The Green Sheet Online Edition

September 23, 2024 • Issue 24:09:02

M&A in payments: Selling a residuals book of business

By Leo Arzumanyan
Global Legal Law Firm

Mergers and acquisitions (M&A) in the electronic payments industry can be complex, particularly when selling a residuals book of business is involved. This article will guide you through the key steps, common pitfalls and essential considerations to help ensure a smooth transaction.

A residuals book of business consists of the ongoing revenue generated from a portfolio of merchant accounts. Residuals are payments made to ISOs, agents or other parties based on the processing volume and activity of their merchant clients. Selling this book can be lucrative, but the process requires careful planning and due diligence.

Key steps in the M&A process

Following are six key steps in the M&A process:

1. Valuation: The first step in selling a residuals book is determining its value. Factors influencing this include the stability and diversity of the merchant portfolio, the average attrition rate, and the length of existing contracts. Buyers typically look at historical earnings, projected future income and potential risks. Professional appraisals are recommended to ensure the valuation is accurate and aligns with market expectations.
2. Preparing for sale: Before listing a residuals book for sale, ensure all contracts with merchants are up to date and assignable. Non-assignable contracts can complicate or derail a sale. Organize financial records, merchant agreements, and other relevant documentation. Transparency is key to attracting serious buyers and negotiating favorable terms.
3. Finding potential buyers: Potential buyers could include other ISOs, payment processors, private equity firms or competitors looking to expand their portfolio. Engaging a broker with experience in the payments industry can help in identifying qualified buyers and managing the sale process.
4. Due diligence: Once a buyer is identified, the due diligence process begins. This involves a thorough review of financial statements, merchant agreements, compliance with industry regulations and potential liabilities. Both parties should be prepared for an extensive back-and-forth during this phase, as buyers seek to confirm the value and viability of the residuals book.
5. Negotiating terms: The purchase agreement should clearly outline the sale's terms, including the purchase price, payment structure (for example, lump sum or installments), and contingencies. Key issues to negotiate include post-sale obligations, earn-out provisions and non-compete clauses. Involve legal counsel with experience in M&A within the payments industry to navigate these negotiations effectively.
6. Closing the deal: After terms are agreed upon, the deal moves to closing. This involves finalizing the transfer of assets, updating contracts, and ensuring all legal and regulatory requirements are met. Depending on the deal's structure, the closing process may include transferring the residuals book to the buyer, updating merchant agreements and notifying merchants of the change in ownership.

Common pitfalls, important considerations

Following are pitfalls and things to consider in the M&A process:

1. Overvaluation or undervaluation: Sellers often face the risk of overvaluing or undervaluing their residuals book. Overvaluation can lead to protracted negotiations or failed deals; undervaluation results in lost revenue. A professional valuation helps mitigate these risks.
2. Inadequate due diligence: Skimping on due diligence can lead to unexpected liabilities or post-sale disputes. Ensure that all aspects of the residuals book, including compliance with payment industry regulations, are thoroughly reviewed.
3. Contractual issues: Contracts that are non-assignable or contain unfavorable terms can significantly impact the sale. Review all contracts in advance to ensure they are assignable and include terms that won't hinder the process.
4. Lack of legal expertise: M&A transactions, particularly those involving residuals, require specialized legal knowledge. Inadequate legal representation can result in unfavorable terms or missed opportunities.

5. Earn-out provisions: Earn-out provisions, where part of the sale price is contingent on future performance, can be contentious. Ensure these provisions are clearly defined, realistic and aligned with both parties’ expectations.

By being aware of common pitfalls and following a structured approach, sellers can maximize the value of their residuals book and ensure a successful transaction. Always engage professionals with experience in the industry to guide you through the process and protect your interests.

This article is for informational purposes only and does not constitute legal advice. Readers are encouraged to seek professional legal counsel regarding their specific circumstances.

An alumnus of the University of San Diego, School of Law, Arzumanyan has a proven track record of drafting, reviewing, revising and negotiating an extensive array of commercial contracts, including vendor, nondisclosure, employment, software-as-a-service, consulting and marketing agreements. Leveraging his prior in-house counsel background, Arzumanyan has also carved out a unique niche within the electronic payments industry as his transactional expertise now encompasses merchant processing, merchant banking and sponsorship, referral, independent sales office, and other related agency agreements. Contact him at larzumanyan@glrlegal.com.

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