y introduction to the electronic payment industry was as an investor. I was with an organization that had capital to invest, and we were attracted to businesses capable of delivering annuity-based revenue streams. Credit card residuals seemed perfect.

The industry was unregulated and misunderstood-great profits at high margins were easy to envision, especially to my then uneducated mind. With capital to invest, lining up scores of highly professional, loyal sales representatives to produce rapid growth and an attractive return on investment was going to be a breeze.

How naïve I was.

After our initial investment, I moved into a business development function with the ISO we had funded; now I was responsible for delivering the returns our investor expected. I was to work closely with management to execute the business plan, hire and retain independent sales representatives, develop lead generation and tracking systems and understand interchange and pricing to deliver sufficient margins to the owners.

So we battled with compensation plans, negotiated with potential sales representatives and office managers, began utilizing technology for merchant proposals and interviewed processors looking for the perfect partner. We hired sales representatives and developed a training manual. We began signing merchant contracts and watched as our monthly residuals began to grow.

Within a few months, we were generating an average of fifty new contracts per month. But then our reps wanted advances and bonuses. We needed staff to review residual reports and to calculate commissions. We had merchants willing to convert provided we paid their termination fees. We needed computers and software to implement our systems. And the rent had to be paid.

Simply put, we were confronted with the same growing pains other businesses faced: We needed to establish sufficient infrastructure to grow our business. As our revenue grew so, too, did our expenses. And while we continued delivering new merchant contracts, we realized how competitive this industry was. With profits measured in basis points, we could not afford to make mistakes with high risk merchants (we took on some liability with our processor), or to adopt an aggressive compensation plan as a recruitment tool (we wanted to pay upfront bonuses and to offer buyouts to our reps).

We continued modifying our business plan to adapt to an ever-changing industry. Our investor, actively assisting us, did not understand why every lead did not close and cringed when we took losses.

Then we started to run out of money. We needed more. And my real education began.

In short order, I found that our industry faced a dilemma: The inability of small- and mid-size ISOs to approach the capital markets could hinder future growth. Since then, I have been determined to find a solution.

Residual Sales

An ISO seeking capital does have some options. Many small ISOs choose to sell their residual streams to generate capital. Processors, banks and individual investors will often buy the monthly cash flow generated by merchant contracts at a multiple between 12 and 24 times the monthly residual, after factoring in historical attrition in the merchant portfolio. It's a relatively simple process and can occur quickly.

But if investors are anxious to acquire residuals, is it good business for an ISO to sell? If you assume the average life of a merchant is five years, is it wise to sell for one-third of the income a merchant is expected to generate over its lifetime? Not unless it's an absolute necessity.

Selling residuals might be the simplest and quickest manner of raising capital, but the money is expensive and it can take significant time for a selling ISO to rebuild its residual base.

Loans - Traditional Institutions

When in need of capital, most businesses turn to the bank. Bank loans provide the least expensive funding in several respects-banks are dependable, the terms are competitive and banks will not demand decision-making power in your company. Unfortunately, in our industry, banks are the least likely of all investors to support your loan application.

They see a tiny business in a highly competitive industry, whose only assets are residuals, intangible until future payoffs and not even visible in financial statements.

An ISO's "collateral is air," says David Putnam of Resource Finance Company, and air doesn't sell to a bank. Banks look at balance sheets to assess collateral, but residuals are an off balance sheet asset. Worse, banks are conservative by nature, and they assume an ISO's merchants will leave or fail. While we may educate individual value investors, until the banks understand the true value of residuals, this preferred method of raising money would remain off limits to ISOs.

Equity Investments

Some ISOs bypass the loan option in favor of seeking equity investments. An ISO seeking to raise equity may turn to a private investor, or venture capitalist. The venture capitalist requires equity in the form of ownership in the business, plus double-digit returns in a short period of time. These investors are rarely passive. They buy not just board seats and financial reports, but also the license to make changes when business is not running optimally.

The decision to seek an equity investor is a difficult one. You are trading your idea, your dream and your vision-for cash. You are inviting a third party who may not understand your industry to question how you operate. As a former investor in ISOs, I know that I was capable of interfering and disrupting operations, even though my intentions were honorable.

I do believe that equity investment is a viable mechanism for an ISO to raise capital-provided that existing management remains in control of operations for as long as the business is performing in accordance with the budget.

The Future - Alternative Funding Options

Given these funding options, what is a cash-strapped ISO to do? The best option, I believe, is to look to our own industry.

At Cynergy, we are committed to finding solutions that help our ISOs grow, and that includes helping them raise money. We have partnered with a lender to offer Cynergy Loan Solutions, a program that allows our ISOs and agents to borrow money, usually up to ten times their monthly residual. The borrowing ISO's loan payments are paid monthly from its residuals until the loan is paid off. The ISO, by not selling, has retained 100% of its original residuals plus 100% of its growth.

Like the program we offer at Cynergy, there is an emerging trend of loan solution programs run by businessmen who understand the business we're in, have capital to loan to developing ISOs and will lend based on-and against-residuals. Without having to sell your residuals, give up equity and control or embrace an added business partner, you can borrow and grow.

You can borrow from lenders who assess your residuals history and recover loan amounts from your monthly earnings. When the loan is repaid, the ISO is left with its residuals, the addition of new accounts and their respective residuals and the increased business value generated by putting the borrowed capital to good use.

As this type of loan solution gains recognition and popularity, it will hopefully grow as affordable as it is practical. As these new products become more developed and competitive, their costs will come down and ISOs will have more leverage when negotiating terms.

How can we in the industry effect this change? It is vital that we start formalizing our businesses. We must produce thorough financial reporting, detailed business plans and accurate, realistic budgets. And we must work together to educate those who control capital-both financial institutions and private investors. A well-documented, well-defined ISO business model will find it far easier and far less expensive to raise the capital needed to grow.

Mitchell Levy is the Executive Vice President and Director of Business Development for Cynergy Data.

Background

Cynergy Data is a merchant acquirer that provides a wide array of electronic payment processing services while continually striving to develop new solutions that meet the needs of its agents and merchants. In addition to offering credit, debit, EBT and gift card processing, along with check conversion and guarantee programs, the company offers its ISOs the ability to borrow money against their residuals, to have Web sites designed and developed, to provide merchants with free terminals and to benefit from state-of-the-art marketing, technology and business support.

Founded in 1995 by Marcelo Paladini and John Martillo, Cynergy Data strives to be a new kind of acquirer with a unique mission: to constantly explore, understand and develop the products our ISOs and merchants need to be successful and to back it up with honest, reliable and supportive service.
For more information on Cynergy Data contact Nancy Drexler, Marketing Director at nancyd@cynergydata.com.