By Scott Calliham
First Annapolis Consulting
In the sale of an ISO or residual stream, merchant agreements, which are intangible assets, are a key element of what the buyer is buying. Moreover, asset purchase structures are common in this industry, and frankly, most of the strategic buyers (as opposed to financial buyers) are "platform players" in the sense that they will wish to convert the underlying merchants to their own platforms.
ISOs and acquirers with agreements with third-party processors should be aware certain terms in those agreements can impact the valuation and/or the sales process of merchant assets. Key terms directly related to ownership of the merchant relationship have the most dramatic impact on valuations. However, tangential terms, some of which are more obvious than others, related to ownership can meaningfully impact asset valuations and potentially hinder a sales process.
More obvious terms impacting value and process
In the event the merchant ownership language is unclear, the value of the asset may be diminished.
Finally, a portability/transfer/assignment right that only becomes active at the end of a processing agreement term poses significant practical problems, and represents a cloud on the title of the assets in time periods other than at the natural expiration of the contract.
Note that the terms "portability" and "transfer" do not have objective meaning – they mean whatever the contract says they mean. So if the contract does not define these terms, there will be a core ambiguity on who has what rights and, again, effectively a cloud on the title of the assets.
In the event transfer rights are unclear or undefined, this may pose challenges (for example, contractual dispute, delays in conversion, etc.) with the existing processor when the owner wishes to convert the portfolio to another third-party processor, and prospective buyers may view this as an impediment to a sale.
Nonsolicit restrictions on the processor in a contract can enhance the value in a sale, while the noncompete obligations of the ISO or acquirer can negatively impact value or impede a sale.
In the event the merchants are co-mingled with other ISO or acquirer BIN/ICAs, this may delay and increase the expense of the conversion.
In the event no transfer rights exist, at a minimum, this may delay any conversion and may even prevent a conversion as the owner of the BIN/ICA may not willingly transfer the rights to another party.
In the event no contractual commitment for de-conversion assistance exists, this may delay and possibly increase the expenses associated with a conversion.
On the surface, this appears to be reasonable – as the ISO or acquirer is typically interested in maximizing value, regardless of the entity purchasing the assets. However, practically speaking, potential bidders may be uncomfortable developing a robust bid simply to see the third-party processor meet the bidder's offer. This may result in lower valued offers from bidders and/or may result in a lower number of offers from prospective bidders. The ISO or acquirer may opt to either get the third-party processor to waive its rights upfront, though this will let the third-party processor know the ISO or acquirer is looking to divest its portfolio. The ISO or acquirer may not wish the processor to know this for various reasons in the event a sale does not go through. This will create a condition to closing the buyer will require and may delay closing.
A variant of a right of first refusal is a right of first offer. This should be more palatable to a seller, as it provides the processor with the right to make an offer for the assets, but the ISO or acquirer is not contractually obligated to accept the offer.
Several factors affect whether a conversion will be successful (for example, number of merchant relationships, if multiple front-end and/or back-ends are used, if differences exist in services offered to merchants on the go-to-platform such as settlement windows, reporting, pricing structures, etc.) and make the conversion process highly variable and often unpredictable. Conversions are either ties or negative outcomes – they are rarely wins. Depending upon the terms related to conversion, this can negatively impact the value of the assets or, at a minimum, cause the bidder to structure the offer to reduce the conversion risk – for example, earn-outs based upon successful conversion, etc.
To maximize the long-term value and divestiture process of a portfolio of merchant-related assets, ISOs or acquirers should attempt to keep these contractual terms and their impacts in mind when negotiating agreements with processors. Of course, the day-to-day aspects of agreements impact value (for example, pricing, servicing, etc.), but ISOs or acquirers can overlook merchant ownership and related terms at the outset when negotiating third-party processing agreements.
There are always gives and takes in negotiations, but if an eventual sale is a possibility for the ISO or acquirer, these guidelines will help achieve optimal value and improve the chances of a smooth divestiture.
Scott Calliham is a Principal in the Merchant Acquiring practice area at First Annapolis Consulting and has been in payments for over 17 years. Scott advises clients on a full range of tactical and strategic matters including M&A transactions (both buy-side and sell-side), new acceptance markets, pricing and retention strategies and tactics, B2B, product research and strategy including e-commerce and mobile issues. Scott can be reached at firstname.lastname@example.org.
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