Starting a debt collection agency can be a lucrative business venture, given the growing need for debt recovery services. With millions of individuals and businesses struggling with debt, there’s an ever-present demand for professionals who can effectively navigate the collections process.
From understanding industry trends, to developing a business plan, to navigating legal requirements, we’ll provide you with the foundation to get your agency up and running.
Business Overview
A debt collection agency works on behalf of creditors and lenders to recover payment from borrowers who have defaulted on their debts. An agency may offer a variety of services, such as bill and debt collection, delinquent small business debt collection, tax collection, repossession, and more. Some businesses specialize in one or two areas.
A debt collection agency can operate in a few different ways. Most businesses work for an individual or business looking to acquire overdue payments on a debt that they’re owed. In these cases, the debt collection business may require a fee for its service, or the business may provide service in exchange for a percentage of the total debt that is owed to the client.
Alternatively, some debt collection businesses buy debt portfolios from businesses. By purchasing these portfolios at a significant discount, the debt collection business can get payments directly from the debtor amounting to the debt’s original value. In this scenario, the debt collection business makes a profit, while the business that sold off the debt still gets a partial payment and doesn’t have to wait any longer or continue to worry about the unpaid debt.
Be prepared for the fact that the debt collection industry is competitive, and there are many well-established and well-known agencies already in existence. New businesses will need to overcome the challenge of gaining clients’ trust and building a roster of initial clients. There are many ways to do this, but this competition can add to the challenge of starting a new business within this industry.
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Industry Summary
The debt collection industry has grown steadily in recent years, and between 2017 and 2022, the industry grew by an average of 1.3% per year. As consumers take on more credit card debt, student loans, and other obligations, the need for collection services is expected to increase. With over $20.3 billion generated in 2022, third-party debt collection is vital for supporting lending markets. While technology has made some collection tasks more efficient, human expertise is still crucial for negotiating with debtors.
The debt collection industry is a volatile one, and it can fluctuate dramatically depending on the strength of the economy. Business owners should work to build up significant reserve savings to sustain their businesses during times when income is low.
Target Market
A debt collection business’s target market will depend on the business’s areas of specialty. Some businesses focus on certain types of debt, like student loans, commercial debt, or credit card debt. Most debt collection businesses will focus on retailers, telecommunications businesses, financial services firms, and healthcare companies with significant unpaid debt. Some businesses may also market to individuals who need to collect debt from renters and other debtors.
Checklist To Start A Debt Collection Agency
If you’re thinking about starting your own debt collection agency, you should keep a few things in mind. Here is a checklist of the essentials to get started.
Step 1: Research the Industry
Before starting a debt collection agency, it’s important first to understand the complex landscape and requirements of the industry. This step is the backbone of your business and can potentially keep you from making a costly mistake.
There are numerous online resources, including industry reports, articles, blogs, and forums where you can learn about current trends, challenges, and opportunities in the industry. Subscribing to industry-specific publications like InsideARM and Collection Advisor can also keep you updated on developments in the sector.
In addition, attending industry conferences and networking events can provide valuable insights and connections. These events often feature expert speakers who share their experiences and best practices, and they offer an excellent opportunity to meet industry leaders and peers.
Joining professional associations like the American Collectors Association International (ACA) can also be beneficial. These organizations often provide members with resources, training, and networking opportunities. ACA International, for instance, offers a comprehensive Professional Practices Management System (PPMS) certification that guides agencies on operational best practices.
Step 2: Write a Business Plan
A business plan should serve as more than just a formal document; it can also act as a roadmap that outlines your business’s goals and how you intend to achieve them. It helps you organize your thoughts, identify potential challenges, and devise strategies to overcome them. Moreover, it’s a necessary document when seeking funding from lenders.
When writing a business plan to obtain funding, there are a few sections that I would focus on.
- Market analysis: The market analysis section should explain what is unique about your debt collection agency and why it will succeed. This could include information about the demand for debt collection services, the gap in the market that your agency is filling, or unique strategies you’ll use to attract and retain clients. Lenders want to see that you have an understanding of the market and a solid plan to capture a share of it.
- Management team: The management team section is significant because it showcases the people behind the business. Lenders often place a high weight on the experience, skills, and track record of the management team when deciding whether to approve a loan. This is because a competent and experienced team increases the likelihood of business success. Therefore, be sure to highlight relevant experience and qualifications that your team brings to the table.
- Financial projections: Financial projections are probably the most analyzed section of a business plan by lenders. They want to see that your debt collection agency will not only be profitable but also generate enough cash flow to repay the loan. Ensure your financial projections are reasonable, well-documented, and show a clear path to profitability. Include income statements, balance sheets, and cash flow statements for at least three years.
