The Green Sheet Online Edition
December 24, 2012 • Issue 12:12:02
Subtle but crucial factors in portfolio sales
When selling a portfolio of merchant accounts, an ISO or merchant level salesperson (MLS) usually considers big-ticket items. These may be overall sale price; multiple, or the number of months of revenue to equal the purchase price; earn-outs, or the post-closing purchase price payments; and attrition.
However, before signing a sale deal, ISOs and MLSs should consider other issues that are more subtle but equally important. The purpose of this article is to highlight some of those issues. This is not an exhaustive list, and some of these may not be relevant to your situation. But they are all worth considering before inking your portfolio deal.
Who gets paid on the last month?
Let's say the deal closes Jan. 15, 2013. A critical issue to determine is who receives the residuals that accrue in January but are paid in February. This last month's trailing residuals are sometimes paid to the seller and sometimes to the buyer; at times, the money is split between buyer and seller.
This should be discussed prior to closing and specified in the transaction documents. If you are the seller and you continue to service merchants during a month for which the buyer is being paid the residuals, consider the value of the service you are providing, as well as the value of the risk you carry opposite the processor during that time.
How is attrition calculated?
Many people have a clear idea of what attrition means, but they sometimes forget that what is obvious to them is not obvious to others. Attrition, of course, is the loss of value or size over time of a given portfolio.
Every portfolio that is not adding new accounts will eventually diminish to zero in value through attrition. While detrimental to the value of a portfolio, attrition must simply be managed and addressed like other commercial issues in a portfolio sale.
Many methods are used to calculate attrition. The one that suits you may not suit another party. Here are three different examples of a 10 percent attrition threshold. These are not full clauses and are written in legalese, but they will give you a sense of attrition measured by numbers of merchants, by revenue, and by numbers of merchants and revenue combined:
- Merchants: Over the course of each year of the first three years of the term hereof, the rate at which merchants, by number of merchants, decreases shall not exceed 10 percent per annum.
- Revenue: Over the course of each year of the first three years of the term hereof, the rate at which revenue in respect to merchants' decreases shall not exceed 10 percent per annum.
- Merchants and revenue: Over the course of each year of the first three years of the term hereof, neither the rate at which merchants, by number of merchants, nor the rate by which revenue in respect of such merchants, shall decrease by more than 10 percent per annum.
The fun with attrition does not end there. When we talk about attrition of revenue, the parties have to define the benchmark of revenue. Should it be the revenue last paid prior to the sale? Should it be an average of, say, three months of revenue before the sale? Should it include a pro rata share of annual fees, such as Payment Card Industry Data Security Standard compliance and other expenses? Should it include early termination fees and other merchant penalties?
The best way to address the task of defining attrition is to run your portfolio through a handful of scenarios and create realistic expectations for yourself regarding the outcomes of those scenarios. Attrition is relevant to portfolio sales, of course, because some portion of the sale price is often conditional on there being less than a defined amount of attrition.
Buyers also have issues as to how to calculate attrition in a portfolio that they are evaluating. Buyers have to find a way to create a realistic expectation for themselves of what will happen to the portfolio they are buying.
What about a personal guarantee?
Having a seller provide a personal guarantee in a portfolio sale is not uncommon, most importantly to protect the buyer from a dishonest seller who re-solicits the merchants the seller has just sold.
Sellers have to be wary of the extent of the personal guarantee. Is it unlimited? When does it start and end? To what extent does the personal guarantee cover post-closing transaction processing, which is normally the responsibility of the buyer? To what extent can the personal guarantee be negotiated to be somewhat limited - in time, quantum or application?
What do new deal counts entail?
Many buyers and sellers agree that the seller will become an agent of the buyer after closing. This is not uncommon, and the decision to do so will usually put upward pressure on the purchase price. To increase that upward pressure, sellers sometimes make minimum new-merchant commitments under such new sales relationships, such as a certain number of new merchant accounts per month for some period of time.
The subtlety here is to ask what a new merchant account means. At one extreme, it could merely mean applications submitted to the buyer, whether or not the applications become real live merchant accounts.
A middle ground is that a merchant identification number (MID) is created as a condition to counting toward the minimum. In another scenario, the MID must process at least one transaction. Some parties will agree that the MID must remain active for at least some period of months.
Naturally, the higher the bar is set, the more difficult it will be for the seller to achieve the desired minimums. No one answer for calculating the new deal count applies to all. The best answer is the one both parties find agreeable, which should then be reflected in the transaction documents.
In contract drafting, clarity is the mother of contentment. Taking a little extra time to flesh out ambiguities saves all parties a lot of heartburn.
In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If you require legal advice or other expert assistance, seek the services of a competent professional. For further information on this article, email Adam Atlas, Attorney at Law, at firstname.lastname@example.org or call him at 514-842-0886.
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