Avoid business icebergs: Do your due diligence

Iceburg floating in the sea

What you see on the surface is not always what you get, especially when it comes to other businesses. Here’s why doing your due diligence is an important step in a business relationship.

We all know the story with icebergs: only one-eighth of it appears above the water, making it hard to judge its true size and nature. The thing with icebergs is that from the outside you can’t see the cracks on the inside that could cause the whole thing to fall apart.

It’s the same with businesses. What may well look like a well run business on the outside could have serious internal problems that may jeopardise the viability of a business relationship. To find out what these cracks may be, you need to do your due diligence.

Just because a business is big and reputable, or has glossy brochures and a flashy website, doesn’t mean it is an ideal customer. It certainly doesn’t mean you should do business with them on reputation alone. You wouldn’t believe the size of the companies on Australia’s worst payers list. The thing is many of them get away with it because they bully other businesses, or they are only slow to pay certain creditors. You need to arm yourself with the knowledge and the tools to counter this behaviour.

Due diligence—boring but important

What do I mean when I say ‘due diligence’? Due diligence is the general term for all the checks that you do prior to entering into a business relationship or transaction with another party. This may include substantiating their company and legal status, looking at their credit history, and gathering testimonials from their current creditors.

Just like icebergs have glaciologists, businesses have debtor registers and credit reporting agencies such as CreditorWatch to collect data and analyse the results. This information will help you keep your eyes open when you make a decision on whether to take someone on as a debtor.

Businesses often get stung when they find out they have been chasing a debt from a company that doesn’t exist. A credit check will bring up the trading name and the company name of a business. This distinction is important when you are after money owed; you need to address your invoices to the company and all follow-up correspondence needs to be addressed to the company, not to the trading name.

Credit status will tell you how risky it is to extend credit to the business. Even if the business has a good credit status, it’s advisable to look at their credit history as well, to note any payment delays or defaults in the past. There may be good reasons for the occasional delay, so ask if you’re unsure of what the data indicates and note any patterns.

Maybe this debtor tends to forget about smaller invoices, smaller enterprises, or businesses in certain industries. Consider asking for a credit testimonial from a business similar to yours, and ask yourself whether you’re willing to accept that behaviour. Perhaps you can formulate credit terms that will counter it.

How solid is the future?

Once you’ve ascertained that the iceberg is solid, don’t assume that it will be solid forever! Recognise that a business relationship is a living thing—many businesses forget this and tend to ‘set and forget’. The business environment changes every day and you need to keep on top of how this will affect your debtors and therefore your business. Check for warning signs regularly, even if you just keep an eye on the news once a week for shifts in the business environment.

It’s also good practice to do a debtor check every month or so, just to ensure the health of your cash flow. You can do this in your own recordkeeping, just by invoicing promptly and setting reminders to chase debtors if you haven’t received payment by a certain time. With services like CreditorWatch, you can create WatchLists that will alert you if another business files a ‘failure to pay’ report on any of your clients, suppliers or partners.

The important part is to act on these notifications. If the debtor knows you’re monitoring them, they are more likely to pay on time. This is especially true of larger companies that may otherwise get away with bullying smaller companies by withholding payment. Big companies have more to lose when their reputation is at stake.

Fighting bad debt

After all your due diligence, if you still want to do business with a risky debtor then one defence against becoming a bad debt victim is to set credit terms that favour you. Try to match your risk appetite with the payment method and be clear about why you are considering an alternative to the standard 30-day invoice.

The Holy Grail is to get your client or customer to pay upfront, but this is not always possible due to market forces. Other favourable credit terms you could consider include the debtor paying you a portion upfront and the rest at an agreed time, or the debtor paying you in regular installments. Limiting the amount of credit you lend is also advisable.

If this doesn’t work and you have a bad debtor on your hands, it’s best to get a third party involved to witness the situation. This third party can be anyone from an external accountant or business coach, to a mediator or legal body.

A service like CreditorWatch can act as a silent third party. Because the service is all about registering bad debtors for the benefit of the business community, your debtor actually puts their reputation at stake when they delay payment or don’t pay you at all. A bad debt register stands as a reminder to them that other businesses can search for, and find, these negative reports against their name. The result? Less creditors willing to do business with them until their behaviour improves.

If you want to use the ‘third party accountability’ method to control your debtor, make sure you communicate the presence of that third party. Tell them that you have an external accountant or business coach who oversees payments and advises you on running your business, or that you aren’t afraid to bring in a mediator or lawyer if things get out of hand. And certainly use the CreditorWatch logo on your invoices and statements to warn them that you can put them on a bad debt register if they don’t pay.

Managing bad debtors needn’t be a chore if you have a strategy in place. Understand what the debtor has to lose by delaying payment or defaulting and use that as the trigger to ensure that they stay in the good books. Don’t be the lost ship in a sea of icebergs—know where you sail!