Related: How to write a business plan
Step 3: Register the Business
Starting a debt collection agency involves several legal steps, and these can vary depending on the state where your business will be located. Here’s a general guide to help you get started:
Choosing a Business Structure
The first step is deciding on a business structure, which can be a sole proprietorship, partnership, corporation, or limited liability company (LLC). Each structure has its advantages and disadvantages.
A sole proprietorship is the easiest and least expensive to start. It’s essentially an extension of the owner, who is responsible for all assets and liabilities.
A partnership involves two or more people sharing ownership, with each contributing resources such as money, property, labor, or skills.
A corporation is a separate legal entity owned by shareholders, which offers personal liability protection but requires additional administrative duties and tax requirements.
An LLC combines elements of sole proprietorships/partnerships and corporations, providing liability protection without the administrative requirements of the corporation.
Related: Comparison of business structures
Forming an LLC sounds complicated and expensive, but using an entity formation service guides you through the process so you know it was done right.
Some popular LLC formation services include:
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Business name registration: After registering the business structure, you may need to register your business name. This process will vary depending on what business structure you pick. Sole proprietors and partnerships will often be required to register a “Doing Business As” (DBA), while corporations and LLCs register with the state during the formation process.
During this time, it’s also a good idea to check if the name you want is available as a web domain, even if you’re not ready to set up a website yet.
Related: Finding a domain name for your business
Obtain business licenses and permits: Debt collection agencies are heavily regulated at the federal and state levels. You’ll need to comply with the Fair Debt Collection Practices Act (FDCPA), Fair Credit Reporting Act, Gramm-Leach-Bliley Act, and Telephone Consumer Protection Act.
Every state has different licensing requirements for debt collectors. Many states require a debt collection license or bond to operate. Research your state’s laws and file the proper paperwork. Some states also require debt collection agencies to have a surety bond before they can be licensed.
It’s worth noting that debt collection agencies face high regulatory and compliance standards. One violation can result in lawsuits and fines in the thousands of dollars, making it imperative to have solid operating procedures and well-trained employees to minimize this risk.
In addition, there are common local, state, and federal business registrations such as a seller’s permit, Employer Identification Number, and Occupancy Permit, among others.
Related: State guides for general business licensing
Step 4: Source Funding
With the business registered and official, the next step is to make sure you have access to the necessary funding. The cost to get started can vary widely, as you can start as an owner-operator working from home, to an office with staff. Back in the business plan step, you should have worked through how much it’s going to cost to get started. If not, start working on that now!
Personal savings are going to be the first source of funding, however, the total cost may be more, which requires finding outside sources of funding. The most common sources include:
Bank Loans
Lenders are a common source of startup funding. Banks typically require borrowers to invest at least 15% of their personal funds towards the total cost of the project. They also look for a good credit score and sufficient collateral. If a bank considers your loan too risky, they might opt for an SBA loan guarantee which can provide the bank with a level of assurance that the loan will be repaid.
Friends and Family
Borrowing from friends and family is another option. People who know you well might be willing to support your business venture. However, mixing personal relationships with business can lead to complications, so it’s crucial to put agreements in writing and clarify repayment terms.
Microloans
Microloans are small loans typically for businesses, often needing less than $50,000. Economic development organizations often provide these, and some even offer business training alongside the loan. This could be a good fit if your funding needs are low or if traditional credit isn’t available.
Local Investors
Local investors can also be a potential source of funding. These are individuals with a higher net worth who have an interest in your industry or supporting local businesses. However, securing investment can be challenging as these individuals often seek high-growth, scalable businesses.
Each funding source has pros and cons, and what works for one business might not work for another. It’s important to carefully evaluate your options and choose the one that aligns best with your business’s needs and goals.
Related: Finding the money to start a business
Step 5: Set Up Operations
Setting up a debt collection agency involves several crucial steps aside from the legal and financial aspects. One of the first tasks is to decide on a location for your business. This could be a physical office or even your own home, depending on your budget and the scale at which you intend to operate.
While it’s possible to start a small business out of a home office, once the business is large enough to hire employees, it’s probably time to move to a larger office. If you are working out of the home, check zoning and covenants in case you have a neighbor who doesn’t approve. Rental costs for office space will depend on the size of the space and location.
Next, consider the equipment you’ll need. At a minimum, this will likely include computers, phones, and office furniture. You may also need a secure filing system to store sensitive client information, whether that’s physical file cabinets for paper documents or secure digital storage for electronic files.
