Too many small businesses do not use contracts with their customers. Some owners tell us that they feel a contract is too cold and impersonal. They believe it is too negative to start off a relationship thinking that a customer might not pay for services. Huge mistake!
We see a contract as the only way to begin a relationship with open and clear communications about how the business relationship will work. It is a positive and proactive tool that can protect you in the case of a dispute, or can also be used to assist with debt collection if the customer does not pay for your product of services.
Here is how a contract (or lack thereof) impacted two companies. Both companies were in the same business, commercial refuse. Both companies were in the same state serving essentially the same customer base.
Company #1 – Had a contract that included a personal guarantee, which meant that the owners would personally guarantee the debt in the event of a default. Since the commercial refuse is very competitive, they asked their customers to sign a one-year contract, which could be canceled with 60 days written notice. Customers also had to agree to terms and conditions that would apply if they did not pay on time: interest rate and the cost of collection would be added. Both had a decent in-house collection process and a good relationship with a collection agency. Company sales reps were made responsible for making sure all contracts were completed and signed.
Company #2 – Had a contract but no personal guarantee. The contract had no cancellation clause, and while it did have a provision for finance charges in the event of a default, it did not include cost of collection.
Company #1 was 20% more successful with bad debt recovery. They were able to pursue owners personally in case of a default, and were able to bill clients who did not cancel service according to the contract. They were also able to significantly reduce their costs of collection since by recovering those costs from their customers.**
Company #2 was unable to recover from a number of customers that were out of business. They often had no notice when a company went to a competitor. They recovered some finance charges but were never able to pass on their collection costs.
If you take your non-paying customers to small claims court, you will have a much better recovery if you have a strong contract. Even if you simply email basic details of your arrangement to your customer, something is better than nothing.
A basic contract will not cost you much at all, and it will save you tons. Ask your attorney to prepare a contract for you today – it will be the best investment you make all year!
** The recovery of collection costs is often limited by state laws and whether the debt is owed by a business or a consumer.
Would you like some more tips on how to reduce bad debt in your business? We have them!