fill the void of unpaid invoices and help with your business's cash flow. They provide the money you need while you wait for the money to come in. Your accounts receivable is sent to a factoring company for a percentage of the account's value, which is usually 70-90%. That money is then sent to you, and the company takes the customer's payment. You receive partial payment as the rest of the cash is given to you.
6. File a small claims case.
You can also take your grievances to small claims court, which is specifically designed for minor disputes. You can use this court if the money in question is under a certain amount. For example, in Kentucky, the cutoff for small claims is $2,500.
How long before you can send someone to collections?
Using a collections agency should be your last resort, but if your business's cash flow is being impacted, and you've run out of reminders and extensions, it might be time to hand it over to the professionals.
The standard timeframe to send someone to collections is 90 to 120 days past due. Research has shown that accounts given to collection agencies between that time frame have a 74% chance of being recovered, according to a poll conducted by the Commercial Collection Agency Association of the Commercial Law League of America. When your customer has disappeared, meaning they've become unreachable and unresponsive, it's time to enlist the help of a collection agency.
Editor's note: Looking for collection services for your business? If you're looking for information to help you choose the one that's right for you, use the questionnaire below to have our vendor partners contact you about your needs.
What is the average amount collections agencies charge for their services?
Like you, collection agencies are paid for their services, and the price is usually the percentage of the collected debt or a flat or fixed fee. Contingency fees are percentage-based models that are determined by the balance of the account. They typically charge 25 to 50% of the amount of debt collected. Flat fees are paid at the beginning of the collection process. Fees are typically $10 to $15 per account.
Other factors that may affect how much you pay your collection agency include the age of your account. The older the issue, the harder it may be for them to recover your money. Therefore, these cases are usually charged at a higher rate because of the difficulty. The smaller the balance you are attempting to recover, the more expensive your fee will be. However, if you transfer a large account balance to an agency, you may be charged less.