There are a number of programs out there today which allow ISOs and sales people to sell their residuals right away after closing a sale with a merchant. These programs can be useful for those who need cash. They are a viable way to run a sales office and make good money. In an era when POS terminal profits no longer pay sales salaries, up-front residual sales can make a lot of sense. Here are some pointers to look for if you’re considering such an option for yourself.
What is included in the residuals you're selling? Credit card residuals are the standard by which all other service revenues are measured - check guarantee, gift card, etc. These ancillary products generally have lower monthly billing than credit card and higher attrition rates. For those reasons, and the perception that non- credit card services are not essential to the merchant, buyers tend to discount these revenue types if they include them at all in your buyout offer.
What about zero credit card volume merchants? Merchants of this type still generate revenue through statement fees and monthly minimums. You can find this kind of revenue in every portfolio. There are merchants out there who will pay for services they no longer use, or use sporadically. While lucrative, this kind of revenue also receives a steep valuation discount.
One of the main criteria for valuing credit card residuals is getting a clear sense of the attrition in the portfolio. Making a realistic projection of how fast the revenues will drop over time due to attrition is key. In the case of up-front buyouts, attrition data isn’t available, so buyers will take a couple of different approaches.
One method is to project a standard attrition rate onto a merchant or the entire portfolio. If industry standard attrition for the type of merchants you typically sell is high, as it would be for very small mom and pop merchants, then you won’t get the highest multiple for these residual streams. In any case, the buyer will most likely mark up the attrition a few basis points to build his return estimate and guard against being wrong on the downside. Being too optimistic about attrition is more dangerous for the buyer than being too pessimistic. Being pessimistic will kill a given deal by resulting in a low price quote. That results in a lost deal. But being too optimistic will kill an entire residual acquisition program through underperforming acquisitions. And that will cost the buyer everything. So expect conservatism on attrition estimates.
Another way to deal with the lack of data on up front merchants is to structure the sale as a two or even three part payout. Usually there is a sizable cash component to the sale at closing, and then later payments at the three, six or 12 month anniversaries depending on the structure. You can expect that each anniversary after closing will have a formula that will calculate the amount of the payout and, again, attrition in the portfolio since the original closing date will be an important part of that formula.
The advantage of a multi-stage payout formula is that you are likely to get a higher price for the portfolio overall because the passing of time will bear out the performance of the portfolio. That reduces the uncertainty of the payout for the buyer, and therefore increases the value.
A typical three part payout formula would probably pay one third to half the total price up front. Then, at six months, it would call for another payment based on the performance of the portfolio up to that date. This payment would be for about another 25% of the total price. Then at 12 months, there would be a final payment. This last payment will take into account the original total amount agreed upon for the portfolio, minus amounts paid so far less the discount for actual attrition which has occurred since the original closing date. The final payment may well be zero if the portfolio doesn’t perform. In fact, the final payment can be negative to the seller —that is, the seller may have to pay some money back to the buyer if the portfolio doesn’t perform.
The formula which determines the last payment can result in a negative number if the attrition since closing date is high enough. That kind of result is called a “clawback,” which is pretty much what it says - it’s a way for the buyer to get some money back from the seller if the portfolio doesn’t perform.
Clawback formulas can result in some nasty surprises. Can you imagine selling your portfolio for a nice profit only to find out months later that you have to pay some money back? That would be ugly.
Selling merchant contracts up front can be a great way to generate cash without having to take the time and effort to find an investor for your business. You can avoid selling equity in your business and the delays of dealing with a bank. This method is fast and certain, and can be an effective tool for you.
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