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How Collections Agencies Work and When You Might Deal With One

  • Writer: DM Monticello
    DM Monticello
  • Jul 3
  • 7 min read

When customers or clients don’t pay their bills on time, it can leave your business struggling to stay on top of expenses. If late payments pile up, you may start hearing the term “collections agency” as a possible solution. But what exactly is a collections agency, and how does it operate?

In this guide, we’ll break down what a collections agency does, when you should consider using one, and how to choose the right partner for your business.

What Is a Collections Agency?

A collections agency is a company that specializes in recovering unpaid debts on behalf of businesses or creditors. When a customer doesn’t pay after repeated reminders, many businesses turn to a collections agency to handle follow-up, negotiations, and legal escalation if needed.

While a creditor (the original lender or service provider) owns the debt, a collections agency either:

  • Collects the debt on behalf of the creditor, earning a percentage of what they recover, or

  • Buys the debt outright, usually at a reduced price, and keeps the full amount recovered

These agencies are experts in contacting debtors, offering settlements, and navigating legal regulations around debt collection.

How Collections Agencies Operate

Once a business hires a collections agency, here’s what typically happens:

  1. Account Transfer: You send the agency details about the unpaid accounts, including contact info, invoice data, and communication history.

  2. Debtor Contact: The agency begins reaching out to the debtor via phone, letters, email, or even text.

  3. Negotiation and Recovery: They may offer payment plans or settle the debt for a portion of what’s owed.

  4. Legal Escalation (if needed): If negotiations fail and the debt is valid, some agencies may pursue legal action with your approval.

They make money either through a contingency model (taking a cut of what’s recovered) or by purchasing the debt at a discount and keeping whatever they collect.

The Types of Collections Agencies

Not all agencies operate the same way. Understanding the different types will help you choose the right one:

First-Party vs. Third-Party

  • First-party agencies work under your business name and appear as part of your brand. These are often used for early-stage collections.

  • Third-party agencies are hired externally to recover older or more difficult debts, usually on commission.

Consumer vs. Commercial Collections

  • Consumer collections involve individuals, such as unpaid medical bills or credit card debt.

  • Commercial collections deal with B2B debt—outstanding invoices between businesses.

Legal Collections Firms

Some agencies are also licensed legal entities that can file lawsuits on your behalf. These are useful for high-value debts that require court intervention.

For more on legal workflows, read How to Manage Compliance for Global Teams.



What Businesses Use Collections Agencies For

Common Industries

Collections agencies serve a wide range of businesses where unpaid invoices are a common issue:

  • Healthcare: Unpaid co-pays, insurance gaps, and billing confusion often result in overdue balances.

  • Retail and E-commerce: Missed layaway payments or returned checks can lead to lost revenue.

  • Professional Services: Lawyers, consultants, and creatives often deal with delayed client payments.

  • B2B Services: Agencies help recover invoices between businesses, especially for services like marketing, logistics, or IT.

Explore similar operational fixes in How to Run a Small Business Profitably.

B2B vs. B2C Use Cases

  • B2B collections often involve negotiating with finance departments, reviewing contracts, and navigating commercial terms.

  • B2C collections focus on consumers, requiring sensitivity and legal compliance with personal data and communication rules.

Improving Accounts Receivable Turnover

By collecting faster and more efficiently, businesses improve their cash flow, reduce bad debt, and gain more control over financial forecasting.

For help managing payments internally, check out Guide to Small Business Invoicing.

Legal and Ethical Considerations

Collections is a heavily regulated industry. Understanding the legal framework ensures you choose an agency that protects both your business and your customers.

Fair Debt Collection Practices Act (FDCPA)

This federal law governs how agencies can:

  • Contact debtors

  • Report debts to credit bureaus

  • Handle disputes and settlements

It prohibits harassment, misrepresentation, and deceptive tactics.

State-Specific Rules

Each state has its own laws on:

  • Licensing

  • Statute of limitations

  • Interest rate caps

  • Disclosure requirements

For example, New York requires certain licensing and has a three-year statute of limitations for most debts. Learn more in How to Choose the Right Collection Agency in New York.

Consumer Rights

Debtors have the right to:

  • Request validation of the debt

  • Dispute inaccuracies

  • Be contacted only at reasonable times

Your chosen collections agency must comply with these rights or risk lawsuits and fines that could affect your brand.

When to Use a Collections Agency

Don’t jump to collections immediately. First, try to collect through:

  • Friendly reminders

  • Updated payment terms

  • Phone or email follow-ups

But if an account is:

  • 90+ days overdue

  • Unresponsive after multiple contacts

  • High-value or legally solid

… it’s time to consider professional help.

Discover internal process improvements in How to Streamline Back-Office Operations.



How to Prepare Your Business for Working with a Collections Agency

Before partnering with a collections agency, it’s important to ensure your internal systems are ready. This makes the transition smoother, improves your chances of recovery, and keeps your team aligned with external collectors.

