Paul A. Rianda is an attorney who has provided legal advice to the bankcard industry for more than 15 years. His e-mail is paul@riandalaw.com.
The type of portfolio you build can have a big impact on the value of that portfolio if you decide to sell it. There are different types of portfolios you can build that become increasingly more valuable as you move up the food chain.Agent Portfolios
The bottom of the food chain is the agent portfolio, which is built by a sales agent that sends merchants to a small or large ISO. The sales agent submits the merchants to the ISO and receives a percentage of the profits derived from those merchants, usually in the range to 50% to 70% of the profits after some basic costs are charged to the agent. In this type of relationship the sales agent often provides little, if any, customer service, has no right to move the merchants and generally has no control over the merchant pricing or anything else for that matter. There also is little risk for the sales agent as the processor is liable for charge-backs, unpaid fees and other losses derived from the merchant.
These types of agent portfolios are least valuable because the sales agent can transfer over little other than the right to be paid the residuals. The sales agent is not allowed to move the merchants. Many times there are restrictions about what other products the sales agent can sell to the merchants since the ISO controls the printing of the merchant statements and often solicits the merchants for other products and services. Anyone buying such a portfolio is just getting the right to get paid the residuals and not much more. These types of buyers typically will pay very low multiples leaving the sales agent with little incentive to sell unless the agent has a compelling reason to do so, which further erodes the sales agent’s ability to drive a hard bargain.
No Risk-ISO
The next step up the food chain is the no-risk ISO. There are really only three processing companies that offer a no-risk ISO program. As in the sales agent program described above, the no-risk ISO is not liable for merchant charge backs, unpaid fees and other losses derived from the merchants that the no-risk ISO submits to the processing companies. Instead, the processing companies take the risk for all those losses even though the processing companies are paying the no-risk ISO 100% of the profits over a fee structure that is very close to the pricing offered to sales agents. In return, the processing companies usually impose minimums on the no-risk ISOs. The processing company is guaranteed a certain amount of income from the no-risk ISO to justify giving it such a good deal.
The no-risk ISO portfolio is more valuable than the agent portfolio because the no-risk ISO has more control over the merchants. A no-risk ISO usually provides most, if not all, of the customer service. This gives the no-risk ISO a more hands-on relationship with merchants that enable it to market other products and services to the merchants. In addition, the no-risk ISO can control merchant attrition by providing superior customer service and controlling termination fees, something a sales agent often is unable to do.
Another value-add for the no-risk ISO is that there are a lot of other organizations just like them that want to grow by acquisition. If a no-risk ISO purchases the portfolio of another no-risk ISO on the same processing platform, the purchaser can easily fold the new portfolio into its existing one. The no-risk ISO cannot move the merchants but this easy integration is the next best thing since the merchants are already on a compatible platform to the buyer.
As a result, a no-risk ISO is usually in a pretty good position if it decides to sell its portfolio. The purchase price for a portfolio is derived from a number called the multiple. The purchase price is determined by multiplying the average monthly residuals by the multiple. The portfolio is more valuable to the buyer than an agent portfolio and the no-risk ISO can often negotiate a multiple that is five to 10 times greater than a sales agent could get for a portfolio. Also the buyer may be willing to increase the multiple given that most no-risk ISOs have some established sales channels and agents that generate a number of merchants per month. This type of sale is probably one of the most commonly occurring today.
Risk ISO
The top of the food chain is the risk ISO. This is an ISO that agrees to be liable for all merchant charge-backs and other losses. Because of this the risk ISO is also in charge of underwriting the merchants in order to try to minimize its risk for merchant losses and to also provide all customer service for the merchants. Typically after the initial term of the agreement with the bank or processing company that it operates under, the risk ISO has a right to move merchants wherever it can.
The risk ISO is much more valuable than the other two types of portfolios described above because it has “enterprise value” in addition to the value of the residuals it is paid every month. To operate, the risk ISO has to build-out an entire infrastructure, including an underwriting department, a risk department to monitor transactions, a customer service unit, technology and support infrastructure and also an enterprise management system to operate the business.
Instead of just getting the right to be paid a residual in the typical sales agent purchase or the limited right to service the merchants in a no-risk ISO sale, the risk ISO transaction involves the sale of an entire enterprise that is ready to do everything needed to accept and service merchants for payment processing.
As a result, a risk ISO can get a much different type of transaction value. If there is a multiple of the monthly residuals used to value the company, that multiple can be a number 10 to 20 times greater than that for a sales agent portfolio. Also, the no-risk ISOs are often valued by a multiple of the EBITDA, an accounting term that means earnings before interest, taxes, depreciation and amortization.
As a result, EBITDA presents a picture of the cash flow profits generated by the risk ISO that enables a buyer to understand what the seller will add to the buyer’s bottom line.
A risk ISO has a much larger and more financially sound group of potential purchasers. Some risk ISOs have sold to businesses outside our industry to companies that saw an opportunity in the payments space. Intuit, the maker of QuickBooks software, for instance, bought a risk ISO to be able to sell payment processing to the users of its accounting software. Some of the larger venture capital companies, large institutional funds and banks also tend to fund deals for the sale of larger risk ISOs. Risk ISOs, with the large group of potential suitors, can command top dollar in a sale.
No matter where you fit in the food chain, building a portfolio can result in a good payday in the end, if that is the strategy you are pursuing. But, the payday can be a lot better if you place yourself in the best tier you can when you start out instead of settling in at a level that does not allow for the maximum level of profits that you can obtain in a sale.
