How to send someone to collections: Guide, rules, and how to avoid

As a small business owner, you work hard to generate sales, but what happens if you end up with unpaid invoices? If a customer doesn’t pay their invoices, you could end up with a negative cash flow, which could ultimately lead to financial hardship or bankruptcy. It’s important to proactively follow up on past-due invoices, which sometimes means sending accounts to collections. 

While no business owner sets out to send someone to collections, there’s often no other choice than to collect on an unpaid invoice. Sometimes, the last resort to getting your payment is to send someone to collections. Before you take that step, however, you’ll need to know a few key terms:  

1. Contact the debtor

Way before the decision is made to send an account to collections, a small business should make every attempt (reasonably) possible to contact the debtor to collect the outstanding payment. 

This benefits both the company and the customer—the business can potentially collect payment faster while maintaining the customer relationship, and the customer can settle the debt without negatively affecting their credit score. 

Some things to consider when contacting the debtor include: 

• Documenting payment history for accurate tracking of outstanding debt.
• Sending clear payment communication, including immediate invoices, automatic reminders before the due date, a formal letter acknowledging the past due balance, and a payment plan offer (if applicable). 
• Making direct contact attempts via phone or email, emphasizing the need for immediate payment before additional action is taken. 
• Documenting all communication, both successful and unsuccessful attempts. Note dates, times, conversation content, emails, and in-person conversations. 
• Sending a debt verification letter and notice to the debtor (as required by law).

2. Understand the collections process

Debt collection is the process of attempting to recover unpaid debts or invoices—in small businesses, it would mean trying to recover unsettled debts from customers. 

Generally, small businesses take internal steps to collect unpaid debt from customers, like sending timely invoices and reminders or connecting with customers via phone or email. However, due to potentially limited resources and legal compliance, the business cannot continue trying to reconcile the debt after a certain time. 

At this point, the business offloads this task to a collections agency, which it hires to collect the outstanding debt in a process otherwise known as invoice factoring. It allows the small business to see the unpaid debt to the collections agency for a percentage of the total invoice amount, giving the small business cash upfront. After deducting their fee, the agency collects the total balance from the customer and pays the remainder back to the business.

3. Meet legal requirements and regulations

When deciding to send someone to collections, you must consider and adhere to the legal requirements and regulations. Otherwise, you could face costly penalties, reputation damage, and other legal action. 

With that said, perhaps the most important thing to understand is the Fair Debt Collection Practices Act (FDCPA), which regulates how creditors and collection agencies can communicate with debtors and others associated with them. 

When making this decision, it’s best to consult your legal team on state-specific collection laws, which can vary but often offer more protections for debtors than creditors. Some laws that vary by state include prohibited collection tactics, so it’s best to be well-versed in these before attempting to collect an unpaid debt. 

Additionally, having required documentation, such as original invoices, payment histories, and communication records, is also a requirement before sending someone to collections, as this will need to be given to the collections agency to validate the debt and meet their legal requirements.

4. Know the cost of using collection agencies

Exploring the cost of using collection agencies can be done anytime for practical knowledge, not just when a debt is owed. While using a collection agency seems like a great way to even partially satisfy overdue invoices, this procedure doesn’t come without a cost. Learning how much it costs to send someone to collections is crucial before making the decision. 

Common fees and costs associated with using a collection agency include: 

• Contingency fees: Most agencies charge contingency fees, which are a percentage of the total amount of debt they recover. This amount is usually 20% to 50% of the total debt amount. 
• Flat-rate fees: Some agencies choose to charge a flat fee regardless of the recovery amount. These fees mostly range from $15 to $25 or more, not dependent on debt amount.

ROI calculations include the potential return amount, the overall cost of using the collection agency, the fee amount, and the likelihood of getting the return. 

5. Assess the pros and cons of collections

While it might seem like the best option to collect an unpaid debt is to send the account to collections, there are some considerations to keep in mind. This process has both key benefits and drawbacks to your business, including: 

Potential benefits: 

• Improved cash flow, allowing the business to better manage expenses. 
• Deters future delinquencies by setting the standard for all customers.
• Time and resource savings from offloading this time-consuming task. 
• Legal compliance is typically withheld by collections specialists.

Drawbacks 

• Cost of services, including agency fees and potential legal expenses. 
• Damaged customer relationships, potentially costing future business. 
• There is no guarantee of recovery, even though collection agencies are experts at locating debtors. 
• Possible legal complications from noncompliance with debt collection laws could hinder the business.

6. Pick a collection agency

After you decide to send an account to collections, you must choose a collection agency. There are many small business collection agencies to choose from, and you’ll want to pick one you’re confident in to recover your unpaid invoices. To help make the best decision for your business: 

• Evaluate agency credentials by reviewing the number of years in business, overall success rate, and industry specializations. 
• Check licensing and certifications to ensure state compliance, in addition to industry affiliations. 
• Understand fee structures, noting transparency, room for negotiation, and any hidden fees. 
• Read reviews and testimonials from other businesses in your industry to understand how operations work. 
• Verify compliance practices with the BBB, thoroughly checking the agency’s reputation. 

7. Maintain best practices through the collection process

Even if you hand an unpaid invoice over to a collections agency to handle, you’re not entirely done with this account yet. Now, you’ll want to shift your attention to your communication with the collection agency for optimal debt recovery. 

• Maintain accurate records between you and the agency, including when they took over the debt and all communication. 
• Follow legal guidelines regarding Fair Debt Collection Practices Act (FDCPA) laws. 
• Understand timeline management with regular reporting, knowing that every account will vary in time to close. 

8. Prevent future collection issues

While you might not be able to prevent every circumstance leading to unpaid invoices, there are some steps your business can take to help customers pay invoices faster and minimize future collection issues. 

Take the following actions below to help secure payment on invoices quickly so that you don’t have to send someone to collections: 

• Have credit check procedures in place for new customers, especially if the invoice will be significant or recurring. 
• Provide clear payment terms that specifically lay out due dates, late payment fees, how to dispute charges, and any consequences of nonpayment, including forwarding to a collections agency. 
• Establish early intervention strategies, such as automatic reminders and early payment discounts, before an account becomes severely delinquent. 
• Provide multiple payment options for ease of access, like online payment, ACH transfer,  payment app transfers, and credit card options.

Choose the best payment setup for your business

Your goal should be to avoid the collections process whenever possible. It is essential to keep your business’s cash flow running smoothly, and having unpaid invoices can cause unnecessary hurdles. 

A QuickBooks Line of Credit can help you bridge the gap in your cash flow if accounts become delinquent so you can still operate your business smoothly while sending someone to collections. 

QuickBooks Payments: QuickBooks Payments account subject to eligibility criteria, credit, and application approval. Subscription to QuickBooks Online required. Money movement services are provided by Intuit Payments Inc., licensed as a Money Transmitter by the New York State Department of Financial Services. For more information about Intuit Payments' money transmission licenses, please visit https://www.intuit.com/legal/licenses/payment-licenses/.