By: Dave Hecker

April 26th, 2004

Reader Rating: 8

Every client relationship your company creates is incredibly valuable -- each has the potential to grow into a long-lasting revenue source.

However, client relationships take considerable time, energy, patience, and effort before they can become a trusted and reliable part of your business. It's a big investment, and when a relationship fails you've usually lost quite a bit of time and effort along the way. In this article, we'll look at several techniques you can use to screen out potentially negative clients such as non-payers, highly litigant clients, clients that are on the brink of bankruptcy, and plain old nightmare clients.

The best way to establish a basic level of protection is to perform basic client screening prior to allocating your precious time and resources to their project. So many Web developers believe that once the contract is signed, they are protected from most problems because the courts will happily force the client to make good on the contract. While this is true in some circumstances, even a small dispute can turn into a years-long nightmare in the court system, with you racking up legal fees every step of the way. Having a binding contract doesn't protect you from an expensive and lengthy process of collections and legal proceedings.

With a little research, however, a surprising amount of these potentially problematic clients can be identified before you expose yourself to any risk. A few simple searches on the Web will provide you with the information you need to make good decisions and handle the potential client appropriately -- and most of these information sites are free.

When Should you do a Background Check on a New Client?

Performing background checks on potential clients can take time, so you'll want to be strategic in your approach. Each situation is different but, as a general rule, you'll want to research the client more thoroughly as you invest more time and resources into that client.

If I'm asked for a proposal by a client that appears to be entirely legit, I'll usually just peruse their Website, and get a feel for their personalities over the phone, before moving forward with the proposal. If the proposal itself is going to take 12 hours because the job is a large one, I might poke around a bit online and perform minimal research before investing the time in preparing the proposal.

Once a deal is in place (i.e. a contract is on the table or a verbal agreement, at least, has been made) I'll usually verify the identity of the company with the corresponding state government, and check a few other free resources (which we'll discuss in a moment) just to make sure there aren't any warning signs.

Once the agreement is signed, however, it's time to do a comprehensive check on the company and make sure that the contract is going to be enforceable and collectable. My goal is to make sure that the client is who they say they are, confirm that the signatory is authorized to sign on behalf of the company, and verify that the company is legal and doing real business. With those three items in place, we can comfortably begin the project knowing that we are, in fact, legally protected by the contract or legal agreement.

How to Get the Information You Need

Now that you've decided to verify some information about your client, let's take a look at the details you'll be seeking, and where to find them.

Note: The following information is directly relevant to US legal and corporate standards, and may not apply to your location. Although the basic premise of qualifying and confirming client information is always important, local laws and resources may vary.

Step One: Confirm The Client's Identity

You'd be surprised how often I receive a signed contract from a new client, only to find that the contract is completely unenforceable. Why? It's usually due to one of these reasons:

1. The official name of the company does not exist in the corporate records of the state or region in which the contract needs to be enforceable.


2. The signatory is signing on behalf of a legitimate company, but is not listed as a principal of that company.

Keep in mind that an incorporated business entity (in the US, a corporation or LLC, but elsewhere, the company could be called a Pty. Ltd., etc.) is an individual entity, separate from any person or group of people. The company must be registered with the Secretary of State in the state in which they're doing business, and the principals (specific people who are authorized to sign and do business on behalf of the company) must be listed by name in the company's corporate filings. Even if a company is incorporated in one state, under U.S. law they must register as a 'foreign corporation' to perform business in a separate state, so this technique should always yield some result.

Exceptions do apply, however, and corporate law is highly complex, but the important thing to remember is that you should always be able to find a record for your client in the Secretary of State's Website in the company's home state, and you should always be able to find evidence that the signatory is a principal of the company and has the legal authority to enter into an agreement on behalf of the company.

These corporate records are generally free and available on the Web. Simply search for the Secretary of State Website in the company's home state and find your way to the corporate records section. Don't know the state in which your client is incorporated? Just ask them -- it's a standard business practice to request this kind of information about a new client.

Now that we know that the organization named on the contract exists, and the signatory is empowered to execute the contract, let's learn a bit more about our client before we start investing in the project.

Step Two: Check The Client's Background

How much work are you willing to do for a client before you get paid? It's easy to say, "We need 50% up-front," but that's not always achievable. Larger clients, for example, tend to have a 15-30 day cycle on their accounts payable, and are used to that payment cycle being taken seriously. So, you'll have to make a decision about how much "credit" to extend them. Here's how.

Having established that this is a legitimate firm, we can expect to find some history about the company in the public corporate records. There are many sources of this information:

• credit reporting companies (like Equifax)
• corporate credit and information bureaus (like Dunn & Bradstreet)
• consolidated information sources (like knowx.com [1])
• consultants who specialize in checking out company backgrounds

We'll start with the free stuff, and move on from there. Once you've reached a level of comfort with this client and are confident that you'll actually get paid, you can forget the whole thing and move forward with confidence. Until then, we'll keep digging until we have the information we need to make the right decision.

At the Secretary of State Website, we learned the corporate status and identified the principal individuals associated with the company. We can take advantage of that information by doing some basic Google searches using the names of the principals listed. Be creative, and you might find press releases, media mentions, or even court records related to these people. You'll be surprised how much you can learn with 5 minutes of snooping once you have the names of the people involved with the firm! Try to get a feel for how long the company has been doing business, and how successful their efforts have been.

