The Green Sheet Online Edition
September 28, 2009 • Issue 09:09:02
Need cash for your business?
So you've grown yourself a nice little portfolio of merchant accounts. You've worked your buns off calling on merchants, learned your market, fought off competitors, found a successful sales model, hired several sales reps (half of whom didn't stay long enough for you to get a payback on your investment) and you now enjoy a respectable monthly residual.
Where's your next move, and how do you come up with enough cash to finance it?
You know of two or three opportunities that could pay big returns, but you need cash to make them happen. Where can you get the cash? Can you find an investor to go in on your ISO? Can you convince someone to loan you the money, or do you need to sell some of your portfolio?
That's a tangle of questions. Let's sort them out.
My assumption is you need more money than you could finance with a credit card. Also, it's not a good time to go to family or friends for funding. And if you've checked with bankers or the Small Business Administration, you know they're not going to help an ISO because ISOs have few tangible assets.
Your options are to find:
- Debt financing - a nonbank lender who will give you cash, secure your portfolio against repayment and require you to make payments until the money, plus interest, is paid back
- An investor who will put money into your ISO and become a partner
- A buyer for part of your portfolio
Everyone I talked to for this article said debt financing is tough to find right now. In the first place, few nonbank lenders will deal with ISOs, and it is difficult for lenders in this business to see where the merchant services market is trending. Without clear direction for the market, some are reluctant to take on new clients.
Two well-known names in debt funding are Darrin Ginsberg of Super G Funding, www.supergfunding.com, and David Putnam of Resource Finance Co., www.resourcefinance.com.
Ginsberg has been purchasing portfolios for many years and has recently begun to provide debt financing for ISOs. Super G will loan up to $1 million to ISOs based on a 50 percent loan-to-value ratio relative to the portfolio. That means you can only get up to about 10 times your monthly residual. The loan term can be one, two or three years.
RFC has been in the business of providing working capital debt financing to ISOs for over a decade. The company's Web site contains valuable information on debt funding and basic finance. Asked about what RFC is doing today, Putnam said the company is "in the lending business," and for the present, continues to service its existing clients.
What do you have to do to qualify and receive debt funding? Typically, you will need to:
- Provide 12 months' residual statements and 12 months' bank statements
- Pass the underwriting of the lender (requirements vary)
- Sign an assignment agreement that puts the lender ahead of you in the flow of residuals
- Sign a personal guarantee
- Sign the lender's agreement
There may be other criteria and covenants the lender will require.
You certainly have the option to find a partner. But the fact is there are few, if any, sources of equity investment in small ISOs today. And I would suggest that most small ISOs don't want to consider an equity partner for the following reasons:
- A new partner will want to have a say in how the business is run and may demand changes you won't be happy with.
- Partners want to be kept informed constantly about how "their money" is being used.
- The equity a partner requires for the investment may be a hefty chunk of your business. (For example: You're thinking 20 percent; the partner is thinking 60 percent.) You may have to give up majority control.
- A new partner may not want to provide the full amount all at once, preferring to write several smaller checks over time if the results are good.
Selling part of your portfolio
The remaining option is to sell part of your merchant accounts. Most small ISOs actually own their residual streams rather than the merchant accounts. That's OK because buyers of small ISO residual streams usually don't want to move the accounts. They want the accounts to stay where they are, continue processing and grow in processing volume.
The buyer will now get the residual check for the part of the portfolio you sell; you will assign the residual to the buyer. Again, check with the buyer to see what his objectives and requirements are.
A number of companies are buying small portfolios today. The buyers I checked with are Harold Montgomery, founder of ART Holdings, parent company of Calpian Inc., www.calpian.com; David Daily, President and Chief Executive Officer of Cutter Inc., www.cutterfinancial.com; and Dean Caso, Principal of Velocity Funding Inc.,www.velocityfunding.com. As mentioned previously, Ginsberg buys portfolios through Super G.
The experts say portfolio values are down because of financial uncertainty, erratic processing volumes and the unpredictable merchant attrition outlook. Most say the range for valuations is from 12 to 18 times the monthly residual.
Of course, the valuation depends on multiple factors such as the mix of merchant types, whether most of the volume comes from a small number of merchants, age of the accounts, record of merchant attrition and so forth.
Debt financing versus portfolio sale
The following are advantages of debt financing:
- The interest on debt financing is probably deductible. Check with your tax expert.
- You retain ownership and will benefit from all growth of the portfolio.
- The cost of borrowed capital is cheaper than selling.
Disadvantages of debt financing include:
- Interest rates are high (16 to 25 percent) and the amount of money you will have to pay each month is considerable. You may be paying a third of your residual check to the lender every month.
- Because of the covenants and limitations of the loan, you may not get all the money you need for your purposes. The lender may also limit what you can do with the money.
- If your business isn't profitable enough and growing fast enough to make the loan payments, you may go into default and lose it all. You have to be sure you can make it financially.
- 4. You still have service responsibility and still bear the risk of merchant attrition.
Advantages of selling are as follows:
- It may be easier to get a larger amount of money when you sell.
- Some consider a sale clean and convenient versus a loan where you have to keep the lender happy. There is a "care and feeding element" to a loan; you have to communicate with the lender, provide reports, perhaps even undergo an audit. Also, many smaller loans today require a personal guarantee.
- If it is getting harder to prevent attrition in your portfolio, it may be better to sell now to maximize the value.
Disadvantages of selling include:
- There may be tax consequences from a portfolio sale. The sale will probably be subject to capital gains tax. Consult your tax expert.
- If you were to not sell but continue to build a larger portfolio, you might get a higher multiple than you would get later by selling pieces of the portfolio off. However, the experts say this is usually only true for monthly residuals above the $200,000 range.
- When you sell part or all of your portfolio, you have little or no chance to benefit from growth of the portfolio you sold. Some buyers may pay you extra if your portfolio grows during the time they are still holding back the final payout.
So weigh the pros and cons. Do the math on the options, or get a consultant to help you. Confer with other small ISOs. Whichever option you choose, I wish you good luck in your new venture.
Mark Dunn is an executive consultant in the merchant bankcard industry and heads up Field Guide Enterprises LLC, a bankcard consulting and training firm. For more information, please e-mail Mark at firstname.lastname@example.org or visit www.gofieldguide.com.
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