Tips For Extending Credit To Customers So Your Investment Is Protected

Are You a Material Supplier or Are You a Bank? If You Extend Credit to Customers You’re Both
Does your business offer lines of credit to its customers? If so, are you approaching these transactions with the same caution as a bank?

To facilitate business transactions with regular customers, many equipment and material suppliers offer lines of credit. Before your business extends credit to a customer, it is important to think of the transaction in banking terms. Every time you provide equipment or materials to a customer on credit, you are lending that customer money. Essentially, you become a lender and the customer becomes your borrower. Ask yourself: “If I were a bank, would I provide them with a loan?”

Whether or not you have an existing working relationship with the customer, you should require a questionnaire regarding creditworthiness as a prerequisite to extending credit. This may include running a credit check. Collecting information about a customer allows you to more accurately analyze the risk of lending them money. If you have an ongoing relationship with the customers, consider whether you’ve already seen red flags. For example, if the customer has made several late payments in the past, or has developed a reputation for defaulting on contracts in the industry, you might not want to give that customer increased control over your resources.

Once you have determined that the customer is worthy of opening a line of credit, the first step is to require that the customer execute a credit application. This application is a binding legal document which should be drafted carefully and with the assistance of an attorney. A well drafted contract will help to preserve your legal rights and create avenues for collecting money if things go wrong. Some recommended terms to be included in your credit application are:

  • Specific provisions related to how disputes regarding payment will be handled
    In some cases it is more cost and time efficient to require that disputes be resolved through arbitration rather than litigation.
  • A representation that the person(s) signing the agreement has full authority to execute the agreement on behalf of the applicant
    Many defaulting customers claim that the person who signed the agreement did not have the authority to act on its behalf and, therefore, the agreement is void. To prevent this defense from being raised, credit applications should always include an agency clause.

One of the most important terms to include in a credit application is a personal guaranty. Through a personal guaranty, the customer is acknowledging that he or she is personally liable if the borrowing business fails to pay its debts. This allows the lending business to leverage against a borrower’s personal assets in the event of non-payment. Personal guaranties are critical in situations where you are attempting to enforce a judgment, especially where an officer of the borrowing business has more assets than the business itself.

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