Next, we'll move to the Dunn and Bradstreet (DnB) Website, found at http://www.dnb.com/ [2]. You'll probably be most interested in the Small Business section. Companies actually pay to be listed in the DnB database because DnB is one of the key credit reference organizations on the Web. However, almost any company will be listed there if they've existed for some time, because DnB also offers basic listings free for any company. While it's not conclusive, a DnB listing supports the evidence that the company is legitimate, as DnB periodically confirms its records against those of the government, in addition to listing its own metrics for risk and financial stability.

In many cases, DnB will offer additional detail for a fee. This detail is usually related to a company's sales and payment history as reported by other DnB members. This is sometimes useful if you're researching a company aggressively, but can be unnecessary. And don't forget to make sure that your company is listed, too! After all, you might be on the other side of this process one day if a potential client does research to check your company out.

At this point, you'll need to start paying for further research, or spending some real time learning about the resources and doing it yourself. Fortunately, there are Websites that will do a comprehensive scan of the public records for a modest fee, typically US$20-$50. My resource of choice is http://www.knowx.com [3]. Knowx offers a handy feature that allows you to search for a company by name first, then view what kind of information KnowX has about that company. If Knowx reports that there are record types that you're interested in, buy the report. If not, you lose nothing.

Leverage the Information You Find

At this point, you should have accumulated a fair amount of info about your potential client. Now it's time to make decisions. If there is little or no information about the company, you can assume it's either brand new, is not a recognized business entity (the client's a sole proprietor, for example), or is lying about it's identity. In this case, you'll have to make a judgment call about how to move forward.

In most cases, however, you'll be looking at your results and assessing the 'big picture' about the company, considering things such as:

• Have there been any bankruptcies? When?
• Is it currently in litigation with other clients or partners? Have other vendors had legal proceedings with this company?
• Has the company been late on its state or federal tax filings? This is found on the Secretary of State site in some cases.
• Is the business's corporate status ok? A corporate status of 'forfeit' or 'deferred' might be major a warning sign.
• Are any of the principals involved in other litigation? Perform a name check on all the principals to see if they are litigant or otherwise problematic business people.
• Are there any sales/size estimations or reporting? DnB sometimes provides this information, but be sure to note if the data is reported or was simply estimated by Dunn and Bradstreet.
• Does the company's self-description correspond to the records you're finding?
• Has the company been involved in successor corporations, complex stock dealings, or other activities not consistent with their size or business type?
• Are there any liens, judgments, lawsuits, or injunctions about the company? If so, look for the Website of the court that holds the information about that event -- they might have publicly available records, too.

Finally, be on the lookout for anything that's just plain suspicious. Use your best judgment and you'll be able to make the right decision, armed with lots of highly relevant information.

Let's look at some real-world examples of how the above process can result in a good business decision that protects you without interfering with your ability to grow.

Example 1: A Small Company's Record Doesn't Match your Signed Agreement

Recently, I signed a small ($3,000) agreement with a company in Los Angeles. They were in a great hurry to get started, and returned the signed contract almost immediately. However, I found no evidence of their company in any records at all, including a Knowx.com business search.

I sent a friendly but firm email to the company, thanking them for their business but explaining that the contract was unenforceable because their business couldn't be found on any corporate record anywhere. As a result, I explained, my company could not extend any credit whatsoever and a full payment would be required before development could begin.

The client balked at this, complained, denied, and then promptly overnighted a cashier's check to my office. It turned out, they were a sole proprietorship and the 'President' liked to add "Inc." to the name to make things look more professional. The contract would have been totally unenforceable, and I was glad I demanded the full-payment.

Example 2: A Legitimate Company has Ongoing Litigation or Judgments

Another company I worked with seemed very legitimate when a basic background check was performed. Later in the project, however, they became a non-payer and I began considering how much credit I would be willing to extend while waiting for payment.

I invested approximately $100 in various corporate records searches. I learned that the company had no large-scale litigation against it (which I already knew), but that 2 of the 3 the principals were immersed in an ugly court battle in civil court. In addition, they owed $300,000 USD in back taxes to the State of Delaware and a local print shop was taking them to small claims court. I learned all of this from a US$20 search on Knowx in the span of 5 minutes. Needless to say, that company's credit line was promptly ended.

Incidentally, I was never paid by that client. I only wish I'd done a bit more research before the whole thing started...

Example 3: A Large Company Has a Clean Record

Sometimes a company is just fine, and it's a good feeling signing a contract with a firm that has a clean record and perfect history. Keep in mind that every company will have the occasional legal hassle, stock reissue, change in the board of directors, or other corporate event. The important thing, though, is that they are stable, honest, and legitimate.

When a company "checks out clean", don't think that your investment in their history check is wasted -- you've simply bought some security for yourself and eliminated a risk factor from your business.

Look Out For Number One

In the end, you can save yourself incredible amounts of time, stress and money by doing a bit of due diligence at the beginning of a client engagement. Considering the low cost of record searching and the incredible hassle associated with collections and litigation, pre-engagement research is about the best insurance policy you could ever find.

Protect your bottom line, yourself, and your business by doing a little work up-front, and you'll thank yourself in the future!

[1] http://www.knowx.com
[2] http://www.dnb.com/
[3] http://www.knowx.com