Investing in specialized debt collection software can greatly streamline your operations. This software can automate tasks like tracking overdue payments, generating letters, and making calls. Some popular options include Simplicity Collection Software, Experian’s Tallyman, and C&R Software Debt Manager.
Once your office is set up, you’ll need to develop a collections strategy. This includes deciding how you’ll approach debtors, how often you’ll contact them, and what methods you’ll use (such as phone calls, emails, or letters). Remember to always comply with the Fair Debt Collection Practices Act (FDCPA), which sets guidelines on how debt collectors can interact with debtors.
Step 6: Obtain Insurance
Getting the right insurance is a key step when starting a debt collection agency. Since you’ll be handling people’s sensitive information, you want to make sure you are covered in case anything goes wrong. A few of these include:
- General liability insurance protects the business if customers are ever injured while on the business’ property. This insurance can cover expenses like legal fees and medical bills.
- Cyber liability insurance: Given the sensitive financial information that debt collection agencies handle, this policy can protect you in case of data breaches or cyberattacks.
- Commercial auto insurance can help to cover expenses if a company-owned vehicle is ever involved in an accident.
- Worker’s compensation insurance helps to cover expenses like lost wages and medical bills if an employee is ever injured while on the job.
- Surety bonds (also referred to as a debt collector bond) are required by many states as a condition of licensing. A surety bond is a type of insurance that your business will follow all rules when collecting a debt.
Related: Types of insurance your business may need
Step 7: Hire Employees
Depending on your business plan, if you plan to hire employees, it’s important to understand the responsibilities and requirements involved as an employer.
A few of the legal requirements to consider:
Obtaining an EIN: An Employer Identification Number (EIN) is required by the IRS for businesses that will have employees. It’s used for tax filing and reporting purposes.
Employment eligibility: Under federal law, you must verify an employee’s eligibility to work in the U.S. This typically involves completing an I-9 form and verifying identification documents.
State reporting: Each state has different requirements for reporting new hires, so make sure to check with your state’s labor department or a local attorney to ensure you’re in compliance.
Worker’s compensation: Most states require businesses with employees to carry worker’s compensation insurance, which covers medical expenses and lost wages for work-related injuries or illnesses.
Labor laws: Familiarize yourself with federal and state labor laws, which cover areas like minimum wage, overtime, breaks, and safe working conditions.
Related: Hiring your first employee
Step 8: Create a Marketing Plan
Marketing a debt collection agency involves a variety of strategies, each aimed at expanding your visibility and credibility in the industry. One effective method is networking, which includes attending industry-specific events and joining local business organizations like the Chamber of Commerce if you are focusing on a local market. This not only helps you meet potential clients but also provides opportunities for learning and collaboration with peers.
Another important strategy is developing key messages communicating your agency’s unique value proposition. This should clearly demonstrate why clients should choose your services over others. These messages can then be distributed through relevant channels, including direct mail and advertising in business-oriented publications.
Online marketing is another important element. This can involve establishing a strong online presence through a professional-looking website, engaging in search engine optimization (SEO) to increase your visibility in search results, and actively using social media platforms like LinkedIn, Facebook, and Twitter to connect with potential clients and industry peers.
Furthermore, consider claiming your business on relevant online business directories, such as Google Business Profile. This can improve your online visibility, make it easier for potential clients to find you, and provide an avenue for clients to leave reviews.
Finally, consider referral marketing by creating a referral network. This involves incentivizing existing customers or partners to refer their contacts to your agency. This is a powerful tool as prospects are likelier to trust recommendations from people they know.
Remember, all your marketing efforts must comply with federal and state laws, including the Fair Debt Collection Practices Act (FDCPA). So, always ensure that your strategies are in line with these regulations.
Related: Low-cost ideas to market a new business
Step 9: Prepare to Open!
As you approach the launching stage of your debt collection agency, several steps still need to be taken. Every business will have different needs, but here are some of the common steps to address:
Bookkeeping: A solid bookkeeping system is essential for tracking income, expenses, and financial transactions. This can be done manually, but using accounting software like Wave Accounting (FREE) or Quickbooks can streamline the process.
Contracts: In the debt collection industry, having sound contracts in place is essential. You’ll be dealing with contracts like debt purchase agreements, service agreements with your clients, and potentially, confidentiality agreements to protect sensitive information. An attorney is best, but RocketLawyer and Law Depot have free and inexpensive templates that may be helpful when starting off.
Bank account: Opening a bank account dedicated to your business helps in keeping your personal and business finances separate, which is a best practice for legal and tax purposes.
