By Lane Gordon
MerchantPortfolios.com
In the present financial environment in which we witness wild daily swings in the Dow Jones Industrial Average, one area of portfolio and residual sales is particularly active - micro deals.
Residual transactions involving net monthly processing revenue between $1,000 and $20,000 are numerous. There are plenty of sellers, and contrary to what many people would like you to believe, plenty of buyers. The first thing you want to do when trying to sell a small residual stream is check your ISO or agent agreement. Many of these agreements virtually prohibit you from selling the small book of business or revenue stream to anyone other than the processor or ISO you represented under the terms of that agreement. What you are specifically looking for is language referring to assignability. This means you have the right to assign, or sell, your revenue stream to a third party. Secondly, you want to understand very clearly what type of first rights your processor or ISO has on a sale.
First rights (or first right of refusal as it is more commonly called) are written into 95 percent of the ISO or processor agreements we see. And they come in varying degrees. The most prohibitive is an absolute first right of refusal. In this case, your ISO or processor can prevent you from selling your revenue stream to a third party for no other reason than that it just doesn't want you to.
Such absolute rights are rare, but they do exist. The more common types of first right of refusal require you to first let your ISO or processor make an offer on your portfolio before you shop it elsewhere.
Or, you might have to bring your ISO or processor any bona fide offer from an interested party and give the ISO or processor an opportunity to match the offer. Either way, you need to understand your processing agreement before you go to market.
After reviewing your agreement and determining you can, in fact, go to market, you should next prepare the due diligence materials you will need to show potential buyers. Typically buyers will want to see the most recent three to four months plus a year-over-year comparison for the most recent month. For example, if your most recent month's residual report is from September 2008, you'll need to provide data for September 2007 as well.
This is so a buyer can run an attrition analysis on the portfolio. If you want to do a little work yourself and get in front of any buyer issues with attrition, you may want to perform your own "static pool" analysis on the residual.
This type of analysis tracks your merchant accounts and their revenues over a 12-month period, starting with the set of accounts that were active one year ago and seeing how many of those accounts are left 12 months later.
Remember, attrition is one of the most important aspects of your portfolio that will affect its valuation. Merchant solvency is a top priority, but if you do suffer merchant attrition it can be explained in a sensible way that will make a buyer more comfortable with the deal.
Revenue attrition less than 18 percent and account attrition less than 10 percent annually is considered by most to be pretty good.
Many potential buyers exist who are not ISOs. There are pure financial buyers out there, too, who are looking to purchase future income streams. Some of these buyers aren't just looking at the merchant processing space either; for example, they're looking at lottery payouts and structured settlements from legal winnings, as they, too, are predictable revenue streams.
The point here is to not limit yourself when you go to market to the couple of companies you have in your Rolodex or that you see in the classified section at the back of an industry trade journal. Be creative and think outside the box.
That said, there is an upside when selling to another industry player. Many ISOs or industry buyers will pay you a higher multiple if you commit to writing a certain amount of future business through them post-transaction. My best advice is to find a vehicle that will allow you to market your residual to a large buyer base.
It's important to remember that, contrary to conventional wisdom, there is a huge marketplace for these micro deals. Sure, the big boys would be loathe to look at these deals because they don't make much sense for them when they run a cost/benefit analysis, taking into consideration the size of acquisition and the time it takes to do their due diligence. For the same man hours, they could be purchasing a $200,000 a month residual. However, there are tons of mid-sized ISOs who would be thrilled to take a look at smaller deals. It's right in their sweet spot. You just have to make an effort to find them - or let them find you.
If you have the luxury of taking your time, it behooves you to do so. When you are negotiating with buyers, don't make your first question be, How quickly can you close and fund the transaction? You may want to get paid tomorrow, but the minute you show the buyer that time is one of the most important elements to your deal, you've done yourself a tremendous disservice. Savvy buyers will instinctively agree to prioritize your deal, and they'll pay you less for their efforts. Sometimes, you don't have the luxury of taking your time, but if you do, you'll get more dollars when buyers don't think you're desperate. Buyers exist for everything, including your portfolio. Don't let industry naysayers convince you otherwise. Get all of your facts together.
Once you've made sure your residual stream can be marketed, prepare and market your opportunity appropriately. It's worth it.
Lane Gordon is Managing Partner at MerchantPortfolios.com, a company specializing in marketing ISOs and portfolios for sale. Prior to MerchantPortfolios.com, he spent a number of years working in the payments industry. Gordon holds degrees from the Massachusetts Institute of Technology and Carnegie Mellon University. He can be reached at 866-448-1885, ext. 301; lane@merchantportfolios.com; or by fax at 508-638-6444.
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