Payment Terms Matter

Many founders focus on sales, and rightfully so. If a company can’t get customers, it won’t be around long. So founders spend lots of time trying to get customers to agree to use their product or service. An equally important but less-discussed topic is payment terms. How customers pay can be just as important as what they pay. This is especially true for early-stage companies that don’t have an abundance of cash.

I’ve talked to a number of founders who readily share their sales metrics. As I learn more about the business, I like to get an understanding of how quickly they collect revenue and how payment terms are structured.

These is no one-size-fits-all approach to payment terms, but here are a few thoughts:

  • Prepayment in full – If you can get customers to pay in full up front, you’ll have the best source of capital. You’ll be able to avoid paying interest on term loans or giving up equity to investors. If your product or service creates a ton of value for customers (they’re begging for your solution), see if any of them will bite. Make sure you (or your accountant) keep track of how much of your cash is from prepayments.
  • Deposits – I think of deposits as partial prepayments. The customer’s putting some skin in the game. Deposits can be structured in various ways. It’s common for companies to require a deposit that’s a specified percentage of the total before doing any work. They’re not as good as full prepayments, but they can help companies avoid borrowing and identify problem customers early.
  • As you deliver – This is a good approach to aligning costs with revenue. It can be done in a variety of ways. The founder of a consultancy told me that he includes a payment schedule in agreements. He knows exactly how much he’ll be paid and when. This ensures that he’ll get regular revenue to help pay the teams doing the work and avoid cash crunches. It also motivates clients to keep projects on schedule. If they drag their feet, they risk fully paying for a project that hasn’t been delivered.
  • After delivery – It’s common for a company to fully deliver its product or service and then request payment after the fact by sending an invoice to the customer. Large corporations love these types of arrangements and often ask for terms of ninety days or more. This means they’ll pay you three months or longer after you deliver and invoice them. This can put a huge strain on cash. If you’re a product company, you likely have to pay for inventory and pay your people before you deliver. If you’re a service company, you still have to pay people and other costs before you deliver. If you allow customers to pay after delivery, you need to assign someone in the company to monitor how much each customer owes and collect payments on time. Customers are already enjoying what you’ve delivered, so it isn’t uncommon for them to “forget” to pay or pay late if they know no one’s paying attention.

Cash is king, and founders should always know how much of it they have. Raising capital from outside parties is one way to make sure the company has ample cash, but strategically structuring payment terms is another approach that can be very effective.