Most business owners who invoice customers for goods or services will encounter the occasional late payment. However, if a customer’s invoice due date has come and gone and you can’t get a firm answer on their payment status, it might be time to consider using a collection agency.
Here’s everything you need to know about debt collection agencies and how they might help your business get paid what it’s owed.
What is a collection agency?
A debt collection agency is a company designed to help individuals or businesses collect outstanding debt after an extended period of time — typically after a 90-day past-due invoice, though this may vary by agency. The lender or creditor pays the debt collection agency a percentage of the amount successfully recovered, also known as a contingency fee.
For businesses looking to collect debts from unpaid invoices, a collection agency uses databases to track nonpaying customers and contact them for payment. Then the agency contacts your customers via written notices and phone calls to obtain the money you are owed. Your point of contact at the collection agency will keep you updated throughout the debt recovery process, including contact attempts and whether they settled with the customer for the full invoice amount or partial payment.
In some cases, a debt collection agency may file a lawsuit against a customer who cannot be reached or who refuses to pay after several months of attempted contact. However, this is typically not the first course of action, and not all agencies are licensed — or willing — to go to court.
How does a debt collection agency make money?
Generally, collection agencies make money through commission or contingency fees — usually between 25% and 50% — based on the amount they successfully recover. Commissions differ based on debt age, type, and balance. (Keep in mind that the older an outstanding bill becomes, the more difficult it is to collect and the higher the commission rate for the collector.) For debts that are especially difficult to collect, an agency may negotiate settlements with the consumer for less than what was owed.
Depending on the collection agency, you may not pay anything for debt collection services unless the agency successfully collects the payment. In other cases — most commonly for more complex or high-risk accounts — you may be required to pay a flat fee, regardless of whether the agency recovers the debt.
[Read more: What to Do When Customers Don’t Pay]
Types of collection agencies
Outside of internal collection departments (commonly known as first-party collection), there are three primary types of third-party collection agencies that may suit different business needs.
- Traditional debt collection agencies: A traditional debt collection agency’s primary function is to contact the individual in debt and attempt to recover the owed funds. They are not licensed legal entities, so they may not file a lawsuit or represent a business in court. However, they can provide valuable documentation and information should you choose to take legal action.
- Legal debt collection agencies: A legal debt collection agency — sometimes referred to as a collections law firm — operates similarly to a traditional agency, except it is run by licensed attorneys with experience in debt recovery. As such, they can file lawsuits, obtain and enforce judgments, and pursue other necessary legal remedies on a business’s behalf.
- Debt buyers: If a business no longer wants to pursue collection, it may choose to sell the debt to a debt buyer. As the name suggests, a debt buyer purchases the unpaid debt for a fraction of its face value. The debt buyer then becomes the legal owner of that debt and thus is responsible for all further collection efforts and outcomes.
The decision to work with a collection agency is not an easy one, as there are financial and reputational risks involved for you as the business owner. You may view a debt collection service as a final option if all other attempts to collect payment have failed.
Signs you may need to use a collection agency
If you have experienced any of these situations with a customer’s invoice, a collection agency may be able to step in and help you get the money you’re owed.
- You can’t reach the customer. When a customer misses their payment deadline, your first action should be reaching out to them via email or phone. If you are unable to reach them after multiple attempts, it’s possible the customer is ignoring your communications to avoid paying their invoice. Keeping a record of these attempts can help the collections process, especially if it requires litigation down the line.
- A payment is over 90 days past due. If you have invoices that are more than three months overdue, it may be time to hire a collection agency. While debts are typically considered harder to recover after this amount of time, collection agencies are specifically trained to handle these types of situations and may at least be able to settle with the customer for partial payment.
- The customer’s payment methods keep failing. Multiple bounced checks or failed online payments could be a sign that your customer may not be able to — or does not intend to pay — what they owe you.
- Your customer gives excuses for nonpayment or asks for special treatment. A customer who hasn’t paid their invoice may cite financial issues or other factors as a reason for their nonpayment and ask you for extended terms or payment deferral or cancellation. This can be a tricky situation to navigate, especially if you have a good working relationship. A collection agency can function as a neutral third party that coordinates payment with your customer while your direct professional relationship with them remains strong.
- Your cash flow is suffering. Late payments impact your cash flow and slow down your entire business operation. Even recovering a portion of the debt can provide some much-needed funding to keep things running smoothly.
The decision to work with a collection agency is not an easy one, as there are financial and reputational risks involved for you as the business owner. You may view a debt collection service as a final option if all other attempts to collect payment have failed.
[Read more: Accounts Receivable: How to Improve Your Chances of Getting Paid]
What collection agencies are not allowed to do
Several laws are in place to regulate debt collection services. The Fair Debt Collection Practices Act (FDCPA) sets the rules concerning debt collection agencies, along with consumer protection from abusive debt collection activities.
Generally, the FDCPA prevents debt collectors from conducting abusive or harassing behaviors, including the following practices:
- Calling the borrower repeatedly at unusual times. A debt collector cannot communicate with the consumer at unusual times — typically before 8 a.m. or after 9 p.m. in the consumer’s time zone — unless agreed upon by a court or the consumer.
- Falsely threatening to sue the borrower. A collection agency cannot threaten to take legal action when it is not intended or cannot be taken.
- Threatening or harassing the consumer. The use or threat of violent physical harm on a consumer, their property, or their reputation is a violation of the FDCPA. Continuously calling or engaging in conversation with the intention of annoying, harassing, or abusing the consumer is also prohibited.
- Using unfair practices to collect any debt. Debt collectors cannot collect interest, fees, charges, or incidental expenses unless the amount is explicitly authorized by the original agreement. This also includes depositing (or threatening) to deposit a postdated check from the borrower that’s earlier than the date on the check without providing advance written notice.
- Providing false or misleading documentation on who is collecting the debt. The FDCPA forbids agencies from designing, compiling, and furnishing forms to create a false impression that the debt is being collected by another entity.
- Directly contacting a consumer who has legal representation. If a collection agency knows a consumer is being represented by an attorney regarding their debt, the agency cannot go above that attorney’s head to communicate directly with the consumer. Direct contact is only permitted if the attorney cannot be reached or gives express consent for the agency to do so.
If a collection agency you’re considering mentions any of the above as part of its process, look elsewhere for legally compliant debt collection help.
[Read more: Is Factoring Receivables Right for Your Business?]
Tips for finding the right debt collection agency
If you decide to use a collection agency, follow these tips to ensure you find one that’s most likely to yield a positive outcome:
- Do your research. Look for agencies that have experience working with small businesses in your industry. Additionally, make sure any candidates are licensed, bonded, and insured and that they meet any other state and local requirements.
- Ask about “skip tracing.” Successful agencies can track down someone who has “skipped town” through a process called skip tracing. This involves using databases to gather, mine, and verify information on hard-to-reach individuals — significantly increasing the likelihood of successful contact.
- Compare costs. Once you’ve vetted an agency’s experience, processes, and credentials, make sure their fees make sense for your business and the specific case. Determine whether the agency uses flat fees (paid up front) and/or contingency fees (based on the amount successfully collected) and what the pricing structures for each entail.
When in doubt, consult with a legal or financial adviser who can help you evaluate your options and find one that best suits your needs.
Sammi Caramela and Lauren Kubiak contributed to this article.
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