Should You Hire a Collection Agency?

How do collection agencies work?

When you have outstanding invoices and have been unable to collect from your delinquent accounts, it may be time to call a collection agency. Collection agencies specialize in chasing down uncollected accounts receivable, usually for a percentage of whatever they are able to secure. 

Once you hire a collection agency, they act as a middleman. They will attempt to contact your debtors and collect the unpaid money for you. It is essential to work with a collection agency that abides by all legal requirements, or else you could still be on the hook for any fines or litigation that arises as a result of violations. If the agency is successful in recovering the debt or a portion of it, their percentage will be taken out of the recovered amount and the rest will be turned over to you.

Collection agencies can be an effective way to continue to pursue overdue balances while turning your attention back to your operations and running your business. However, it’s important to note that they should be considered a last resort. Always try to collect overdue invoices yourself first.

How to choose a collection agency

Once you’ve made the decision to hire a collection agency, make sure you select the right one. If you follow the advice below, you can be confident that you’ve hired a reputable agency that will handle your account with care.

Do your research.

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

Ask if they are qualified.

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 the licensing requirements 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 (FDCPA). [Read related: What Is The FDCPA?]

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.

Understand how they will work for you.

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, one that treats your former customers the way you’d want to be treated and still gets the job done.

Sometimes debtors leave town. If that happens, one tactic many agencies 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 ask about specifically.

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 information 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.

Make sure they’re insured.

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 could be 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. Ask for proof of insurance from any collection agency to protect yourself. This is most often called an errors and omissions insurance policy.

Be ready to pay.

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. Keep this in mind 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 or purchase of debts.

Payment on collection

In the payment-on-collection model, the collection agency 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 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.

Find out if you can break your contract.

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 you can enact an escape clause if the agency hasn’t delivered. Alternatively, if the company presents a fraudulent agreement, you can generally break the contract. But you’ll want to consult a debt collection 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. You can also simply ask the company what their cancellation fee is.

Pros and cons of hiring a collection agency

Hiring a collection agency comes with its benefits and drawbacks, so you should weigh the decision carefully before hiring one. Consider the following before sending a collection agency after your unpaid accounts receivable — if the pros outweigh the cons, it’s probably worth moving forward.

Pros

• You’ll likely get paid: Assuming your agreement or contract is clear and you can demonstrate that services were rendered, a collection agency will likely be able to collect on your behalf. That’s money in your pocket that you wouldn’t have seen otherwise.
• You won’t have to handle it: If you’ve ever had to chase a nonpaying client down repeatedly, you know how disruptive it can become to the rest of your work. Hiring a collection agency means it won’t be your problem anymore, and you can rest assured that someone is working on it day in and day out.
• Collection agencies can track down hard-to-find clients: If someone has successfully ducked your communications and proven difficult to track down, a collection agency might have better luck. By employing a technique called skip tracing in debt collection processes, these agencies are able to find even the most stubborn disappearing clients. Note that skip tracing may involve additional costs, though.
• Collection agencies are cheaper than court: Going to court is expensive, and collection agencies represent an option between negotiation and litigation. Although collection agencies will take a chunk of what they collect on your behalf, it’s a lot cheaper than going to court. Besides, that money isn’t coming out of your pocket, as it would be if you were spending on lawyer’s fees.

Cons

• Collections don’t always work: Sometimes collection agencies fail to recoup the money you’re owed. This could be because your agreement wasn’t airtight or because the client refuses to pay, citing some grievance with the quality of work. Some clients may even be willing to go to small claims court if they believe they would be able to avoid paying (or if they think you’re not willing to dedicate the resources needed to litigate).
  
• It could damage your business relationship: In some cases, a client you’ve sent to collections is one you could do business with in the future. If they’re usually on time with their payments, consider working with them to establish a payment plan before sending them to collections. That way, you can continue working with them in the future when their financial situation improves. If your client is a habitual nonpayer, though, it might be worth sending them to collections anyway.
• You won’t collect the full amount: Collection agencies need to get paid, and that money is going to come out of your accounts. To compensate an agency for its work in collecting your money, you’ll pay a percentage of that amount — sometimes a significant one. While some money is better than none, ask yourself if the amount you’ll receive is worth the cost of chasing it down.

Collection agencies can help you get paid — for a price

When you are unable to collect a payment you’re owed, a collection agency can step in and do the heavy lifting for you. While it will typically cost you a percentage of whatever is collected, it’s well worth it to bring in some of the cash instead of letting the invoice go unpaid. Still, there are some factors to consider before hiring a collection agency, including whether you’ve exhausted all other options first. Once you bring in a collection agency, there’s no going back, so be sure it’s the right choice for your business before sending them after your unpaid accounts receivable.

Jacob Bierer-Nielsen contributed to this article.