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Grow Your Business Finances

Should Your Small Business Hire a Collection Agency?

How SMBs Should Hire a Collections Agency
Credit: Stephen VanHorn/Shutterstock

If you have unpaid invoices from clients, you're not alone. A 2017 report by Sage called "The Domino Effect: The Impact of Late Payments," found that 10 percent of invoices are either never paid or paid so late that the company is forced to write them off.

If you're the owner of a small or medium-size business, you probably don't have the staff to dedicate to running down one in 10 invoices. If that's a large number of unpaid invoices for your business, it may be worthwhile to hire a collection agency to deal with clients that aren't paying their bills. But where do you begin?

Editor's Note: Looking for a collection agency 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 sister site, BuyerZone, provide you with information from a variety of vendors for free:

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Different agencies have different specialties. For example, some are better at getting results from larger businesses, while others are skilled collecting from home-based businesses. You'll want to make sure you're working with a company that will actually serve your needs.

This may seem obvious, but before you hire a collection agency, you need to ensure that they are qualified and licensed to act as debt collectors.

Not every state requires that collection agencies be licensed, but most do. Before you begin your search, understand what the licensing requirements are for collection agencies in your state. That way, when you are interviewing agencies, you can speak intelligently about your state's requirements.

Check with the agencies you speak with to ensure they meet the licensing requirements for your state, especially if they are located elsewhere. You'll need to confirm they adhere to the rules of the Fair Debt Collection Practices Act.

You should also check with your Better Business Bureau and the Commercial Collection Agency Association for the names of reputable and highly regarded debt collectors.

While you may be passing along these debts to a collector, they are still representing your company. You need to know how they will represent you, how they will work with you, and what relevant experience they have.

As you consider collection agencies, ask them what tactics they use in their collections process. Just because a tactic is legal doesn't mean that it's something you want your company name associated with. A reputable debt collector will work with you to lay out a plan you can live with, that treats your former customers the way you'd want to be treated and still gets the job done.

Sometimes debtors will leave town, and one tactic many use is skip tracing. That means they have access to certain databases to help locate a debtor who has left no forwarding address. This can be a good tactic to specifically ask about.

You should also dig into the collector's experience. Have they worked with companies in your industry before? Is your situation outside of their experience, or is it something they are familiar with? Relevant experience increases the likelihood that their collection efforts will be successful.

You should also discuss with the collection agency how they will work with you. You should have a point of contact that you can communicate with and receive updates from. They should be able to clearly articulate what will be expected from you in the process, what you'll need to provide, and what the cadence and triggers for communication will be. Your chosen agency should be able to accommodate your chosen communication needs, not force you to accept theirs.

If an agency isn't forthright about their practices, and you find out later that they are being overly aggressive, that agency and possibly your company can get sued by the debtor.

Regardless of whether you win such a case or not, you want to be sure that your company is not the one on the hook. Get proof of insurance from any collections agency just to be sure. This is most often called an errors and omissions insurance policy.

Debt collection is a service, and it's not a cheap one. In many ways, it's the last resort before giving up on unpaid invoices completely. It's important to remember this when you discuss fees when looking to hire a collection agency.

There are generally two payment structures you can expect when talking with a debt collection company.

Payment on collection: In this model, the business works on collecting the debt and pays your company when collection is made. Their fee is typically a percentage of each invoice. The catch is that should the collector settle for less than the invoice amount, the agency's fee does not decrease.

As an example, let's say you negotiate 25 percent of each invoice will be retained by the collection company. If you have an invoice for $1,000, the agency's fee would be $250. If the debt collector, however, negotiates a settlement of $500 with your client, you'll only see one-quarter of the original invoice amount.

Purchase of debts: This is the most hands-off method but also requires that the debt collector take on the most risk. As a result, this model tends to be the more expensive option.

When a collection agency purchases your debts, they pay you a percentage of the outstanding invoices. If you have $50,000 in unpaid invoices, an agency may pay you $15,000 to purchase them from you and then proceed to work on collecting on the unpaid amounts. Any money that they collect is now theirs to keep.

Hiring a collection agency may help you recover lost income from bad debts. But companies must be careful when hiring a debt collection firm to ensure that they are properly licensed, experienced and will represent your company well. Debt collection can be costly, but the amount you receive from unpaid invoices may be worth it.

Once you've signed an agreement with a collection agency, it can be tough but not impossible to break. Check your contract for a termination clause. If not, contact the agency and directly negotiate such an arrangement.

A termination clause could permit you to break the contract by paying a fee or providing notice within a specific time frame. There may be a deadline in the agreement by which time if the agency hasn't delivered, you can enact an escape clause. Or if the company presents a fraudulent agreement, you can generally break the contract. But you'll want to consult a lawyer first.

A material breach of contract could be grounds for termination. For instance, if they do not follow through on key points of the contract, you may be able to break the agreement. Or you can simply ask the company what their cancellation fee might be.

Dawn Kuczwara

Dawn Kuczwara is a freelance writer and marketing consultant specializing in small to mid-sized technology firms. With close to 20 years of experience in IT and another 10 in digital marketing, she has the background to help technology companies get the attention of their ideal clients.