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Education

Pricing during earn-out drama

Portfolio sales include an earn-out. The earn-out is a
portion of the purchase price that is paid to the seller as
a function of the performance of the portfolio following
Legal ease: closing. Earn outs can vary greatly from as little as 20
percent of the purchase price to as much as 60 percent of
the purchase price.

In any case, during the earn-out period, which begins on
closing and ends some years thereafter, the buyer usually
Buyout gotchas: and rightfully believes that they own the merchant
relationships and have considerable rights with respect to
merchant terms and pricing. Buyers, however, may have
watch out portfolio their own reasons for increasing or decreasing pricing,
which could have the effect of increasing attrition or
sellers decreasing revenue on the portfolio.

Either of these adjustments could make or break the
By Adam Atlas seller's ability to gain the anticipated earn-out purchase
price amount. Some buyers will purposefully increase
Attonery at Law pricing to generate higher revenue off of the purchase
portfolio. However, the increase could have an unforeseen
SOs work their tails off to build up a portfolio of and devastating effect on attrition that would deprive the
merchants. The hope is that the ISO will be able to seller of a substantial amount of the purchase price.
monetize that hard work by selling to a buyer who
I sees value in the merchant relationships and rev- The parties must therefore carefully consider their
enue stream. respective rights in respect to the pricing of merchants
during the earn-out period.
Unfortunately, in the contemporary "MBA-ized America,"
to quote Elon Musk, there is a lazer-like focus on the Attrition calculation shockers
bottom line that sometimes finds its way into ISO buyout
agreements. The purpose of this article is to arm sellers What is attrition anyway? There is no textbook definition
with tips on the kinds of fast ones that buyers sometimes of attrition in payments. The most common, levelheaded
try when structuring buyout deals. definition is the percentage decline in net revenue on a
static pool of merchants over the period of a year. For
Your last residual? Oh, that's mine example, if the buyer purchases 1,000 merchants, then
attrition might be calculated as a function of the change
Suppose you are negotiating the sale of an ISO portfolio in revenue in respect to those merchants from the time of
during the month of January, with a view to closing on closing until a year thereafter.
February 1. Most common-sense sellers would expect
that January residuals, payable in February, belong to the There are, of course, many other ways to calculate
seller—notably because the seller has continued to work attrition. No perfectly correct method exists. What is
for them throughout January by providing customer important is that the seller fully understands the formula
service and carrying a degree of risk, and so on. for calculating attrition and be able to see the earn-out as
being within reach in light of the formula.
These are reasonable assumptions, but sellers should
read their buyout agreements carefully because they are Buyer fraudulently moving accounts
often drafted such that the February residuals, although
earned and accrued in January, are actually payable to the Sometimes, temptation for some buyers is simply too great.
buyer and not to the seller. This can be a rude surprise Imagine the difference between having to pay $1 million
that knocks one month's multiple off of the purchase of earn-out because a purchased portfolio is performing
price. If the parties agreed on a 40-times multiple, when well versus allowing a "friend" to solicit accounts in the
seller stops owning the residual one month earlier than portfolio, thereby causing it to attrit and depriving the
expected, the seller is effectively being paid only 39 times. seller of their $1 million earn-out. This level of dishonesty
is not common, but sellers should still be aware that buyers
The solution here, of course, is to be certain of precisely have the ability to deprive them of an earn-out by moving
when the cutoff will occur. This issue should be part of accounts out of the purchased portfolio.
the first discussion buyers and sellers have. It should not
be discussed the day of closing. Buyers are sometimes surprised when asked to be bound
by a nonsolicitation provision governing a merchant
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