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Credit and Collections:
Part Three

arlier counsel has asserted, "In the emerging company, there is no place for marginal business, collection agencies, or bad debts." However, a minority of emerging businesses have used the aggressive provision and management of credit as a successful marketing strategy. In an economic sense, the decision to embark upon an aggressive credit strategy involves a cost-benefit analysis. This riskier alternative warrants consideration.

          An aggressive credit policy is based upon the statistical determination of losses coupled with an assertive collections policy. This marketing strategy calculates that the incremental net income from these more precarious sales will offset substantially the inevitable bad debts and forfeitures. An aggressive credit policy seeks to attract additive sales volume; the net returns are expected to be lower than the margins on more credit-worthy business, but there will still be substantial cumulative income even after provision for losses, collection costs, and write-offs.

          But an aggressive credit policy moves the emerging company into a very different kind of business. The cardinal rule that we must know our customer thoroughly still prevails. However, the customer we now know either one-on-one or as a statistical aggregation is a customer presenting some possibility of default. The imminence of possible default produces a different relationship with our customer.

          First, this relationship presents a tough ethical question that is commonly sublimated: "In our quest for increased sales revenues, are we taking advantage of and inflicting possible harm upon a customer when we know there is a possibility of default?" Quite dramatically, this is a question masked by third-party detachment as large banks rush to issue every-increasing numbers of credit cards, with absurdly high credit limits, to persons whose credit-worthiness is steadily declining. Today, credit card operations represent the most profitable part of their business for many large banks. While the banks may deem the default rate "manageable," these buccaneer credit practices wreak devastation upon the families that have been enticed into predicaments with which prudent credit managers know too many of them cannot cope.

          The owner/manager of the emerging business frequently encounters this same ethical dilemma. While we are rarely in a position to question a customer's abusive or compulsive credit card use, the ethical question may be encountered in the extension of direct credit. It can be especially troubling when we have developed a personal friendship with the customer. We are not doing a customer or a friend a "favor" by extending credit in an amount or a form that in any way exceeds the guidelines of sound credit management.

          Second, in today's complex and litigious society, the emerging business must be prepared to support a knowledgeable credit management and collections operation. This is an expensive activity, and emerging businesses often try to skimp on these costs. Disaster may not be far away when the owner/ manager adds credit management to his/her already overburdened list of personal job responsibilities. If the emerging business is unable or unwilling to support a knowledgeable credit management and collections operation, it should not embark upon an aggressive credit strategy.

          And third, it is mandatory that the emerging business obtain adequate security or collateral to fully protect its position. Experience shows us that otherwise "nice" people often do unbelievably devious and nasty things when confronted with financial misfortune. Should the customer fall into foreclosure or bankruptcy, past friendships evaporate. In fact, we will probably be dealing with a bunch of hostile strangers — a creditors' committee. If our credit position has been properly secured, the ultimate resolution may be satisfactory. However, if we are an unsecured creditor, we are likely to be nowhere; it is often prudent to walk away and simply seek better new business elsewhere.

          The owner/managers of emerging businesses who are patient and shrewd not-infrequently benefit through credit disasters. The key is to have liens on marketable property of significantly greater value than the creditor's obligation that can be exercised to discharge the defaulted contract. This is a strategy where some emerging businesses have thrived, but it is a tough business in which friendships seldom survive. It is not a business for the fainthearted.

          More than any other marketing strategy, the aggressive provision and management of credit demands that we must know our customer. Unsettling surprises abound in this business; we can never know too much about a prospective debtor. This strategy may offer some attractive growth and earnings possibilities, but it must be subjected continually to the most rigorous cost-benefit analysis.

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