Let’s be frank. As a start-up, you’re probably working with a very lean budget, and a few late-paying customers can really scramble your financial planning. Monitoring the creditworthiness of your clients is also something you must do to build your own business credit.
Charging late fees may help you get paid on time. The other side of the argument is that charging fees or interest on late payments works against your own best interest because it alienates customers at a time when you are working hard to build a base. Some other approaches may work better.
Two things are clear though.
- You should not charge fees on late payments unless you have a written agreement with the customer that permits you to do so. It should include explicit language along the lines of, "Accounts not paid within terms are subject to a ___% monthly finance charge."
- To prevent any possible conflict with usury laws, you should also calculate the fee as a percentage of the amount owed, rather than as a flat fee. The usual advice is 10% or less annually, but state usury laws vary, so make sure to have your standard agreement evaluated by an attorney qualified to practice law in the state or states where you operate.
Three Reasons to Assess Late Fees
Many suggest that including a provision covering late fees in your agreement with your customer clarifies expectations. There should be no question about when payment is due, and what will happen if it is not forthcoming. If your customers are friends with whom you dealt before you finally decided that your avocation was a business, this is also a way to signal a new formality in your relationship. It's not unfriendly. They'll probably applaud your step into the big-time.
It is a relatively automatic way shape client behavior. There’s plenty of software out there that can do the calculation and update your billing, and it may take only one late fee for a customer to shape up. It may also keep you from fuming about a particular client’s payment habit with all the potential spillover into your business relationship. Client misses payment date, client pays fee, all is forgiven.
Finally, you need to cover the cost of your collection efforts. Even that brief reminder note written on the bottom of the second notice costs you time and money.
Some Other Ways to Get Paid on Time
Although the evidence is difficult to quantify, others argue that assessing a late fee does very little to ensure timely payment. Instead, they suggest other approaches.
Minimize your risk by asking for a portion of the overall cost at certain benchmarks or as an up-front payment. Alternatively, offer a discount for payments made prior to a certain date.
If you have client who typically pays late, find out why. Are they dissatisfied with your work? This problem clearly has to be addressed in some other way than a late fee. Is their cash flow such that another billing cycle would work better –mid-month or every six-weeks — rather than at the beginning of the month? Remember, yours is not the only start-up out there. If your products or services are not a high priority or you customer simply cannot afford them, it may be time to lose that client. You cannot be asked to work for free, at least not for long.
Tailor Your Techniques
The truth is, you can mix and match these approaches to getting paid on time, depending on the particular client. There is no reason to treat a good long term client like a stranger or a small business like a larger one. You may decide, after your business has become more established, that you can afford to risk alienating some of your more difficult and unprofitable customers. The key, however, is to establish a written agreement about the payment of late fees at the beginning of a transaction. It is even better to discuss it orally as well, so there is no question about whether you intend to enforce it. You haven’t obliged yourself to take a kinder and gentler approach, but you’ve preserved all your options.