The cost of running an agency seems to constantly increase. Added to that, collection problems can make those increasing costs more difficult to bear. Many agencies turn to late fees, interest charges, and credit card surcharges to offset some of these costs and encourage collection. But which are the most effective tools?
Late Fees: Effective Tool or Accounting Hassle?
When faced with the prospect of late payments, many agencies first turn to late fees. A late fee is a percentage or fixed fee charged as a consequence for not paying an invoice when due. The important thing with late fees is that they are not amounts that accrue based on the amount of time the invoice is outstanding. Rather, they are one-time charges, and usually fairly minor.
We are all familiar with late fees in the context of a lease, credit card, or bank loan. Generally, a late fee must approximate the actual costs that the agency incurs in dealing with a late payment. Extra invoicing, extra collection efforts, etc. Importantly, a late fee can’t be a penalty. So, for example, if an agency incurs an extra$500 in costs when collecting a $10,000 invoice, a late fee of $1,500 would probably be an unenforceable penalty.
But are late fees good tools for encouraging collections? In our experience advising agencies, the answer is no. Unlike with high volume servicers such as banks, landlords, and credit card companies, late fees do not seem to encourage payment and they are not a meaningful source of revenue. Most agencies end up waiving late fees if the client pays the balance (even if late). When that happens, the agency has incurred the cost of calculating, invoicing, and managing the late fee charge without the corresponding compensation.
If late fees aren’t very effective, why do we see them so often? Well, with high volume servicers like banks, landlords, and credit card companies, their entire business is built around servicing accounts and collections. It’s a huge revenue source for them. Also, because leases, bank loans, and credit cards play a different role in our lives, the consequence of lateness can be more significant (e.g., eviction, foreclosure, loss of credit). Those additional remedies aren’t things agencies have access to. And even when collected, because agency invoicing is much lower volume, late fees aren’t a significant source of revenue. As a result, we generally don’t include late fee clauses in the contracts we draft.
Further Reading: The Creative Agency’s Guide to Getting Paid
Interest: Time is Money
What’s worth more? $10,000 paid today or $10,000 paid in a year? Of course, $10,000 paid today is more valuable. Why? Because you get the value of using that money over the next year. At a minimum, you could invest it in an interest bearing or appreciating asset. In an agency, having money today may facilitate growth, fund extra sales efforts, or avoid having to borrow money at a high rate.
This is the power of interest: an amount charged against an outstanding balance based on the amount of time the invoice is outstanding. Your agency is not a bank to your clients. When payment is delayed, you should be compensated for that delay. Remember, interest doesn’t compensate you for the cost of collection efforts. It compensates you for the amount of time you don’t have the money.
We recommend that agencies retain the option to charge interest on late balances. In today’s interest rate environment and considering that agency invoices are general, unsecured debts, an interest rate of 18%+ is appropriate.
That said, most of our clients don’t try to collect interest when things are collected reasonably promptly. Like late fees, interest is often waived even if a client’s payment isn’t exactly on time. And also like late fees, if interest is just a few bucks related to the invoiced amount, it can be more trouble than it’s worth. Instead, interest is saved for when things take a really long time to collect or become adversarial. Imagine a client owes you $100,000 but you spend 18 months (maybe starting a lawsuit) to collect. A clause charging interest at 18% could yield an additional $27,000. The ever-increasing interest can be an important piece of leverage in settlement negotiations — encouraging the client to pay sooner rather than later.
Convenience Fees: Revenue Source or Illegal Charge?
Collecting payment by credit card means your agency incurs fees: 2.9% of the amount charged (plus merchant fees) is probably a good estimate. These costs can really add up. Some agencies respond by charging “convenience fees” or surcharges when clients pay by credit card.
While this strategy makes sense, there are pitfalls. Credit card surcharges like this are illegal in Massachusetts, Connecticut and Puerto Rico. Even if your agency isn’t located in one of these states or territories, if your clients are, you need to respect those state laws. Complicating things, bans on credit card charges are regularly considered by other states and there is always talk of a federal ban.
Even though surcharges are subject to regulation, cash (ACH, check) discounts are legal and can basically get you to the same place. To preserve your margin, your agency’s default pricing would need to be a bit higher and your SOW could offer a discount for payment by ACH.
That said, we sometimes recommend that agencies treat credit card charges as overhead rather than trying to assess against specific clients (whether by surcharge or discount). Having consistent pricing allows you to tell a consistent story and better determine overall agency margin. If you feel that your margins are too low after credit card charges, it probably means your prices are too low.
The Best Approach to Ensuring Prompt Client Payments?
Agency collections are a constant struggle. And late fees, interest, and credit card surcharges are imperfect tools for covering the costs of payment delays. For most of our agency clients, interest charges and discounts for cash (vs card) payments are the preferred tools for encouraging prompt payment. The ideal situation of course is getting the full amount up front. From there, installments in advance over the project are terrific. Interest, late charges and surcharges become less of a concern when you already have the money. Also, consider how you might offer a matrix of prices in your proposal to encourage more up front payment.
