Part of the problem is that you admit you received the service AND that you owe the original $500, regardless of the quality of the service. Instead of paying it, you now have the consequences (that they get to decide) for you not paying the debt owed on time.

I do collections at times on small amounts (less than $150) and will tell you that it takes more time than one might think administratively to have all the ducks in row to pursue. And if it is sent to an outside attorney or collection house, that pretty much can easily double the debt at least.

Honestly I don't see how it is possible that you will win any lawsuit and yes, it will rack up more interest and attorney fees. So while you can offer a lower amount, in the end they can continue on the path and possibly get more than $2k.