Late Payment Collections: Legal Options for SaaS and Professional Services Startups

The First Step: Issuing a Final Demand Letter

Before considering legal action, one step moves the issue from a simple accounts receivable follow-up to a formal dispute: the Final Demand Letter. This isn't just another email reminder. It is a formal, pre-legal document that signals your intent to escalate if payment is not made. Its purpose is twofold: it communicates seriousness to the client, often prompting payment, and it creates a critical paper trail demonstrating your good-faith effort to resolve the debt before going to court.

This letter should be sent via a trackable method, like an email service that shows when the message was opened or certified mail for significant amounts. The content must be professional and direct, referencing the invoice number, amount due, and original due date. Crucially, a Final Demand Letter must set a new, firm deadline, typically 10 to 15 business days, for the payment to be made in full. This communication shifts the dynamic and sets the stage for any subsequent legal steps for overdue payments.

Your Three Options for Handling Non-Paying Clients

When your final demand is ignored, you arrive at a key decision point. Handling non-paying clients requires a strategic choice based on the invoice amount, your resources, and your relationship with the client. There are three primary unpaid invoice solutions to consider.

1. Strategic Write-Off
2. Sometimes, the smartest move is to absorb the loss. This is not an admission of defeat; it is a calculated business decision to preserve your team's focus for revenue-generating activities. The reality for most pre-seed to Series B startups is that founder time is the most valuable asset, and chasing small debts can be a significant distraction. A typical benchmark for a write-off is any invoice under $1,000, though for pre-seed startups focused on traction, this threshold might be closer to $2,000. You can find more information in the IRS guidance on business bad debts for tax treatment.
3. Collections Agency
4. Engaging a third party is an effective option for larger debts or when you lack the bandwidth to pursue payment yourself. Collections agencies typically work on contingency, taking 20-50% of the amount recovered, so you only pay if they are successful. This path requires less work from you, but it also means you relinquish control over communication and will almost certainly end the client relationship. It's a powerful tool for debt recovery for startups when the invoice amount justifies the revenue share.
5. Small Claims Court
6. This path allows you to seek a legal judgment against the client without the high cost of hiring an attorney. Small claims court is designed for straightforward disputes, but it has limitations. Upfront filing fees are typically $50-$200, and dollar limits vary by state, ranging from $2,500 in Kentucky to $25,000 in Tennessee. You can find guides on small-claims court dollar limits by state. This option is most viable when the client is in your state and you have clear documentation of the debt.

Staying Compliant: The Legal Rules of Debt Collection

As you begin the process of enforcing payment agreements, you must operate within legal boundaries to avoid creating new liabilities. The primary federal law in this area is the Fair Debt Collection Practices Act (FDCPA). While the FDCPA formally applies to third-party debt collectors, not original creditors like your startup, you should treat its principles as a best-practice guide for your own communications.

This means no harassment, no false statements, and no unfair practices. Maintaining professionalism is not just about compliance; it protects your brand's reputation. Furthermore, be aware of state-specific laws. For instance, some state laws, such as California's Rosenthal Act, extend FDCPA-like rules to original creditors. Adhering to these ground rules ensures your collection efforts do not inadvertently expose your business to fines or lawsuits. To prevent issues proactively, see how to set up credit control for startups.

How to Navigate the Small Claims Court Process

If you determine that small claims court is the right path, a structured approach is key. The process is designed to be accessible, but success depends on preparation. Follow these steps to build your case.

1. Gather All Documentation: Collect the signed contract or statement of work, copies of all invoices from your accounting software, proof of service delivery, and a complete record of communications. This includes your Final Demand Letter and proof of its receipt. Your ability to present a clear, chronological story backed by evidence is paramount.
2. File a Formal Complaint: File a complaint with the appropriate local court and pay the filing fee. The court will provide instructions on how to formally “serve” the notice to the client, which is a required step to ensure they are officially aware of the lawsuit.
3. Prepare for the Hearing: Organize your evidence and be ready to explain the situation to the judge concisely. Remember this critical point: winning a judgment is not the same as collecting the money. If the court rules in your favor, you receive a legal judgment, but you may still need to take additional steps, like garnishing wages or placing a lien on assets, to receive payment.

When to Hire a Debt Collections Agency

Choosing one of the many collection agency options can be an effective solution, especially for larger or out-of-state debts. A B2B collections agency takes over the entire process, from initial communication to potential legal action, freeing up your time to focus on your business.

When vetting agencies, look for one that specializes in your industry, whether SaaS or professional services. Ask about their process, fee structure, and reputation. A professional agency will operate as an extension of your company and adhere to all laws. Their fee is a percentage of the recovered amount, so there is no upfront cost. For a Series A or B startup, a formal policy might send any invoice over $5,000 that is 90 days past due to collections. You can establish these rules with a clear credit control for startups process.

The primary trade-off is the loss of control and the end of the client relationship. Once an account is in collections, that business partnership is effectively over. This is a significant decision for a startup, as you are not just collecting a debt but also making a final statement about a business relationship.

Conclusion

Knowing how to collect unpaid invoices from clients in the US is a critical skill for managing a startup's cash flow. The right approach depends entirely on the situation. For small debts under $2,000, a strategic write-off is often the most efficient choice. For larger, in-state debts with clear documentation, the small claims court process offers a low-cost path to a legal judgment. For significant invoices, especially with out-of-state clients, a reputable collections agency provides a hands-off, results-oriented solution.

Regardless of the path you choose, the process must begin with a formal Final Demand Letter. This single step solidifies your position and is the foundation for any escalation. By establishing a clear internal policy for handling these situations, you can make objective, financially sound decisions that protect your runway and allow you to focus on building your business.