How to Collect Small Business Debt

Last Updated: May 6, 2021 References Approved

Small businesses rely on a healthy flow of income to remain in business—especially since over 50% of new businesses fail within the first five years. For small businesses, a bad debt can mean the difference between profitability and net losses. For a small business, collecting debts can be a difficult and, occasionally, litigious process. There are a number of things you can do to increase your chances of being paid. Read on to find out how to avoid bad debts, manage overdue payments and collect debts.

Part 1

Part 1 of 3:

Avoiding Bad Debts

1
Develop a payment policy. Before you provide any services or goods, contract with your customer so they understand what they are responsible for paying and when. Make sure all document language is clear. Discuss the account with the customer so you can be sure they are familiar with any charged amounts and due dates. Payment terms need to be agreed on by both parties.
- Consider adopting a late payment fee to encourage on-time payments. You may choose to charge a percentage of the total bill when payments become delinquent—2% is typical. Make sure all late fee policies are included in your contract or payment policy.
- You may prefer to ask for at least 50% of payment upfront. This ensures you at least receive something in exchange for your time and efforts.
- Do research about collecting interest. Federal and state laws regulate the collection of interest on debts. Always make sure that any interest you charge is lawful and included in your payment policy to avoid debt forfeiture or a fine. You can check usa.gov for your state's usury laws.
- You can also check your state's attorney general website for information on legal interest rates and legal practices in your state.
2
List the due date on every bill you send. Some invoices state, "payment due upon receipt." You may also use "net 15 days," "net 30 days" or any other period of time in which you expect someone to remit payment.
- Placing a due date on a bill encourages your customer to include it in a current or upcoming billing cycle. If you do not place a due date on the bill, the business or individual may wait a month or two before paying, especially if bills are tight.
- Don't wait 30 days from the date of service or delivery of the product to send out a bill. Bill every 15 to 30 days. The sooner you send out the bill, the more likely you will get paid sooner.
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3
Send reminder bills. When a payment becomes past due, immediately send a reminder noting the amount owed as well as the fact that payment is now past due. Many customers are so busy that they simply forget a bill hasn’t been paid. They will often pay it as soon as they realize payment is past due.
- Keep a record of all contact with the debtor. You will need the dates and times of your calls, letters and any other communication about the late payment, in case of legal action. You may also need to address this information when you contact the debtor.
4
Keep a contact with each company or customer. Make sure you have relevant contact information, such as address, telephone number and extension number, if available.It is also good to check in with your business contacts regularly. Engaged business relationships promote a mutual desire to fulfill transactions.
- Address each bill directly to the person who makes financial decisions in a business or the person responsible for the account.
- If you don’t have a contact for a business transaction, you can usually call the front desk and be connected to Accounts Payable.
5
Create a procedure for dealing with debts. You will need to decide what happens when payments are late. Generally, you first send out a reminder, then call the customer or business that is late with a payment, follow up, try to negotiate and then take it to collections or pursue legal action if the debt remains unpaid. Everyone in your company should understand the process so they know where to direct those who owe debts when they reach out to you.

Part 2

Part 2 of 3:

