Insider Finance

It's Payback Time

Are your deadbeat debtors getting you down? Don't get mad, get even.

Magazine Contributor

April 1, 2002 6 min read

This story appears in the April 2002 issue of Entrepreneur. Subscribe »

When the tech bubble burst last year, the accounts receivable at Lynn Parker's public relations and branding firm started to accrue so quickly that they threatened the existence of her business. "We had several hundred thousand dollars in overdue accounts, and as the dotcoms went belly up, so did our chances of ever seeing the money they owed us," says Parker, 45, principal and co-founder of Seattle-based Parker LePla. "It was a real wake-up call for us. We knew we were going to have to make collecting accounts receivable a priority."

7.6
million jobs were created by venture capital invested between 1970 and 2000.
SOURCE: National Venture Capital Association

The down cycle hasn't just impacted those providing products and services to the technology sector. Entrepreneurs in nearly every industry are feeling the pinch of reduced cash flow as they wait . . . and wait . . . for payment. In a time when money is hard to come by for all but the most reliable businesses, letting accounts receivable pile up could cost you the little cash you have left to maintain and grow your business.

"Many of my clients are experiencing a ripple effect from the downturn in the economy," says Los Angeles collections attorney Richard G. Baumann. "The slow payers make creditors wary about their own cash flow." Baumann says that in an up cycle, most entrepreneurs are too lax in granting credit and often neglect having any infrastructure in place for systematic collection of overdue accounts receivable. "In a down economy, business owners shift their operations to focus on accounts receivable issues that may have been languishing for some time."

Planning Makes Perfect

Take steps to improve your bottom line by casting a gimlet eye toward your overdue accounts and by creating an efficient and comprehensive collection plan, just as Parker did.

"We instituted a flow-chart process indicating what steps each employee should take for every day the account was overdue 30 days," says Parker. The steps Parker LePla has used range from simple e-mails from the account executive who handled the client to, in extreme cases, turning the matter over to an attorney. The plan was an overwhelming success: Accounts over 90 days old shrank from $450,000 to $45,000 in just six months.

33%
of fast-growth CEOs said lack of capital could impede their growth over the next year.
SOURCE: PricewaterhouseCoopers

An effective collection plan should also involve a thorough review of your accounting system's "front end," such as checking credit references more carefully and obtaining comprehensive information about a customer's payment history. "Look for the red flags at the beginning of the process," cautions Baumann. "Due diligence gives you more leverage if the customer can't or refuses to pay." Baumann advises his clients to beef up their credit applications and to require a guarantee of the principals' assets if there is any question about creditworthiness. A personal guarantee, says Baumann, "ensures a debtor will take an overdue account seriously."

Due Diligence

After your plan has been implemented, be firm and persistent when dealing with customers, but balance that with a savvy approach to maintaining customer relations. "Flexibility and persistence are key," asserts Mark Kushinsky, president of Boston-based MaidPro Corp. "We've had great luck with collections where we have continued to supply services while collecting past-due amounts."

Kushinsky, 36, has learned from past experience that just sending past due notices is not going to get the job done. "You need to communicate with your customer and [set] dates and amounts," says Kushinsky. "If the agreement is broken, follow up as soon as possible."

Still, no matter how comprehensive your credit-collection plan or how effective your due diligence, a customer may still choose to ignore your in-house attempts to collect the overdue account. When this happens, your best chance of collecting is either through a collection agency or by turning the matter over to an attorney. Collection agencies typically assume all collection responsibilities and charge 25 to 40 percent of what they collect. If they can't collect the debt, they usually do not require any payment for their work.

"We use collection agencies as a last resort," says Kushinsky. "In most cases, the customer wants to pay but is unable to due to economic conditions. Collection agencies only work if the debtor has the means to, but has no intention of, paying the debt."

Still, collection agencies have limited means of collection other than through phone calls. A collection attorney, on the other hand, gives you the strong upper hand in that there's an immediate threat that legal action could be brought against the nonpaying customer.

"Use an attorney who devotes most of his or her practice to commercial collections work," advises Baumann. "A good collections attorney has the technology and staff to locate assets of the debtor quickly and explore the best options for the most efficient method of collecting the debt."

Attorneys typically handle collection cases on either a contingency or an hourly fee basis, depending on the situation. According to Baumann, collection attorneys will handle a case on a contingency basis if the debtor has sufficient assets. With a contingency fee agreement, the attorney retains a percentage of whatever is collected. "Depending on how difficult it will be to collect the money, most lawyers charge 25 percent to 33 percent for a contingency case," says Baumann.

Though a contingency fee agreement carries virtually no risk for the entrepreneur, an hourly fee arrangement may be a better course of action. "If the collection is for a large amount and the debtor has assets, hourly is the most economical route since it is likely the case will not be labor-intensive," says Baumann. "It has to be evaluated on a case-by-case basis."

When a customer isn't responding to your efforts to collect or has flat-out refused to pay, it may be a telltale sign that bankruptcy is on the horizon. "If one of your customers files for bankruptcy, the law gives them an automatic stay from creditors as soon as they file the petition," explains Baumann. That means you must stop your collection efforts and go through bankruptcy court to collect your dues. You should contact counsel immediately after you receive notice that your customer has filed for bankruptcy because rules regulating time and payment can be complex.

But don't try collecting a debt immediately before the customer files for bankruptcy, cautions Baumann. The bankruptcy code allows the court to take back the money the customer paid to you and put it back under the bankruptcy court's control so it can be distributed to creditors in accordance with bankruptcy laws.

No matter what the economy brings in the coming months, Parker predicts that systematic collection will become an indispensable and permanent part of the business community. Says Parker, "It's good, common-sense business."

Sean P. Melvin is an author, attorney and assistant professor of business at Elizabethtown College in Elizabethtown, Pennsylvania.

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