here was a time when credit cards were new, and debit cards were unknown. The retailers of America were a vast, untapped market, and ISOs were boarding merchants like gangbusters. ISOs and merchant level salespeople (MLSs) enjoyed upfront commissions on equipment sales or leases, while their residuals from transaction fees increased gradually over time.

For growing a business, this formula was simple but successful: Revenue from POS terminal sales funded business growth.

But today, merchants who do not accept bankcards are rare, and the number of ISOs and MLSs competing for merchant accounts is through the roof. Margins are decreasing as companies lower their rates to win accounts; ISOs are consolidating, which further stiffens competition; and free-terminal programs are eviscerating a once dependable income stream.

ISOs can fold POS terminal costs into processing fees and eventually recoup their investment. But the initial funding has to come from somewhere - usually ISOs' and MLSs' pockets. While larger, more established ISOs may be able to afford this outlay, smaller offices, or those just starting out, don't have sufficient cash-flow to do so.

Ironically, ISOs with the steepest growth patterns may find themselves in a negative cash-flow position just when opportunities are flying.

Many reasons to finance

"Most people look for financing in response to a problem - say a personal financial need like college or medical expenses or a desired retirement - or a response to a growth opportunity such as an acquisition, expansion, entry into a new market or an investment in a processing front-end," said Harold Montgomery, Chief Executive Officer of Calpian Inc. The company purchases residuals and offers other forms of ISO financing.

"The cash flow from residuals can be significant and valuable," said David Putnam, President of Resource Finance Co., which provides ISOs working capital loans based on, secured by and repaid from residuals. "But ISOs often have difficulty obtaining working capital because banks and traditional lenders find it difficult to value, collateralize or monetize a residual stream."

Each avenue for ISO funding has benefits and pitfalls. Choosing a source wisely requires determining timelines; short- and long-term goals; the actual costs of each funding alternative; the amount needed - and when it will be needed; the extent to which your financial partner will be involved in your business; and the lender's exit strategy.

It also requires building a core team of financial, legal and managerial professionals to ensure that the process goes smoothly, while amassing what seems like an infinite amount of financial records, five-year marketing and spending plans, and miscellaneous paperwork.

It's a big job, but a necessary one.

Many alternatives to consider

A straightforward proposition of trading debt for growth can sound like a no-brainer, but the hidden costs of long-term debt coupled with the routine costs of doing business can make the resulting growth a profit drain. Some even say more businesses are brought down by success than failure.

"Borrow what you need, not what you can get," Putnam said. "Look for a positive differential between the financing costs and your ROI [return on investment]. You want to be sure you have sufficient resources to avoid being choked by the debt service. Don't take on unneeded debt burden unless you have a productive use for the money."

To help ISOs avoid borrowing more than they can comfortably repay, Resource Finance has made it easy to go back for additional loans after receiving the initial amount.

"To some degree, the size of the deal can help determine where to find funding," Montgomery said. "If you need $10,000 to $20,000, you'll probably turn to family and friends first. Once you get much above that, you're probably looking at a bank or one of the financial institutions that understand the ISO industry - like my company [Calpian] or Resource Finance Co."

The larger the loan amount, the narrower the field of potential lenders. When funding needs approach tens of millions of dollars, Montgomery said, "at that point you might even consider trying to obtain venture capital or going public, which a few ISOs have done."

Finding funding is just the first step. It's the beginning of an ongoing financial relationship. "You have to give a lot of thought to how you'll communicate with your financial partner," Montgomery said. "And long before you sign on the dotted line, you should have thought out how it will all end. If you haven't ... defined an exit strategy, you are building a time bomb into your business."

Also, an ISO should carefully examine every available financial resource. "The cheapest deal is not always the best one," Montgomery said.

Here's a look at some financing options available to ISOs:

Bank loans

Bank loans are a relatively low-cost option, and banks end their involvement in the borrowing ISO's business when the last payment check clears. But very few traditional lenders understand ISO operations. They're looking for tangible assets, profit and loss statements, and audited financials - preferably showing a steady profit over a long time.

A growing ISO is most likely to need cash during its startup phase; however, banks frown upon businesses that don't have proven track records. Few bank lenders recognize future residuals as an asset.

"One of the fundamental problems with traditional banks is that they can't get their head around the ISO business model," Montgomery said. "You just can't perfect your lien position from a bank's point of view. Some ISOs have gotten loans from regional banks, certainly. But by and large, banks just don't lend to ISOs. ... You can burn a lot of time meeting with a bank ... only to discover the loan just doesn't happen in the end."

Friends and family

This group of lenders tends to believe in you and your future. They will probably charge less to provide funds, and their financial auditing requirements are likely to be less stringent. Also, a lack of familiarity with the ISO business model usually won't lead to loan denial.

