We all are interested in the value of our company or perhaps just part of it – a single portfolio for example. But what’s it worth? You can get as many answers to that question as people you ask. But there is only one answer that matters – the right one from a qualified buyer. There are certain unchanging laws of financial gravity at work in the world which dictate what things are worth.
    Let’s start here with this bedrock principle: A business asset is worth the value of its cash, future cash flows, discounted for cost of capital (usually interest rates), risk and a return to the buyer. That means that if you take the expected free cash flow of your business for a reasonable period, discount it back by the cost of capital, discount it further for risk and a reward to the buyer, you get the current cash value of the business.
    A static portfolio of merchants can be valued this way. But first you have to know the expected cash flows – and that means knowing the real attrition rate of those cash flows. Attrition can be measured three ways: The number of merchants falling off each month, the card charge volume falling off each month or the residual dollar volume falling off each month. Clearly, the last one is the one that counts when it comes to portfolio valuation. There is no replacement for the dollars coming in, they are the foundation of your value.
    Your business is probably composed of at least two parts–one or more static portfolios of merchant residuals. In addition, there is the ability to produce additional cash flows in the future to consider. This capacity is normally called “sales,” but I want you to think of it as the ability to produce new cash flows. Asking how much cash flow and when is the start of the valuation process. Normally, sales capacity does not have the same valuation as a proven cash flow stream because there are risks attached to it – like market conditions changing or people leaving the business. However, the future cash flows of this part of your business can be estimated and valued as well. Usually, this kind of analysis results in an “earn-out” structure where the seller has to earn his way to the desired price over a period of time through producing a certain cash flow stream acceptable to the buyer. This is a way for buyers to shift execution risk onto sellers – the equivalent of calling your bluff.
    There may be a third component to value which is your administrative capacity. This only has value if it allows for or enhances the creation of cash flows in some measurable way. Perhaps your back office is so good that it lowers the cost of each merchant sale and therefore drops more to the cash flow. That’s great, and presumably would be rewarded through the earn out structure – if your cash flow is bigger, your earn out payoff will be bigger as a result. But, don’t expect that your administration will command huge value. More often than not, acquisitions are made because the buyer intends to dismantle all the overhead the seller created in order to maximize cash flow from the purchase.
    You might have other valuable parts of the business such as brand names, or software which can add value to the sale of an entire business. But in all cases, these valuations should have some basis in cash flow creation, even indirectly.