By Jeffrey I. Shavitz
Affinity Solutions Inc
If you need access to growth capital to purchase smaller companies, pay your sub-agents, invest in marketing and staff, or develop your IT systems, where are you going to get it? This is a question that continually rears its head in the payments industry.
Banks and traditional sources of capital don't understand the business and won't lend at any price, while nontraditional lenders charge astronomical fees, impose inflexible terms and demand short maturities.
As a result, people previously thought their only alternative was a sale of their portfolio. Unfortunately, many people did not consult tax counsel. They thus found themselves incurring the painful wrath of the IRS and paying steep interest rates to the IRS, and even steeper penalties.
Please understand that I am neither a tax attorney nor a CPA, but many of my friends in the industry who own ISOs or, conversely, are merchant level salespeople (MLSs) running one-person offices will ask me for my opinion regarding company or portfolio "exit" strategies.
Approximately three years ago, my partners and I sold our company Charge Card Systems Inc. to CardConnect, and I experienced both the legal and accounting issues during that transaction. I was very fortunate to have been introduced to a great team of people at the CardConnect organization, and we shared a similar philosophy of where the industry was heading and how best to accomplish our mutual goals.
Selling a business or a portfolio is a complex transaction – and it's the same paperwork whether your company has 100 merchants, 1,000 or 10,000 merchants. Yes, there are more zeros, but the intent is similar in completing a transaction.
One major distinction between receiving capital for running your business versus my situation in selling my company to a new entity is that receiving an influx of capital is different than understanding a potential buyer's vision and mission statements and determining whether the philosophy of the existing and new management team will work well together (maybe this can be the content for an upcoming article). But again, to protect myself, I advise you to consider what I have to say, but check with your financial advisers (legal, accounting, etc.) before making any decisions. This way, I can sleep at night.
This article is not about determining the current multiple for your portfolio; is it 20 times your monthly residual, 24 or 36? I don't know. If you don't know, you probably should find out; it's always better to negotiate terms when you "don't need" the capital. Portfolios with a particular industry concentration may achieve a higher multiple versus a general portfolio of many industry niches. Historical attrition numbers play another significant variable. You get the point.
Contrary to popular belief, the sale of a portfolio does not result in capital gains tax treatment. The sale of a portfolio results in ordinary income being realized. Under the so-called "substitute for ordinary income" doctrine, a taxpayer cannot convert what otherwise would be ordinary income into a capital gain. Further, the courts have construed the IRS code to treat the sale of income rights created through personal services as producing ordinary income, not capital gains.
As a consequence of these issues, the industry has faced a serious dilemma with regard to raising capital. Financial service companies are eagerly entering the payments space, as they understand the power of residual income, growing merchant portfolios (of course coupled with mitigating attrition) and the return on investment that can be realized.
Terms will range, but for this example, I'll use a 12 percent interest rate, interest only payments for 12 months and a five-year repayment term. The following example compares a sale versus a loan scenario.
(*Assumes no hold-back)
With the loan scenario, you retain full ownership of the portfolio while getting the capital needed to expand and grow without triggering a nasty tax problem. So, before you sell, it's worth considering all and other options.
When Ken Musante, President of Eureka Payments LLC, was the author of Street SmartsSM several years ago, he explored the topic of portfolio sales in "Variations on valuations," which we published Aug. 23, 2010, in issue 10:08:02. Following is an excerpt from that article:
CCGUY shared what many Forum respondents agreed with: selling a portfolio provides a cash infusion but may not be the best long-term decision. He wrote, "In the long run the way to go was to get a line of credit from the bank based on personal and business credit.
"[We] had one small portfolio we thought about selling once, too, and we service the merchants but we do not add to it. Selling would have been a nice influx of cash, but holding on to it has paid a lot more over the long haul."
CCGUY was able to get a bank loan, which generally have much lower interest rates but come with a cost. Banks require substantial documentation and, as CCGUY pointed out, the loan was based on personal credit, which typically means banks will require a personal guarantee, blurring the line between your private and business lives.
THECREDITCARDMAN reiterated CCGUY's point when he said, "I needed 50k to fund some projects and did not want to use personal monies. If I sold the rights to one of my portfolios, $4,200/mo @ 12x, I would have gotten the 50.4k. Instead, I asked for a loan against, @ 11 percent, 12 months payback = $52,800. Now the loan is almost paid, and I still have the income stream."
To delve further into how portfolio sales work, the issues that arise, and things to do and not to do, enter "portfolio sale" in our website's search engine (www.greensheet.com). A list of articles from our extensive archives will appear for your perusal.
Jeffrey I Shavitz is the Managing Director of Affinity Solutions Inc. and its Navigator product. His experience in payments including co-founding Charge Card Systems Inc. that was sold to Card Connect in 2012, Alternative Merchant Processing, dedicated to high risk merchant processing and Charge Card Funding involved in the cash advance space. Jeff's first book, Size Doesn't Matter - Why Small Business is Big Business; Profit NOW from the Small Business Boom!, will be released in August 2015. He can be contacted at 800-878-4100 or firstname.lastname@example.org; for additional information on his activities, please visit www.jeffshavitz.com.
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