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The Green Sheet Online Edition

April 28, 2008 • Issue 08:04:02

Strategizing for ISO growth

By Lane Gordon

There are two primary ways to grow as an ISO: organically, through your existing sales efforts, and by acquisition. There are trade-offs between these two strategies, of course: You could ratchet up your existing marketing efforts with financial investment, or you could appropriate additional funds toward an outright ISO or portfolio acquisition.

In contemplating an acquisition, you need to do a significant amount of evaluation, not the least of which is examining internal client acquisition costs. It's important to know how much it presently costs your firm to acquire an individual merchant account, including all marketing efforts and overhead.

Once you have this information, you can begin evaluating the trade-offs between expanding your existing sales operation and purchasing an ISO or portfolio.

Generally, you can expect to pay significantly more money on a per-merchant-account basis to acquire an ISO or portfolio in comparison with your own internal merchant account acquisition costs.

If you find that you can acquire ISOs or portfolios at a lower per-merchant acquisition cost than you can internally, you may want to re-evaluate your sales operation's cost structure or eliminate internal sales efforts and grow through external acquisitions alone.

More often than not, an ISO finds equilibrium between external acquisition and internal growth, as opposed to the acquisition-only scenario.

Why acquire?

The per-merchant account cost of buying a portfolio or ISO normally will be a multiple of your internal acquisition costs if you're running efficiently. Assuming the costs to acquire externally are higher, you might ask why so many companies acquire portfolios and ISOs.

Among the reasons are the ability to:

  • Grow significantly faster than would be possible by internal growth alone
  • Achieve significant growth in profitability by taking advantage of more favorable processing terms
  • Take advantage of market "arbitrage" opportunities by purchasing smaller portfolios and ISOs at lower multiples than the multiple your company is valued at
  • Diversify/expand into new or unique markets

The first of these four reasons is self-explanatory. If you are boarding 100 merchants a month, and you purchase an ISO that is also boarding 100 merchants a month, then you've effectively doubled your monthly account growth - at a price.

You've sacrificed capital to save time. You paid a multiple of your internal account acquisition costs to double the speed of your growth. It might have taken you a year to board 1,200 accounts previously, whereas now with the new acquisition you can board 2,400. Additional economies of scale may also allow you to board even more accounts by leveraging the resources of the combined operation.

The ability to increase bottom line profitability through acquisition may not be as clear.

You may be asking, How can I increase profitability if I'm paying a higher multiple per-account to acquire another ISO than my current per-merchant acquisition costs using my internal sales force?

Typically, the answer lies in the underlying ISO agreement of the potential acquisition target. Let's say that you own a Processor A ISO and you're contemplating purchasing another Processor A ISO.

The idea of purchasing to increase profitability revolves around the idea that your ISO agreement is superior to the one in place at the prospective acquisition target.

If the prospective acquisition target's transaction costs are significantly more than yours (due to an inferior ISO agreement) and you can move the accounts to your agreement (check with your attorney) at a preferential pricing structure, despite the fact that you may pay more on a per-account basis, the acquisition may bring immediate profitability.

This comes about by extending the strength of your ISO agreement to those newly acquired accounts.

It is vital to have a strong group of knowledgeable advisers assist with your analysis. Start with an attorney who specializes in negotiating and understanding merchant processing ISO agreements.

Market "arbitrage" is the ability to take advantage of the spread between the lower multiple valuation of small portfolios and ISOs and the higher multiple your company is or will be valued at as you continue to grow. A portfolio or ISO with 100 accounts will typically sell for significantly less on a per-account basis than a portfolio or ISO with 5,000 accounts.

If you can purchase an ISO or portfolio at 20 to 30 times monthly residual, and if your company (being larger) is valued at 50 or 60 times monthly residual (these numbers are for illustrative purposes), the acquisition will be accretive to the value of your firm. For each $1 you spend, theoretically you can add $2.50 to the value of your ISO or portfolio.

The ability to diversify or expand into new or unique markets is another major reason for acquiring an ISO or portfolio. In this situation, the acquisition is seen as "strategic."

Let's say your merchant accounts are concentrated in a certain geographical region or industry sector. You may contemplate diversifying by purchasing an ISO or portfolio that can help spread your risk, geographically or by industry.

Perhaps your portfolio is primarily composed of MO/TO or card not present merchants. You may contemplate acquiring a brick-and-mortar ISO or portfolio to diversify risk.

Alternatively, you might be primarily brick-and-mortar retail, and to avoid some of the risks of a recessionary contraction, you decide to find an ISO or portfolio consisting primarily of petroleum accounts or online sales.

In all of these cases, you must possess a very clear understanding of your ISO agreement; the ISO agreement of the portfolio or ISO you are looking to acquire; attrition; the average age of the accounts; account make-up (brick-and-mortar, Internet, MO/TO and so forth); account activity (whether the account is processing a healthy amount of transactions every month); geographic and industry diversification; and risk concentration (whether an inordinately large percentage of the monthly residual produced by a very small subset of accounts).

A thorough understanding of these factors will allow a prospective buyer to begin evaluating whether an acquisition is the best strategy. end of article

Lane Gordon is Managing Partner at MerchantPortfolios.com, a company specializing in marketing ISOs and portfolios for sale. Prior to MerchantPortfolios.com, Gordon spent a number of years working in the payments industry. Gordon holds degrees from the Massachusetts Institute of Technology and Carnegie Mellon University. He can be reached at 866-448-1885, ext. 301; lane@merchantportfolios.com; or by fax at 508-638-6444.

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