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By Dean Kaplan
If you provide goods or services to your customers on credit, you are lending money like a bank. Banks, however, do not loan money without first evaluating a potential customer’s credit to determine the likelihood of getting repaid. You need to act like a bank and collect information from potential customers, evaluate the information to determine the level of credit to grant, and then grant certain amounts of credit based on agreed upon terms of payment.
The credit application is the initial document you will use to collect information and establish contractual terms with your customers. A credit app should be designed to:
- Gather information and permission required to evaluate credit.
- Describe the terms of granting credit.
- Include terms to protect the creditor if a customer defaults.
- Include other terms governing a business’s relationship with the customer.
- Have a legally binding execution block.
Credit Application Considerations
There are some vendor/customer relationships that require lengthy contracts describing the business relationship due to the volume of business and critical terms for either party; however, the credit app is not the place for a lengthy contract. In many cases, though, the credit application is going to be the only document between you and your customer that’s signed by the customer. The credit application offers a unique opportunity for you to establish critical terms (and protections) in your relationships with your customers.
At the beginning of the relationship, you have something that your customers want: product or services to be provided now and paid for at a later time. This is the time when customers typically will agree to industry standard terms. Once you have started doing business, customers will be less likely to agree to any new conditions.
Fortunately, customers understand this, and key terms can easily be built into the credit app; a balancing act, however, is still required. Customers will be turned off by long forms and contracts, and they may turn to other vendors with easier applications. You, therefore, need to find the sweet spot that works best for them with respect to the length of the application and the terms incorporated therein.
Typically, credit applications are one page long if they only collect information, and two pages if they also include terms for granting credit. Occasionally applications can be longer, but in general, two pages should be sufficient to obtain the necessary information and the necessary terms to protect your company.
Information Desired to Evaluate Credit
The key pieces of information that you will need to evaluate credit are:
- Who is obtaining the credit (name)?
- What type of business are they (type of entity such as corporation, LLC, or proprietorship)?
- Who is the business owner; who is the person making the order; who is the accounts payable contact?
- Where are they located (physical and mailing addresses; owner’s home address)?
- How to contact them (phone, mobile phone, email address)
- How they will order from you (purchase order, phone, email, fax)?
- The amount and type of credit they are seeking?
- References (bank and other vendors)
Once you have this information, it is important to do a little investigation to make sure the applicant is creditworthy. If nothing else, run an inexpensive business credit report for as little as 3 cents if you have a subscription, or $8 for an individual report.
Contractual Terms to Include
It is important that the credit application be a contract and include the following terms:
- The application is a binding agreement.
- The person signing is authorized to bind the company.
- The information is accurate.
- The vendor (you) are given permission to evaluate the applicant’s credit.
- It is the vendor’s sole discretion to grant credit.
- The customer owes the vendor for anything provided on credit.
- The vendor’s forms have precedence over customer’s forms such as purchase orders.
These terms ensure that your customer understands they are signing a contract and gives you the necessary permission to evaluate their credit, grant credit on your terms, and deal with potential problems based on any additional terms provided in the application.
Default Provisions
A credit application should also protect you in the event that your customer does not pay on time. Some of the key items to include are:
- A personal guaranty if the customer does not pay
- Interest rate on late payments and acceleration of all invoices/payments if a payment is past due
- Customer will pay collection costs and attorney fees if applicable
- Disputes will be litigated (my recommendation) or arbitrated (more expensive)
- The location where any lawsuits must be filed
- A jury waiver
If your customer doesn’t pay on time, these default provisions can give you a huge advantage during the collection process by giving you leverage over other vendors who also might not be getting paid, and help you recover collection costs which otherwise might not be permitted by law.
Properly Designed Signature Block
It is also important that the signature block is properly designed. The person signing the contract needs to include his/her title so you can determine if you believe he/she has authority to sign on behalf of the company.
If a personal guaranty is included, it should have a separate signature line and NOT include the person’s title at the company since the person is signing as an individual, not an officer. If the customer is in a community property state and the personal guaranty is critical for extending credit, then you will need to get a spouse’s signature as well.
Final Thoughts
The best way to minimize the possibility of not getting paid is to get a good contract up front, properly evaluate a customer’s credit, and take prompt action when a customer does not pay on time. Statistics compiled by the Commercial Law League of America show that once an invoice is delinquent, the chance of collecting declines more than 1 percent per week. By the time an invoice is 90 days past due, there is already a 26 percent chance it won’t be collected — and it gets worse as time goes by. Protect your business with a good credit application.
The post Protect Your Business From Deadbeats With a Well-Designed Credit Application appeared first on AllBusiness Experts.