The Green Sheet Online Edition
October 23, 2017 • Issue 17:10:02
The sale of a portfolio
Most of us in the ISO world feel we own the accounts in our merchant portfolios. What an ISO actually owns, however, is the percentage of residuals promised to the ISO from the processing entity. Merchant accounts are under contract with the acquirer, which, in most cases, is the bank.
So when merchant level salespeople (MLSs) say they don't want to sell their accounts when a portfolio is being sold, they fail to realize the accounts don't belong to them. They have merchant relationships, they receive residuals, but account ownership isn't theirs. They have no say if a portfolio is being sold.
My sales office recently completed a portfolio sale. Our agreement had a provision stating that if our processor sold a certain percentage of its business, our residual portfolio automatically would be included. The contract also contained a promised multiple, which we had agreed years earlier to modify downward due to changing portfolio valuations. Many years ago, I heard of ridiculously high multiples offered by processors. Those days are gone unless a portfolio is immense or specialized; even then, the multiples paid are not what they once were.
The complexity of payouts
So how does one determine what a fair payout is for the ISOs and MLSs who have written a portion of the accounts being purchased? In speaking with several people on the subject, I found several factors affecting the determination of multiples.
First, not all the money is generally paid out upfront. Agreements typically require an attrition clause and continued production. A hold back can exist for two to three years. Basically, the processor feels if you want to get paid in full, you must continue to produce and maintain a fixed level of attrition on your accounts.
As an ISO involved in a portfolio sale, the first question that came to mind was, how much money should we keep in-house to insure we survive over a period of time until new production kicks in? Unless you're closing your business, having enough capital to cover a minimum of two to three years of current operating expenses is important.
Additionally, though it may appear at first glance that the profit to the ISO is high, that isn't necessarily so. Everyone needs to profit, including the ISO, but with a sales force in the street to support, it is nowhere what people think.
Typically, an ISO has loans to repay. In our industry, it takes a huge initial investment to operate, especially in the first three to four years. Think about how long it would take for residuals to cover a monthly nut of say $50,000, when the office residuals grow by maybe $500 a month, eight months out of the year, and the income falls off or experiences no growth four months out of the year.
Spending $50,000 monthly seems high, but when you consider business location, salaries, rents, as well as the cost of insurance, furniture, computers, Internet, phones and paper supplies, it all adds up. If you own another business with space you can use for free, it helps, but you still have every other cost associated with a business.
Factors affecting multiples
How does one determine multiples for payment, without making all the decisions based on personal thoughts or friendships? The best way we found was not to assign names to portfolios. Instead, we based the multiples on the following:
- Portfolio size. Too small, not good. Too new, not good.
- Whether portfolio is weighted. If one or two accounts make up more than 25 percent of the income, it is not good. If those accounts changed processors, the portfolio would lose 25 to 50 percent of the value.
- How portfolio is weighted. If the sales office moved a few accounts would that cause a large portion of attrition for the office?
- Degree of activity. Has there been zero new production in, say, three months or one year?
- Portfolio growth. Does the sales office appear to be building or in hibernation?
- Attrition. What is the portfolio's level of attrition over the past 12 months?
- Gains versus losses. Were more accounts added than lost due to attrition?
- Portfolio age. Is the portfolio brand new?
There were some surprises, but in general, once we assigned names to portfolio evaluations, with some tweaking, it did make sense. We had to come up with several levels of multiples. That is where our accountant came into play. Getting a two-year forecast based on both payments that would come into the company and estimated expenses, made it easier to determine what the multiples could be.
MLS versus bean counter
There is always difficulty when partners try to establish multiples to be paid out. Even though the math is there, and you open up statistics for review, MLSs always believe we should pay more, whether warranted or not. The accountant always wants to prove out the numbers now and plan for the future.
This can lead to a breakdown among company partners. No one wants conflict; the way these issues get solved is through compromise. MLSs must listen to the accountant and the accountant has to believe MLSs know their people well.
It must be fair, but fair market and fair pricing are subjective. The value should be placed on agents who have a good size book of business, work primarily with that ISO and continue to be productive. Dead books are fine, but without new production, their value continues to decline. New production is also fine, but until you've had a few years of experience with someone, you don't know them well. Books of business based on one or two large accounts are scary, because after payment, moving just those few accounts can be a killer.
Will there be another sale?
Getting paperwork together for a portfolio sale is an enormous task. One question that continually popped up during our sale was, will there be another sale? This is difficult to answer. One would have to be blind not to see the consolidation going on in our industry today. I'd like to guarantee that my ISO will never go through a sale again, but unfortunately, it isn't in my control.
It's possible to opt out of a sale given the right agreements, but certain questions must be explored, for example: Will the new owners treat my company and agents well? Will they have the same or better level of support? Will we get lost in the shuffle? If the buyer brings valuable benefits, the worst outcome would be that MLSs resent a decision not to participate in a sale once they see what the new owner is offering.
Steven Feldshuh, President of Merchants' Choice Payment Solutions East, has 18 years' experience in sales and ISO development. Directly prior to joining MCPSE in 2012, he was President of Payment Partners. In his current position, Steven devotes the bulk of his time to assisting agents in building their portfolios. Contact him by email at email@example.com or by phone at 212-392-9202.
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