In collecting business debt, it pays to keep an open mind.
If you’ve ever hired a collections professional to help you recover money from a non-paying client, you probably started out hoping to recapture 100%. It’s only natural you would want to win back every dollar your debtor has failed to pay for months, maybe even years.
You may feel disgruntled when the collections team presents you with 2 unsavory options: accept a single lump-sum payment that reflects a deep discount or agree to a long-term payment plan that might eventually pay more, but poses obvious risks.
You may dislike both options, but you’ll still need to choose one. Here’s a real-life case study from our friends at The Kaplan Group. This shows how one firm grappled with the alternatives.
A successful settlement goes off the rails.
Not long ago, an international company specializing in architectural technology came to us for help in recovering $77,000 owed by a single debtor.
We felt encouraged when the debtor agreed to a long-term payment plan that included a $17,000 discount for paying off the remaining $60,000 balance within 20 months. Things went well for a while, with $23,000 recovered in $3,000 monthly increments. But then the debtor defaulted again, leaving a discounted balance of $37,000. Our clients were incensed, since the original (non-discounted) balance still stood at $55,000 – a loss they refused to let go without a fight.
A sudden shift reopens the door.
After months of pursuing the debtor via USPS, email and other channels, we learned that the company’s accounting chief had suffered a heart attack. They were now using a consultant to run their finance department, which meant we had an opportunity to reopen negotiations.
In talking with the consultant, we inferred that a one-time, lump-sum payment might work for everyone. But the debtor continued to hold out for a discount on the balance owed.
While accepting these terms would be painful for our client, we nevertheless felt it would be be the right business decision because:
> Restarting the long-term payment plan posed serious risks, especially since the company had defaulted twice before.
> We were negotiating amid the financial chaos of a global pandemic that showed no signs of abating.
> The debtor’s finances had been precarious even before COVID-19 tore the world economy apart (and they were likely to weaken further still as the crisis continued).
> The debt was 18 months old, which meant the chances of recovering the full amount stood at just 25% and would continue to fall over time.
A 360-degree look at the client’s options.
Naturally, our client felt frustrated. They had already agreed to a significant discount on the total amount owed. When the case wrapped up, they would also owe us a contingency fee on funds recovered.
At this stage, the numbers just didn’t make sense to them. They balked at the thought of abandoning long-term payments, which they felt were the best way of recovering what they were owed.
Here’s the actual written advice we offered them.
We completely understand your concerns and would like to submit a few figures for your consideration.
If we are able to collect another $20,000 from the debtor, we will agree to keep our contingency rate at 15%. (Based on current contract terms, the fee should be 20% because the total collected falls into a higher category, but we’ll hold to the original 15%.) This would mean a $3,000 fee, netting you an additional $17,000.
We have already collected $23,000 on your behalf, for a net of $19,550. So if we collect another $20,000 as a lump-sum payment, your total net recovery will be $36,550. If we can recover $25,000, your incremental net would be $21,250, for a total net of $40,800.
The original principal amount owed was $77,770, so that would be a net recovery of a little over 50%. That might not seem great, but the raw numbers aren’t the whole story. We are now in a risk-reward situation that presents you with 3 options.
- Sue for the remaining $55,000 principal plus interest, which would boost the contingency rate to 35% and add $1,500 in upfront legal costs. Given the court backlog caused by the pandemic, we will likely hear nothing for at least 18 months, during which time the debtor may close their doors or file for bankruptcy, making recovery much less certain. Even if the court awards you the full amount, you will still need to collect – with no guarantee of success.
- Restart the $3,000-per-month payment plan with a 15% contingency rate on the remaining $37,000 due under the current settlement agreement. This means a payment plan that runs for 6 more months, but could very well take years if COVID-19 continues to wreak havoc on our economy.
- Try to collect a single payment of $20,000 to $25,000 at 15% contingency, thus avoiding the risks posed by the other 2 options.
Most clients who are in a similar position right now are cutting their risks, either because they urgently need cash or feel that long-term payment plan risks are unacceptably high. However, some clients choose riskier options if they trust that the debtor will stay in business and they don’t need the cash right now.
A tough choice – and a positive outcome
In the end, our client decided that seeking a $25,000 lump-sum payment would be wiser than going to court or risking the failure of another long-term payment plan. Everyone breathed a sigh of relief when the debtor agreed to the deal and remitted promptly.
As this real-world example shows, there are many factors to consider at every stage of the game. A skilled collections team will not focus solely on the amount you are owed. Your industry sector, the overall state of the economy and the financial health of your debtor are highly relevant to the decisions you must make. Always look for advisors who will walk the road with you and provide quality advice along the way.
For more perspectives on business debt, including the best ways to reduce accounts receivable risks, visit our blog.