There are pitfalls though. Most people's friends don't have deep pockets, so the amount of funding available tends to be small. And there is a risk that misunderstandings will cause rifts in personal relationships. Furthermore, loaning money may awaken in loved ones a dormant interest in the ISO's business; ill-advised, unwelcome advice and interference can become a problem.

With this type of financing, a well-thought-out (and articulated) exit strategy is crucial. Otherwise, friends or relatives may expect surprisingly short terms for payoff. They might also call in a loan because of a personal crisis or because a closer relative needs money. Or they may be miffed when the loan is paid off, assuming their help is no longer appreciated.

Venture capital

Almost the Holy Grail of ISO financing, venture capitalists offer large sums of working capital to startup companies.

But according to Putnam, the average venture capitalist looks at 2,000 business plans per year, considers 20, performs due diligence on 10 and actually invests in only two or three. Venture capitalists generally look for companies with new technologies or unique business propositions, long-term growth potential and - this is what kills the deal for most ISOs - high margins.

Besides the slim odds of landing funds, the downside for ISOs is that venture capitalists usually get to influence company decisions, are entitled to a significant portion of the company's equity and, according to Putnam, charge an annual percentage rate of 30% to 50% on loans.

Mezzanine financing

Mezzanine financing is a hybrid of debt and equity financing. It's often used to finance expansion of existing companies and has certain advantages: The debt is subordinated to other debt - such as loans provided by banks or venture capitalists. Funds are treated like equity on a company's balance sheet, and this may make it easier to obtain standard bank financing or venture capital. Also, approval is often relatively quick compared to banks.

On the downside, mezzanine financing usually gives the lender the right to convert to an ownership or equity interest in the company if the loan is not paid back on time and in full. Annual percentage rates usually range from 20% to 30%.

Borrowing against residuals

ISOs often think of selling residuals when seeking cash to fuel growth, but borrowing against residuals might be a smarter way to go.

"A lot of people don't even know that they have the option of borrowing against their residuals," Putnam said. "It's a way to monetize their portfolio without selling it off. It has always been difficult to convert this value into cash that can be used to fuel growth. And selling off and shrinking the business in order to grow the business seems counterproductive.

"The ISO does not have to dilute his ownership to get working capital. Nor does he have to sell off his portfolio in order to grow his portfolio - which is very costly. The ISO is able to obtain growth funding while keeping 100% of his residual portfolio intact. By borrowing against residuals ... once the debt is paid off, you own your stream free and clear - and you own the growth that has occurred."

Anna Solomon of Fast Transact said her company sought financing from a small local bank and got it. Fast Transact paid its loans on time, but the bank was unable to issue enough debt to cover Fast Transact's needs. So the company turned to Resource Finance.

"While I would not normally go after such high-interest debt financing, it solved our immediate growth problems," Solomon said. "Now that our profitability is paying for the loans, and keeping us cash-flow positive, we will probably not need this type of financing in the future. ... I don't have any regrets." It's the easiest way to get financing over $50,000 in a pinch, she added.

In addition to financial institutions, some processors will make loans against residuals or even buy residual streams. "If that resource is available to an ISO, they should certainly look into it," Montgomery said. "They should consider all aspects of the deal, though. There is a certain loss of control. It may be difficult to change processors, for example, so you need to weigh the fact that you're putting all your eggs in one basket."

Selling residuals

Sometimes an ISO needs capital, but it can't assume its residual checks will continue in the same frequency and volume as in the past. Or, an ISO may just not want to commit to increased debt. For those situations, portfolio sales, in whole or in part, may be the best option.

An ISO's owner might want to leave the industry or retire, have an immediate financial need, such as medical bills, or want to diversify investments into another area. "We had one ISO recently that wanted to buy a building," Montgomery said. "Sometimes an ISO needs to get a balance sheet in order, for example, if they are trying to get a bank loan. Selling a piece of the portfolio is a quick, clean way to do that."

Speed is also an advantage: Only those who understand the industry buy portions of residual portfolios, so an ISO doesn't have to educate its potential financier. Calpian, for example, can have funding to an ISO within a week.

Additionally, for many entrepreneurs, control is a vital component of any deal. In many financing arrangements, an ISO must give up varying degrees of control of its business. Some ISOs resort to merging with larger acquirers. Companies like Calpian help ISOs stay in control, Montgomery said. "Our philosophy is that no one knows the ISO business better than the ISO."

Several viable financing options for growing ISOs exist. The more informed the ISO, the greater the odds it will secure the right loan to help it carve out a lucrative niche in today's competitive payments environment.