Learn how a credit application can help you screen new clients and protect your cashflow.
If you're providing a service such as marketing or technology, a credit application might not seem like an obvious need. But anytime you perform work for a client before you're paid, you are in fact loaning the client money. Before you loan your clients money, make sure they fill out a credit application.
A credit application has three main purposes:
- To evaluate your customer's creditworthiness.
- To establish terms with your customer.
- To provide protection in case your customer defaults on the agreement.
You don't want your credit application to be too lengthy, especially if you are also going to have a contract, but to be effective your credit application needs to have certain key elements.
Information to evaluate your customer
To evaluate your customer, you need some basic information. This should also include information you might need if the customer becomes delinquent. For example, instead of only collecting the contact information for accounts payable, also collect contact information for the owner or senior management, depending on the size of the company. The more phone numbers, cell numbers and email addresses you have, the better.
The most basic information to collect is the name, address and phone number for the company and any parent companies. You will also want references and bank information. Performing a basic check of any information given can prevent you from doing business with a fraudulent company. You would be surprised at the number of companies who do business without first confirming even the most basic information.
Establishing terms with your customer
It may be obvious, but all too often I've seen clients who did not have any written terms of agreement with their customers. Without something in writing a customer can claim that the salesperson told them they could wait and pay until a certain date, or that they wouldn't have to pay if they were unsatisfied with the services. If there's no other written information, the law might allow the terms on your customer's purchase order or their claims of a verbal agreement to decide a dispute.
There are seven terms that your contract should include:
- A binding agreement. This lets the customer know that the document they're signing is a binding agreement, not just an application.
- Authorization to bind company. This states that the person signing the application has a right to do so.
- Information is true. Hopefully, if someone lies or misrepresents themselves on the application, you'll catch it. But if not, this term makes the person who fraudulently fills out the application legally responsible for the information they provide.
- Right to investigate. Legally, you cannot run a credit report on someone without their permission. This term gives you that permission.
- Vendor's sole discretion. This is like the "we have the right to refuse service to anyone" sign you see in the window of restaurants. It clarifies that just because the client fills out the application, you don't have to do business with them.
- Applicant owes vendor. This is another one that seems obvious, but it simply states that the customer will owe you for any goods or services.
- Primacy of form. Purchase orders, contracts, emails … there are so many different ways to communicate and make agreements with clients. This term states that your credit application is the ruling one. If you include this clause (and even if you don't) make sure any terms stated in the credit application are the ones you want to use.
Terms to protect you in case of defaults
As a collection agent, these are the terms that I am most interested in. These provisions can give you a lot more leverage when dealing with delinquent accounts and might be enough to put your invoices at the top of the debtor's pay list. There are six terms you need to include in order to protect yourself.
- Personal guaranty. Not everyone will agree to this, but that doesn't mean you shouldn't ask. Sometimes people agree to it simply because it is in the application. A personal guaranty means that the owner of the company takes personal responsibility for the debt. This doesn't mean you will necessarily be able to recoup money if the company goes out of business or the owner stops paying on invoices, but it gives you a better chance. A personal guaranty will give your invoices priority over other vendors who did not get a personal guaranty.
- Interest and acceleration. These two elements can be listed separately or combined into one clause. Basically, you want the right to collect interest on past due invoices. Acceleration means that once any invoice is overdue, you can demand that all invoices or the remaining contracted amount be paid immediately.
- Collection costs and attorney fees. These terms state that if you have to go to court or a collection agent in order to collect the money you are owed, the client is on the hook for the fees. You want to make sure you include "collection costs" in this term so that your collection agent can use this as a negotiation tactic.
- Litigation vs arbitration. Many people believe that arbitration is better than going to court. Arbitration is seen as a quicker process. But as a collection agent, I recommend having a clause that states that you have the right to go to court. Because you have to pay the arbitrator for their time, out of pocket expenses for arbitration are always much higher than the filing fees associated with going to court. Arbitration does not give you the same ability to do discovery as you have in court proceedings. The discovery process is very important if your customer is disputing the balance, especially if the customer is lying. Finally, if you have a lawyer willing to work on a contingency basis (as they often are for collection issues) there is no difference in the costs of lawyer fees. Make sure you fully understand the difference between litigation and arbitration before signing any contracts.
- Home field advantage. This clause states that if you have to sue, you have the option to do so in your own backyard. For collection cases, it is less expensive to sue where your customer is located. But if there is a dispute, it can be very advantageous to sue where you operate, making it harder for your customer to defend the lawsuit. Having the option as to where to sue gives you more leverage in negotiations.
- Jury waiver. It's very unlikely that your case will go to trial, and even less likely that it will involve a jury. But, if it does come to that, you might prefer to have a judge decide the matter. Juries can be swayed by emotional arguments that have nothing to do with the facts of the case.
A good credit application is just one element of due diligence and good record keeping. Make sure to check any terms you've included on your credit application against any terms written on your contracts or invoices. If your terms differ it can cause confusion and prevent clients from paying their bills. Not every client will agree to every clause or term in your credit application; that's alright. You can evaluate each situation as needed and remove clauses if you feel comfortable doing so. If you are the one filling out a credit application, make sure to read it carefully so that you fully understand any terms you are agreeing to.