Collecting Debts

1
Understand your debtor. Try to figure out why the payment is late. Most debtors fall into 1 of 3 categories—either they want to pay but can’t do it on time because of difficulties with finances, they habitually delay payments as long as possible due to priorities for the month or they have decided not to pay you at all.^{[1]
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- When you speak to the person or department that owes you money, try to uncover what type of debtor they are. Once you understand if non-payment has to do with finances, priorities or actual avoidance, you can come up with a solution for both parties that is, hopefully, mutually beneficial.
- Keep in mind that negotiating with a debtor is a process. Take time to listen to the customer and offer solutions that you think will be appealing to them. This will increase your chances of achieving a win-win situation.
- Know that a business with financial trouble may not want to discuss their possible failure. If the business is in financial trouble, then you may consider offering them a settlement amount instead of trying to obtain the full payment.
2
Call the debtor about the account. The first step after mailing a bill and reminder is to contact them by phone. Identify yourself and your reason for calling.
- Do not harass the debtor, just be straightforward. Always use a civil tone and try to convey a desire to keep a positive relationship. You can address consequences further down the line.
- Ask the person how they are and if they received your invoice. To discuss the late payment, try: "I am concerned because your payment is now (insert how many days) late. What can I do to help you make this payment and minimize consequences, such as (insert consequence)?" You can also ask if there is a reason they want to discuss on why the payment has been late.
- Try to get a verbal agreement that the invoice will be paid and when.
- Follow up the conversation in a week by phone, email or mail.
- Never apologize for asking about a debt that is owed to you. Remember that the money rightfully belongs to you.
3
Call back in 15 to 30 days. If the debtor has not yet paid the debt, then you will want to remind them that the debt is still outstanding. At this point, the debt is probably around 60 days late. The longer payment is delayed, the less likely you will be paid.
- You will want to be polite and ask how the person is doing before talking about the debt. At this point, you need to be clear that consequences are forthcoming. You can say: "As we agreed when you signed the contract/payment policy, when payment becomes (insert the amount of days) late, (insert consequences)."
- Remind them all the times you have sent out notices, called, etc. See if they are willing to make a payment toward what they owe before you get off the phone with them.
- Inquire about reasons for which payment is delayed. Be understanding. Ask if the debtor desires to pay by payment plan in order to avoid interest.
4
Discontinue all services or goods that the debtor receives. The amount of time that needs to pass before this happens should be detailed in your payment and company policies. Call them and send them a written letter of warning before discontinuing service for non-payment.
5
Write demand letters. These letters should address the account and include past invoices and references to past communication. Although they should not be directly threatening, the language should increasingly reference harsher legal action if they ignore their bill. Make sure you include a date that they must take action by to avoid further consequences.
- For a small fee, you can work with an attorney or collection agency (without turning the debt over to them) at this step to make your letters more persuasive. Sometimes a customer will decide to pay when they see the collection agency or attorney information on the demand letter.
- Some companies offer services such as writing a series of letters, making telephone collection calls on your behalf, and more.^{[2]
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6
Negotiate with the debtor. Negotiation may be your only chance to receive some payment for your services or goods. Ask what they can pay or offer them a discount, depending upon the situation. Pursuing payment after this step can be expensive, so it may be worth it to accept whatever the debtor can pay.
- If you know the business or customer is avoiding payment, it may be less expensive to give a discount and never deal with them again than to hire a collections agency or lawyer.
7
Send a "pre-collect notice" to the debtor. The letter is usually sent by a collection agency letting your debtor know you are seriously considering turning the debt over. This should state what options that the debtor has at this point and the date by which they have to respond. Sometimes debtors may respond when they realize this may be their last chance to deal with you before the debt affects their credit.
8
Be aware of bankruptcy. If you suspect your debtor may go bankrupt, then you will need legal advice from an attorney. You will also need to file a proof of claim to help your case. Once the debtor files bankruptcy, you can no longer take action to collect the debt unless the court decides otherwise.
- Signs that someone who owes you money may be considering bankruptcy include: delayed payment, no communication with you and adverse economic conditions.

Part 3

Part 3 of 3:

