Risk and Reward are the two sides of almost every business deal. What are you risking if the deal doesn’t go well? What will you gain if it does go well? Does the reward justify the risk? In collections, we often have to weigh risk and reward and make similar calculations.
When trying to decide what the riskier or safer course of action is, we consider not only the amount of money owed, but also the specific debtor company and management, the business sector and the economy in general. Right now, for example, unpaid invoices are extremely risky for many business sectors. The pandemic has shut down some industries, dramatically curtailed other sectors, and creating surprising risk for some companies that isn’t obvious from just looking at the service or product they provide. If you are owed money now, you will want to act quickly to recoup as much money as possible. Every day that the money is owed to you is a day that money is at risk.
I recently shared the story of a client who had to decide if they should accept a lower lump sum payment, or try to gain more money by allowing a payment plan. Given the general economy, and the poor financial health of the company owing money, I advised that they accept the one time discounted settlement payment. However, with a different company, or this same company in a different economy, we may have advised something different. With investing, we often think the bigger the risk, the bigger the reward. That is not always true with collections. Sometimes, a big risk will only yield a small reward.
The Risk of Going to Court
Perhaps the biggest risk/reward scenario in collections is going to court. When we get to the point where litigation is the only alternative, we do not always advise suing. Instead, our advice to our clients is based on Return on Investment (ROI). We have to consider the potential cost, the potential return, and the likelihood of getting the return. Internally, we use a simple expected value equation as part of our thought process before giving a recommendation. For example:
Potential recovery: $10,000
Net recovery (after 35% contingency fee) $ 6,500
Likelihood of actually collecting 50%
Expected value of recovery $3,250
Risk and Reward Calculations
If our clients’ only have to pay $500 to sue, most of them are likely to proceed with litigation in the situation described above. But, if they have to pay $1,500, they won’t. Any statistician would tell you that a bet of $1,500 with an expected return of $3,250, is a good bet. But, given the hidden costs of suing, such as time and travel, it doesn’t always feel that way.
At The Kaplan Group, we win virtually all of the lawsuits we initiate. We encourage clients with claims having legitimate disputes or high counterclaim potential to avoid the courtroom if we can arrive at a reasonable settlement. This reduces the risk. However, the biggest risk is the ability to actually collect. In the example above, if the likelihood of collecting was 75%, the expected value of recovery would be $4,875 (75% x $6,500), and at that point, even a $1,500 investment looks more compelling. But, if the likelihood of collecting is only 20%, then the expected value of recovery would only be $1,300 (20% x $6,500), and at that point, it is hard to justify even a $500 investment.
Today, after Covid-19 had a big impact, courts are backed up even more, meaning that it will take even longer to receive a judgement. This makes going to court an even riskier move as we don’t know if the debtor will still be in business 2 years from now when we finally have the judgment.
Risk and Reward in Large and Small Firms
Our larger clients, and those with professional credit management staff, tend to litigate when the ROI looks promising. They understand that debt collection litigation is just another business investment opportunity, and they should proceed whenever it meets their standard investment criteria. However, many of our smaller clients, and clients without professional credit management in place, are less likely to want to go to court. The investment of time and money is just not as obvious for them.
All business runs on the idea of balancing risk and reward. Knowing more about how a collection agency views the balance can help you make your decisions with more confidence.