The Green Sheet Online Edition
January 23, 2017 • Issue 17:01:02
ISO portfolio seller's checklist
Having advised on a number of ISO portfolio purchase and sale transactions, I thought it would help to outline key items for an ISO portfolio seller to consider before, during and after a sale. For the purposes of this article, I will assume that the selling ISO has already weighed the advantages and disadvantages of selling.
Every portfolio buyer must conduct due diligence before buying. Even with the most honest of sellers, buyers still owe themselves a duty, and may also owe their investors a duty to fully review the books and records of the portfolio being purchased to see that they are going to get what they are paying for.
Due diligence for ISO acquisitions often involves the seller showing the buyer information related to the portfolio and ISO agreements, such as residual reports, merchant agreements, etc. Taking a careful look at the ISO agreement, the selling ISO will see that much of that information (particularly the ISO agreement) is confidential and cannot be disclosed without permission of the processor that is a party to the ISO agreement.
Before engaging in in-depth due diligence with the buyer, the selling ISO may have to obtain permission from the processor to disclose information to the potential buyer. Getting this permission is not usually a problem, but pressing ahead with due diligence without permission may result in the processor alleging breach of the ISO agreement, which would put the residual sale in jeopardy.
What's for sale anyway?
In decreasing order of substance, here's what an ISO may be selling as part of selling an ISO business:
- ISO shares: When an ISO sells its company share, the buyer is buying the entire business, and the corporate entity of the ISO becomes the purchaser's property. In principle, the buyer inherits the ISO with its various contracts and liabilities.
For example, if the ISO had contracts with two processors, theoretically, those contracts remain in place with the ISO after its shares are transferred to the buyer. Note, however, that some ISO agreements contain a "change of control" provision, meaning sale of the ISO can occur only with the processor's prior consent. Failure to obtain such consent may result in the processor putting the ISO in default and thus putting that company's value in jeopardy.
ISO purchase transactions rarely involve the sale of shares. The main reason for this is that when you buy a company, the company's liabilities stay with it. If, in the past, the ISO took on a loan guarantee or other liability, the ISO will be saddled with that responsibility after the sale unless it is specifically released. ISO buyers therefore usually prefer to buy assets, not shares.
- ISO assets: By purchasing a defined list of assets, the purchaser is usually able to avoid inheriting a lingering liability of the ISO business being sold. Most of the time, the key assets are the ISO agreements with processors and the agent agreements that the ISO has with agents.
Each of those agreements is usually reviewed as part of the buyer's due diligence process to see that the buyer is getting what he or she expects, with no surprises. Each ISO processor agreement and agent agreement purchased should be subject to an explicit assignment. The assignment of an agreement means substituting one party for another. For example, the seller's company may be replaced with the buyer's company as a party to the ISO agreements with processors.
Buyers will usually not conclude a purchase until the processors in question have approved the proposed assignment. A buyer would be foolish to release the purchase price without knowing beforehand that, after closing, the residuals would be paid to the buyer instead of seller.
- Just residuals: Some buyers will simply want a "residual redirection." This lesser form of purchase does not directly involve the shares (share sale) or parties to ISO agreements (assignment). Instead, the seller instructs the processor to pay residuals to the buyer instead of to the seller.
This form of sale is easier to implement. There is less need for tinkering with ISO agreements, etc., but it also complicates the long-term relationship between buyer and seller. To continue receiving the residuals purchased, the buyer depends, more or less forever, on the seller's ISO agreement, with all of its ups and downs.
If the seller fails to meet certain minimum requirements of the ISO agreement, and residuals suffer as a consequence, the buyer is stuck in the "back seat" of the seller's relationship with the processor.
Another complication of buying just residuals is that confusion may arise as to who should service the portfolio's merchants. Absent discussion and clear language in the purchase agreement, the seller may conclude it need not service the accounts for which residuals have been sold. If the buyer doesn't assume that service obligation, the merchants could become neglected and subject to greater attrition.
Buyers of only residuals sometimes also reserve the right to refrain from selecting a specific group of merchants for actual purchase until some years after closing. For example, a purchaser may buy $50,000 per month in residuals, understanding that 36 months later, it will select a specific group of merchants that will be transferred to the buyer.
Assuming the seller's ISO agreement allows for such slicing and dicing (which often isn't the case), a question arises as to whether the buyer should be entitled to $50,000 in 36 months or some lesser amount, taking into account reasonable and foreseeable attrition.
Residual sales should be well thought out in advance because, otherwise, the parties may face confusion and disappointment down the road.
Terms of sale
When selling an ISO business or portfolio, the key consideration beyond purchase price is how quickly that price will be paid and on what conditions. Buyers will pay more when sellers will wait longer to receive the purchase price. Similarly, buyers will pay more for portfolios that decline in value more slowly. Specifically, if the residuals purchased by the business don't decline substantially, the seller is more likely to receive the highest purchase price available.
Some sellers will refuse to wait for any part of their purchase price. This places the buyer in the position of having to trust (or bet) on the seller's honesty and the strength of the business purchased. Naturally, the seller will expect a lesser purchase price but will also be relieved of having to meet post-closing performance guarantees.
No buyer wants to see the value purchased disappear. Consequently, purchasers will require sellers to agree to not solicit the merchants they have sold for some years after closing. For an honest seller, this is not controversial. However, even honest sellers are put to the test when merchants call after closing complaining the buyer's service is sub-par or they simply prefer working with the seller.
Sellers should take the long view and not ruin a chance at a purchase price payout simply to place a few accounts from the sold portfolio. Similarly, buyers need not take an excessively harsh view of sellers who are approached by merchants from the portfolio sold. Perhaps buyer and seller can take advantage of the relationships between those merchants and the seller for the good of all parties.
Many purchase scenarios involve the seller becoming an agent of the buyer, making it easier for the seller to keep supporting the portfolio sold and renew the accounts in that portfolio for the benefit of both parties.
Non-competition means the seller will not be involved in the ISO business in a defined place for a specific amount of time. A non-competition covenant is not usually given by a seller unless the seller is willing to be out of the ISO business for a specific amount of time and the seller is given additional compensation for not competing.
To be clear, non-competition is not the same as non-solicitation. A seller bound by only a non-solicitation clause can continue to be involved in the ISO business, provided the seller does not harm the buyer's portfolio.
A seller that is also bound by a non-competition clause will likely have to find another line of business for the non-competition period. That kind of promise usually comes at a price for the buyer.
There are, of course, many other considerations for ISO sellers, but those discussed herein are key.
In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. For further information on this article, please contact Adam Atlas, Attorney at Law via email at firstname.lastname@example.org or by phone at 514-842-0886.
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