Choosing a Debt Collection Route

1
Choose how to collect the debt. To collect a debt, you can give the debt to a collection agency, go to small claims court or go to civil court if the amount is more substantial. A collection agency specializes in collecting debts and usually works for a percentage of the debt payments they receive—usually 50%. Small claims court does not require attorney fees and may be a good option with smaller debts. Civil court is really only feasible when amounts owed exceed $40,000.^{[5]
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2
Select a debt collection service. If you decide to move forward by giving the debt to a collection agency, then you need to know how to make the best agency choice. Always research your options. Call collection agencies and talk to them about your situation and find out whether they think they can collect the money owed.
- Know that some individuals and businesses will not be concerned when you hand the debt over to a collection agency. They don’t care about their credit scores or reputation. In these cases, the legal system may be a better option.
- Be sure that the agency you choose is licensed and bonded for business. Also, make sure they follow state and federal laws for debt collection, such as the Fair Debt Collection Practices Act. It can make your business look bad if you do business with an agency that is not compliant.
- The Consumer Protection Agency in your state or the regional Federal Trade Commission (FTC) office keeps records of grievances filed against an agency. Check with them first before selecting a particular agency.^{[6]
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3
Turn the debt over. You’ve decided the money you’re owed is large enough to pursue. You have determined that the cost of an agency is lower than just ignoring the debt or writing it off as bad debt when you do your taxes. You’ve picked an agency and have now “sold” the debt to them to manage.
- Be sure to give copies of all previous correspondence to the agency. Understand that you will not receive the full debt and will likely receive about 50% of what the agency can get from the debtor or whatever percentage you and the agency agree on.
4
Take the debtor to small claims court. If you are owed a modest sum, such as $5,000 or less, then this is a viable option. Small claims court was developed to avoid excessive legal fees for relatively small, contested amounts. It ensures you can receive some of the funds owed without having to pay high court and attorney fees. However, be aware that even if you are awarded a judgment in small claims court, the defendant can still refuse to comply. You do have some options for enforcing the ruling, but these will take up more of your time and money. Also, keep in mind that after a case has been filed in small claims court it cannot be appealed.
- You will need to do paperwork in order to file a small claims action, and you will need to make sure the debtor is served. You will have a court date where your case will be decided, and you will likely have small fees to pay for paperwork.
- Try a mediation. This is often done as part of small claims court. It is useful in the case of a dispute about payment amounts, and it can help you reach a settlement. You will need to split the cost of a professional mediator with your debtor.
- Seek arbitration. An arbitrator is an impartial party that rules on a case. If both sides agree to arbitration, the decision is final.
- Report the debtor to the state's credit bureau. You may choose to bring in an attorney to make sure all paperwork is done right. The aim of this is to place the debt as a bad mark on the debtor's credit record.

Expert Q&A

Question

Can I take back the account from the collection agency?

Jill Newman, CPA
Financial Advisor
Jill Newman is a Certified Public Accountant (CPA) in Ohio with over 20 years of accounting experience. She has experience working as an accountant in public accounting firms, nonprofits, and educational institutions, and has also honed her communication skills via an MA in English, writing jobs, and as a teacher. She received her CPA from the Accountancy Board of Ohio in 1994 and has a BS in Business Administration/Accounting.

Jill Newman, CPA

Financial Advisor

Expert Answer

It depends on the terms you established with the collection agency. If you sold the debt to them, it is their debt to collect. If you merely hired them to collect the debt, you can choose to not renew the contract when it is up, or cancel it if appropriate.
Question

Are there any steps that you must follow before you send someone to a collection agency?

Jill Newman, CPA
Financial Advisor
Jill Newman is a Certified Public Accountant (CPA) in Ohio with over 20 years of accounting experience. She has experience working as an accountant in public accounting firms, nonprofits, and educational institutions, and has also honed her communication skills via an MA in English, writing jobs, and as a teacher. She received her CPA from the Accountancy Board of Ohio in 1994 and has a BS in Business Administration/Accounting.

Jill Newman, CPA

Financial Advisor

Expert Answer

There are really no rules for turning someone over to collections. Be aware that you will likely only collect 50% of the original amount owed, and this action may damage your relationship with the customer. Attempting to negotiate and come up with a win-win solution may be in your best interest.
Question

Who and where do I contact first to begin legal tactics to collect for contract services performed?

Jill Newman, CPA
Financial Advisor
Jill Newman is a Certified Public Accountant (CPA) in Ohio with over 20 years of accounting experience. She has experience working as an accountant in public accounting firms, nonprofits, and educational institutions, and has also honed her communication skills via an MA in English, writing jobs, and as a teacher. She received her CPA from the Accountancy Board of Ohio in 1994 and has a BS in Business Administration/Accounting.

Jill Newman, CPA

Financial Advisor

Expert Answer

First attempt to settle with the service provider. If the amount owed is less than $5000, you can file a claim in small claims court, which will keep your costs at a minimum. You can also contact your state's attorney general and local Better Business Bureau to file a complaint. All of these things may compel the service provider to settle with you. If not, the Bar Association in your area most likely offers free legal consultation and could present options.

Warnings

Always research your country or state's debt collection guidelines before pursuing a debt.

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Be aware that it is illegal to falsify information in seeking the collection of a debt.

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