1. Standardize Your Payment and Collection Terms

Clear policies help avoid confusion and set expectations early. Your invoices and contracts should clearly state:

  • Payment due dates

  • Late fees or penalties

  • When accounts may be turned over to collections

You can also include language like:

"Accounts unpaid beyond 60 days may be transferred to a third-party collections agency."

This statement alone can encourage faster payments.

For tips on improving internal operations, check out How to Maximize My Team’s Productivity.

2. Train Your Team on Escalation Protocols

Before an account is sent to collections, ensure your internal team:

  • Sends at least two written reminders

  • Attempts one phone call or email follow-up

  • Logs all communication efforts

Having a standard operating procedure helps your team act fairly and consistently.

Explore more on operational structure in Tips for Effective Team Management.

3. Organize Documentation Before Handoff

Agencies need a full picture of each account. Prepare:

  • Signed contracts or service agreements

  • Detailed invoices or statements

  • Communication logs

  • Any partial payment records

Organized documentation improves collection success and protects your legal standing.

See Guide to Hiring Back-Office Operations for guidance on efficient recordkeeping.

4. Communicate With Customers Before the Handoff

Before sending an account to collections, consider giving the customer one last chance with a final notice. A message like:

"Please note that if payment is not received within 7 days, your account will be referred to a collections agency."

This approach often works—without needing outside help.

For customer relationship strategies, visit How to Build Long-Term Customer Loyalty.



Choosing the Right Collections Agency

When you’re ready to bring in a collections partner, don’t just go with the first name you find. The wrong agency can harm your reputation, violate the law, or fail to recover your money.

Here’s what to look for in a reliable agency:

1. Proven Industry Experience

Choose an agency with experience collecting in your sector. A firm that specializes in healthcare, for example, will understand HIPAA compliance and how to talk to patients professionally. Likewise, a B2B collections firm will be familiar with business contracts and commercial terms.

Explore hiring best practices in What Are Staffing Companies?.

2. Licensing and Legal Compliance

Make sure the agency is:

  • Properly licensed in your state

  • Familiar with federal laws like FDCPA

  • Bonded and insured

Check their standing with the Better Business Bureau or relevant consumer protection agencies.

3. Transparent Pricing

Ask about:

  • Collection fees (typically 20–40% of recovered funds)

  • Upfront costs (if any)

  • Fee structures for flat-fee vs. contingency models

Get all fees in writing before signing any agreements.

For similar decision-making frameworks, check out Cost-Effective Strategies for Business Growth.

4. Communication and Reporting

Choose an agency that:

  • Sends regular updates and reports

  • Offers easy-to-read dashboards or summaries

  • Responds promptly to questions or concerns

This transparency builds trust and lets you evaluate performance over time.

Red Flags to Watch Out For

Avoid agencies that:

  • Use scare tactics or threats

  • Refuse to put agreements in writing

  • Have poor online reviews or legal complaints

  • Push you into a long-term, inflexible contract

These signs suggest a lack of professionalism—and possible legal risk to your business.

Read more on avoiding bad partnerships in How to Choose the Right Remote Work Agency for Your Startup.

Alternatives to Collections Agencies

Collections should be your last resort. Try these strategies first:

1. Offer Payment Plans

Sometimes, customers want to pay but can't afford the full amount upfront. Offering a structured payment plan may recover more money and preserve the relationship.

2. Automate Reminders

Use billing software or a virtual assistant to send regular reminders and overdue notices. Often, a gentle nudge is all that’s needed.

See Virtual Assistant Services for Small Businesses for outsourcing support.

3. Engage a Credit Counselor (for consumers)

If the debt is personal (not business-related), recommend the debtor contact a certified credit counseling service. This can lead to structured repayment agreements that benefit both sides.

Explore proactive planning in The Ultimate Blueprint for Business Growth.

Conclusion and Best Practices

A collections agency can be a powerful ally when unpaid accounts start piling up—but only if you use them strategically and responsibly.

Key Takeaways

  • A collections agency recovers debts when in-house efforts fail.

  • Choose between consumer vs. commercial, first-party vs. third-party options.

  • Always verify licensing, legal compliance, and ethical practices.

  • Only escalate after exhausting internal follow-ups and reminders.

  • Keep documentation clean, clear, and ready for handoff.

By doing your research and setting clear expectations, you can recover more money, reduce bad debt, and protect your customer relationships.

Learn how to build long-term business resilience in How to Build Your Dream Team.



OpsArmy: Your Partner in Smarter Business Operations

OpsArmy is building AI-native back office operations as a service (OaaS). We help businesses run their day-to-day operations with AI-augmented teams, delivering outcomes across sales, admin, finance, and hiring. In a world where every team is expected to do more with less, OpsArmy provides fully managed “Ops Pods” that blend deep knowledge experts, structured playbooks, and AI copilots. Think of us as your operational infrastructure: running faster, leaner, and smarter business execution. Visit operationsarmy.com to learn more.



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