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The Green Sheet Online Edition

February 22, 2016 • Issue 16:02:02

Targeting retail SMEs can kill your ISO's value

By Adam Hark

The thrill of signing a new account never gets old. The adrenaline rush you experience when closing a deal is real and, arguably, well deserved. From a merchant level salesperson (MLS), perspective, life is good. A new deal translates into more revenue, padding a residual stream that you may or may not sell one day.

As an MLS, your long-term business strategy is straightforward: write more accounts. You target a range of retail, small or midsize enterprises (SMEs), and one business type is as good as another, whether it's a small restaurant, boutique or convenience store.

Through the eyes of an ISO

The owner of the ISO you write for, however, has a different perspective. The ISO owner presumably understands how difficult it is to capture new business and knows that in the retail SME game, the struggle is real. These businesses are constantly bombarded by merchant service providers competing for their transaction dollars, willing to poach these accounts with the king of all value propositions: lower pricing.

For the ISO owner, it's a never-ending battle to write more accounts than he or she loses, complemented by an inexorable, incremental loss of profitability as the battle against other payment service providers plays out on the competitive pricing front.

Through the eyes of a buyer

In today's marketplace, most buyers of bankcard properties are funding their acquisitions with outside money, not cash on hand. This evidences a degree of sophistication in that these buyers have successfully negotiated a debt or equity relationship with an investor.

Further, many such funding partners are investment banks, which will only place their money with partners who have a well-thought-out strategic vision, along with the industry expertise to properly evaluate acquisition opportunities.

And there is something every ISO owner should know about these buyers and their funding partners: they do not look at SME retail merchants as high-value businesses, and they assign low valuations to bankcard properties populated predominantly by these merchants. However, if a bankcard property, ISO or portfolio comprises vertical-specific, SME retail merchants, the preceding statement does not hold.

So how do you explain the variance? Why do buyers and their funding partners perceive things this way?

The straight dope

Small retail businesses seek extremely simple payment solutions because their businesses dictate that they don't need anything more sophisticated. Thus you see more and more small businesses switching over to the Squares of the world. And even if they do utilize more traditional payment processing services, the profit margin on small businesses is minimal.

For midsize retail enterprises, there's room to negotiate better margins, but unless you're also providing them with some form of technology solution, they will continue to periodically switch payment service providers as they seek the lowest pricing. In both instances, your portfolio, if it consists of these types of businesses, will exhibit significant churn and minimal profits. This is why buyers assign a lower valuation to bankcard properties containing these types of merchants.

If you've successfully penetrated a specific retail SME vertical, buyers will infer the portfolio is of a higher quality, and therefore greater value. Vertical-specific penetration suggests the merchant service provider is drawing from a unique knowledge base that allows him or her to be more than just a payment provider, but a payment provider who specializes in tailoring payment services to a specific merchant type.

Vertical specificity also suggests the payment provider may be using technology – POS or software-based business management solutions – to lock in these merchants. The buyer would expect to see higher margins from the payment services and the technology, and stickier accounts, which would keep the attrition down. For these reasons, these types of bankcard properties would be valued higher.

Targeting retail SME business types across the board is fine for an MLS, but ISOs need to build value in your business, and targeting retail SME accounts willy-nilly not only won't add value, it can kill it.

end of article

Adam Hark is co-founder of MerchantPortfolios.com, a dba of Preston Todd Advisors Inc. With over a decade of experience in the payments industry, Adam specializes in mergers and acquisitions, growth and exit strategies, and asset and enterprise valuation for payment processing and payment technology companies. He can be reached at adam@merchantportfolios.com or 617-340-8779.

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