Buying bad debt is a common practice among institutional investors looking to make money in a non-traditional investment. Bad debt can be any form of accounts receivable from a business that is unable to collect money from clients buying products on credit. Tips for buying bad debt include not buying extremely old accounts receivable; looking for companies that have unpaid debts, but a good financial history; using recourse agreements when buying debt and purchasing a wide variety of bad debt types. Investors should also have a specific dollar amount they are willing to use to purchase bad debt in order to mitigate potential losses.
Most companies will age their accounts receivables or loans using standard accounting techniques. For example, accounting or business software programs will list open accounts receivable in terms or 30, 60 or 90 days old. When buying bad debt, investors may want to avoid debt older than 90 days, as these accounts are pretty much lost in terms of collection. Another alternative is to buy extremely old accounts receivable — such as 120 days and older — at heavily discounted prices. Rather than giving 50 percent of the accounts value as compensation to the seller, buyers may give only 30 percent of the accounts' values in order to mitigate their losses from these highly noncollectable accounts.
Another tip for buying bad debt is to only purchase accounts or loans from companies that have a good financial record. It may be possible that the company has simply fallen on hard times and is willing to negotiate the outstanding balance. Purchasing the accounts receivable at a heavy discount can give the buyer more bargaining power to collect the outstanding balance. Using this process, buying bad debt can become quite lucrative, especially if the negotiated price is extremely low. Other times, a delayed payment method may result in the otherwise financially strong company gaining the ability to repay the loan in full.
Buyers of bad debt should consider using a recourse agreement to help mitigate losses. These agreements typically state that any noncollectable amounts for the bad debt are reimbursable by the seller. This prevents the buyer from accepting too many bad debt accounts that result in heavy losses to the buyer. Another way to mitigate losses is to purchase different types of bad debt. For example, buyers should create a portfolio of bad debt from car loans, mortgages, standard accounts receivables and other loans made by sellers. If one group of loans results in high noncollectable accounts, the losses should be offset by the other loan types.