Pricing: Determine your pricing structure. This could be a flat fee, a percentage of the amount collected, or a combination of both.
Industry associations: Joining industry groups like ACA International, the International Association of Credit Portfolio Managers, or the Debt Buyers Association (DBA) can offer numerous benefits, including networking opportunities, educational resources, and industry updates.
Grand opening: As you gear up for the grand opening, ensure that all the operational aspects are in place and functioning correctly. This includes staff training, setting up communication lines, and having a clear strategy for client acquisition.
Common Questions When Starting A Debt Collection Business
How much does it cost to start a debt collection business?
Starting a debt collection agency can vary substantially in cost, generally ranging from $10,000 to $100,000. The initial investment can be relatively modest if you plan to operate from a home office and keep the operations lean, especially in the beginning. Here, we will get into the various costs you will likely encounter while setting up your business.
Legal and registration fees: Generally, business registration could cost between $1,000 and $5,000, depending on state licensing requirements and the complexity of your business structure.
Office setup: If you rent a commercial space, anticipate a cost ranging from $500 to $5,000 per month, typically requiring initial deposits. Furthermore, the basic office setup, including furniture, computers, and telecommunication systems, could cost around $10,000.
Insurance: For a startup agency, the initial insurance cost might range from $500 to $2,500 annually.
Software: Investing in reliable debt collection software is necessary to streamline your operations. The initial setup might cost anywhere between $1,000 and $10,000, depending on the features you opt for.
Marketing: Marketing costs are another consideration. While ongoing marketing expenses can add up over time, even the initial cost of setting up a website, printing business cards, and launching your first marketing campaign can be significant.
Training and certifications: Allocate a budget for training and certification courses to enhance your expertise and credibility in the industry. This might cost approximately $500 to $2,000 initially.
Miscellaneous expenses: Aside from the above-mentioned primary expenses, factor in miscellaneous costs such as stationery, utility deposits, and other minor investments, which could sum up to around $2,000.
Last, it is a good idea to have a financial cushion to handle operating expenses for the first three to six months. It’s a safeguard against unforeseen challenges and to maintain a steady cash flow in the initial days of your business.
These are just some of the costs involved in starting a debt collection agency, and the actual expenses can vary based on many factors.
How profitable is a debt collection agency?
The profit potential for debt collection agency owners can be quite lucrative. Industry statistics show that a common compensation model is to charge clients a contingency fee of 20-30% of the debts successfully collected.
For example, if a new agency lands contracts worth $500,000 in collectible debt and is able to recover 60% of that amount ($300,000) in the first year, they could charge a 25% contingency fee. This would equal $75,000 in revenue on the $300,000 collected.
If we estimate operating expenses at about 60% of revenue, which is average for a debt collection agency, the agency would have $45,000 left over as gross profit.
As the agency grows its portfolio of client contracts and improves collection rates over time, both revenue and profitability can scale rapidly. Top performing agencies often maintain contingency fees closer to 20% while also working on much higher volumes of debt. This results in net profits in the hundreds of thousands for experienced owners.
Keep in mind that this is a simplified example, and real-world scenarios can be more complex with a variety of fluctuating factors influencing the final profit margin.
What skills are needed to run a debt collection business?
While you won’t need a business degree to start a debt collection agency, certain skills and experiences can increase the business’s chances of success.
Debt collection experience: A business owner who has worked as a debt collector within another agency will be at an advantage when starting his or her own debt collection business.
Interpersonal skills: Debt collectors need to be able to build rapport with debtors and also be talented in reading people and negotiating. These skills can help to increase a business’ successful debt collection.
Financial and math knowledge: Having a strong understanding of math and finance basics, especially when it comes to interest rates, will be helpful in the debt collection industry.
Phone skills: A business owner who speaks well and stays calm and cool on the phone will have an advantage both in talking with debtors and in promoting the business to potential clients in need of a collection agency.
Technology skills: Familiarity with technology and troubleshooting skills are valuable in this industry, which centers around phone and computer use to find delinquent debtors.
Management experience: A business owner who has previously hired, trained, and managed staff should be better prepared to manage a collection business’ employees than someone who doesn’t have management experience.
Marketing: Debt collection businesses need to market to potential clients, so an owner who can do some or all of the marketing can save the business money. When an owner is actively involved in marketing, they may be better able to get new clients to sign on.
What is the NAICS code for a debt collection business?
The NAICS code for a debt collection business is 561440, which is classified under Collection Agencies.
The NAICS code (North American Industry Classification System) is a federal system to classify different types of businesses for the collection and reporting of statistical data.
Related: What is a NAICS code?
