The Green Sheet Online Edition

December 10, 2018 • Issue 18:12:01

Preparing for a portfolio sale starts on day one

By Christopher Hernandez
Portfolio Buyer

Most calls I receive start with, "What can I get for my portfolio?" Fair question, right? My answer is always the same and not what most potential sellers want to hear: "Well, that depends." The truth is selling your portfolio, albeit an asset, is nothing like selling real estate or a boat. Many variables specific to this industry affect the selling price, more commonly known as a multiple.

Mergers and acquisitions activity in payments is distinct from other industries. The selling price is affected by who your processor is, the contract terms for selling to other ISOs, current merchant pricing, whether your portfolio is high risk, your attrition, your location and, most importantly, your willingness to continue to work with the buyer post sale.

Select your processor carefully. The processor you choose can be critical to your exit strategy. It can directly affect the interest level of perspective buyers and, in some cases, whether you will get any interest at all. There are certain processors (I will not name names) that buyers will not touch because of their bad reputations. We know all processors are not created equal; some are more desirable than others. A processor's reputation for ISO and agent support, as well as merchant support will play a major role in what your offer will look like or if you will get an offer at all.

Critical issues

When buyers consider your contract terms and portfolio, they will look for several things:

1. A right of first refusal (ROFR) clause. This will tell buyers more about how long a processor will have to make a matching or counter offer if they make an offer (LOI). So, the sooner you get that accepted LOI to the processor, the better. That is when the clock starts for the processor to make a counter offer. In many cases, if the processor does not respond within that time frame, it has waived ROFR by default, so make sure to have digital confirmation that the processor received it.
2. Information on portability. Buyers will want to know whether the merchants can be moved to another processor. 99.9 percent of the time the merchants are not portable. When a seller approaches me, most of my efforts are focused on approaching ISOs that work with the same processor. In rare cases, there is a work around for this obstacle.

   An enterprise sale (buy the entire company/LLC) or a residual payment redirect (changing payment info to the buyer's bank) can circumvent this issue, but an enterprise sale is a lot more involved and can cost more in legal fees to complete. A redirect can be riskier for the buyer because the MIDs are still under the seller's control and can be changed back again. Because of that risk, the multiple may reflect that. Also, in very rare cases in some agreements, the processor doesn't have to match or beat an offer from a buyer, but simply can refuse to grant the seller a waiver of the ROFR. In this case, you may be stuck.

3. Merchant pricing. This can be a complex subject. Buyers will want to know how sticky your merchants are. As we all know, some merchants will jump ship for a half basis point, and most buyers understand this. That aside, evaluating your pricing will give buyers an idea about whether merchants already have one foot out the door. In many cases, attrition increases during the transition when accounts are being moved into the buyer's portfolio and are charged higher rates.

   So, it is important for both buyer and seller to know where they stand before going too far down the road. If the buyer can use the existing statements for a period, it is a bonus. On the plus side, most of the time the buyer is able to not only offer better pricing, but more products and services and merchant support. This can make merchants a lot stickier.

   If you are staying on to continue to work with the buyer post sale, this can make you more money, more easily. So, everybody wins.

4. Factors affecting level of risk. If you accept all business types, you probably know about high-risk processing. High risk doesn't just mean marijuana dispensaries and online dating. High risk can also mean high concentration. This is another variable that is considered a high-risk purchase for a buyer. So, the multiple will reflect that. As a buyer analyzing a portfolio that averages $100,000 in residual income, if 80 percent of that income is from one merchant, that portfolio is also high risk.

   Also, when an ISO and merchant have a close relationship, buyers fear that if the seller goes, the merchant is soon to follow. That ISO has nurtured that merchant for many years in some cases, so there is a high risk the merchant will be lost. In addition, if the merchant goes out of business after the sale, the buyer will then be under water on a seven or eight figure acquisition. And keep in mind that high levels of chargebacks can be a factor. Finally, if the portfolio has significant liabilities like ISO loans or lawsuits, they are not necessarily a deal killer, but certainly will affect a buyer's interest and offer.

5. Attrition. Nobody likes losses, but they are an absolute certainty. Businesses shutter for many reasons that are out of the control of ISOs or agents. Buyers understand that. That is why buyers look at your attrition and will generally include an average 10 percent attrition guarantee as one of the stipulations for a sale. Ten percent is considered a fair number for the unavoidable losses that will occur.

   In the past, attrition guarantees were based on merchant (MID) loses. A typical attrition clause would require that during a predetermined time during the earn-out period following closing of the sale (usually 24 months), the seller would be responsible for replacing a lost merchant with another merchant that produces equal or greater residual income.

   Today, a different method is generally employed. Attrition is based on income loss rather than merchant loss. Thus, the seller would be required to maintain the income of the portfolio for the duration of an agreed upon period. If the seller is not able to maintain the income, the seller may not qualify for the remaining earn-out payments. Buyers typically pay 70 to 80 percent upfront at closing. The remaining 15 to 20 percent is paid over an 18- to 24-month period, which is referred to as an earn-out period.

6. Location, location, location. Geography played a big factor in portfolio sales in the past. ISOs were looking to purchase portfolios in an area where they already had a presence. If a buyer already had an office and boots on the ground, that was a huge plus for a seller – and still is. However, today's payments industry encompasses the world. Businesses are no longer confined to their immediate locale. Buyers are establishing footprints nationwide. What easier way is there to do this than through acquisitions?

Next steps

I've saved the most important question sellers ask for last: "What should I do after I sell?" Again, the answer is, "Well, that depends." If you are ready to buy that trawler and charter fish, you can get help to arrange the best terms for your exit. If you're looking to stay in the business and want to maximize an offer from a buyer, sign up to work with the buyer. The buyer will likely offer a better split than you're getting in addition to better pricing, support, products and services. Most importantly, chances are high you will add a couple of multiples to the sale.

Many buyers will not buy a portfolio without continued involvement from the seller as part of the sale. If you'll be sticking around for the next few years and continuing to earn, you will be mitigating the buyer's risk.

I have heard far too many ISOs and agents say, "I wasn't aware of that," when I tell them a portfolio will be hard or, in some cases, impossible to sell. It's a tough conversation to have. Unlike the terms and conditions no one reads when downloading and registering a mobile app, you need to read the terms of your sales agreement. Otherwise, you won't have the keys to that exit you'll soon be looking for.

Christopher Hernandez is CEO of Portfolio Buyer, www.portfoliobuyer.com, a mergers and acquisitions consulting firm that focuses on the merchant services industry. The firm's buyer network concentrates on purchasing merchant portfolios and residual streams with the objective of providing clients personalized, professional service and the maximum portfolio valuation. He can be reached at chernandez@portfoliobuyer.com.

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