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Should I Finance My ISO?

The decision to finance a business is usually more of a business decision than a legal decision. However, once the decision to finance is made, there are important legal issues to be considered in structuring, drafting and implementing a financing of the ISO business.

Most of the clients that I advise on financings have been in business for at least five years and are in a position to plan the future of their businesses with a greater measure of certainty than startups. This does not mean that financing is only for veterans, but some experience might be useful before mortgaging your business to a lender.

Here are 10 points (among many others) to be considered from a legal and business perspective when you decide whether to enter into an ISO financing transaction:

  1. Do You Need It? I always advise against entering into a financing unless the need for it is clearly demonstrated. There are two fact situations that, more than others, demonstrate the need for financing.

    The first is where the business will fold without an injection of additional cash. In this situation, the principals of the business need to decide whether they will allow the business to go under or whether they will take the additional risk of a financing (i.e., a loan) to stay afloat.

    The second situation where financing is particularly useful is where an ISO wishes to expand significantly within a short period of time and lacks the resources to do so. A decision in this second situation requires a balancing of your interest in a successful but slow growth business versus a faster growth but higher risk business. At the end of the day, these are business decisions for you to make.

  2. Who is the Lender? As many of us know from personal mortgages, the relationship between a lender and a borrower is quite intimate. Some borrowers make the mistake of borrowing from the first lender who is willing to lend to them without adequately researching the alternatives.

    It is always in your interest as a borrower to compare the terms offered by a lender with those of other lenders. In addition, try to find another ISO that has borrowed from your proposed lender and find out what the borrower's relationship with the lender is like. I advise all of my clients that the relationship between parties to a contract is at least as important as the wording of the contract itself.

  3. How Much? Never forget that, to a certain extent, it is in the interests of the lender to lend you more money than you actually need. All businesses need a cash reserve, but avoid borrowing significantly more than you actually need.

    The first reason for this is that you will end up paying more interest than required to save or expand your ISO business. A second reason is that you will extend the time during which your business is vulnerable to creditor remedies (i.e., foreclosure).

  4. At What Rate? What is the interest on your borrowing? Remember, interest rates are at their lowest level in 20 years. Shop around for the best rate.

  5. How Long? When are you expected to pay back the loan? The first instinct of a borrower is often to see how late a loan can be paid back. However, don't forget to also consider that you may wish to repay the loan early. Consider the possibility that your business may be more successful than you had planned, and structure the terms of your loan documentation accordingly.

    Give careful consideration to the penalties that will apply to both late payment and early payment.

  6. Negative Controls? Negative controls are a shopping list of activities that will be subject to a veto of the lender once the loan has been disbursed. Typical negative controls include the following: restrictions on transfers of shares of the borrower, restrictions on business activities of the borrower, restrictions on spending by the borrower and restrictions on further borrowing by the borrower.

    Borrowers often make the mistake of thinking that these are not negotiable items. The saying "He who has the gold makes the rules" has some truth to it, but the lender has a business reason to enter into a financing transaction and therefore has a business motivation to do it on terms that all are agreeable to the borrower.

    Pay careful attention to the list of negative controls and consider whether your business can operate effectively under them. Negotiate accordingly.

  7. Security Lenders will require various forms of security to make sure their loan is repaid. Some typical examples: a security interest in residuals of the ISO (i.e., if you don't pay back the loan, the bank gets your residuals), a security interest in the shares of the borrower, and a promissory note stating that upon a default the full amount of the loan will become due in a personal guarantee by the principal shareholders of the borrower.

    Once again, the types and terms of security granted are negotiable and should be negotiated.

  8. What is a Default? Read the default clauses to all loan documents carefully. You likely will be surprised by the simple actions or inactions of the borrower that may constitute a default. Make sure that a default may not occur by actions of the lender alone. In other words, the lender should not be able to declare a default "at will."

    Be sure to understand all of the default clauses and consider what might happen if each one of them were triggered; this piece of work may save your business from seizure by the lender.

  9. Residual Protection The key asset of an ISO is usually its residual income. When a lender to an ISO forecloses on its loan to the ISO, the principal asset used to pay down the loan owing to the lender is likely to be residual income on the ISO portfolio.

    What is strange about this scenario is that the best entity to protect residual income in the ISO portfolio is the ISO itself and not the lender.

    When negotiating with a lender, consider what kind of mechanisms will be put in place for the lender to properly manage the ISO portfolio before and after a default by the ISO.

  10. Get Legal Advice Advice from your lawyer, or a lawyer with expertise in financing and the electronic transactions business, is highly recommended when financing an ISO business because the wording of loan documentation is often technical and should be reviewed by an expert to protect your interests.
In addition, your lawyer can make suggestions that you might not have considered. I would prefer not to have to make this point so blatantly, but the subject of this column makes it necessary.

Adam Atlas, Attorney at Law, is Legal Editor for The Green Sheet, Inc. Contact him via e-mail at or phone 514-842-0886. 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.

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