Why Sell
Companies consider a sale of assets or equity at various times in their lifecycle. When selling a portfolio, they are often raising capital for another purpose, reinvestment in the business, personal use of cash, paying off debt etc, without selling the company. This strategy allows them to continue in the business, subject to constraints in the sale.
Equity sales, which are more complex, generally come when someone has decided to retire or has reached some other milestone in life. There are other considerations when selling the entire business, i.e. retirement and tax planning, will the price yield enough to walk away completely, particularly when paying off other equity holders, agents etc. A seller may also decide just to take some cash out of the business through a sale to a new investor, whether majority or minority.
Valuation
There are multiple methods for developing a valuation, for a portfolio or company equity sale. Some of the most common are:
Multiple of last 12 months EBITDA or current average monthly residuals. This method is widely used in Payments and tends to be the starting point for most deals. Other factors will be discussed in this paper that can impact these valuations.
Another method used is a discounted cash flow model based on prior 3 years of PL and a forecast of 3-5 years. This is used primarily in a company sale and gives consideration for new business growth and capital investment requirements. This is the technical view of value for any entity which demonstrates the value of strong new sales growth and/or a productive downline agent base. There is inherent value in those downline agent relationships for any seller. A proposed list of synergies will also be prepared by the buyer as part of the forecasted PL. The buyer will review this list and negotiate with the seller as part of their diligence on the deal. These synergies are important, for revenue and expense, as they enhance the value of the company.
When thinking about a portfolio deal there are also different options. The most common is a multiple of monthly residuals, including gross residuals where the seller buys out its downlines, or a sale of net residuals, i.e. house accounts, and the seller’s share of existing merchants. There is often an arbitrage to be earned by selling gross and buying out downlines, but it requires funding and negotiation with downlines to agree to sell their share.
Multiples can range from 6x for smaller, retail ISOs with modest growth, to 8x+ for larger wholesale ISOs/FSPs and Payfacs. Owning risk and, especially merchant contracts, increases the multiple for an ISO. Owning a BIN and doing their own underwriting to board deals can increase value, as can having portability rights in their processor agreement. For an FSP which owns its own BIN and holds the merchant contract their value is maximized because they can more easily port MIDs to a potential buyer, without the need to map pricing on the merchant application from one processor to another.
Preparing for Sale
When preparing for sale there are some fundamentals that need to be prepared. The first step is the last 24-36 months of residuals, for all processors. This is typically available immediately and is a good starting point. The next piece may or may not be readily available, depending on the ISO. Last 2-3 yrs of financials statements are required, including PL, Balance Sheet and Statement of Cash Flows. The last 12 months, at a minimum, should include monthly PL at least. It would be great if the financials are in GAAP and audited but most ISOs don’t do audits unless they are have debt and or have been through the process previously. Cash based financials are acceptable as a starting point, if that’s what the ISO has. Smaller ISOs may only have tax returns prepared annually so some work will be required in that case. A Quality of Earnings review will typically be required by the buyer, sometimes even if there are audited financials.
Portfolio Review
A portfolio review is a good step to preparing for a sale. It helps to know upfront basics about the book ie Industry focus, Concentration of merchants, High Risk etc to identify issues a buyer will want to understand. High Risk merchants can be dealt with, especially if your advisor gets in front of it with the seller at the beginning. High Risk doesn’t necessarily kill the deal but, if material, the buyer will want to understand what the high risk is and what impact it has on their purchase. Many buyers will want to exclude certain merchants from the deal, including high risk, new merchants etc. Your M&A advisor should be able to help facilitate this review, it happens on all deals, regardless of whether the business is selling portfolio of residuals or the entity. It is also advisable to do a review to make sure residuals are being paid properly; both from the processor and to downline agents.
Contractual Relationships
The seller will need to organize their contractual relationships, which are very important for the buyer. These relationships include seller’s processor/ISO contract, downline agent agreements, merchant applications, debt agreements and any other contracts which have been entered into that could have a continuing impact on the book for the buyer. Some issues we see on many deals are Right of First Refusal for the seller, minimums required by the processor or ISO, exclusivity, non-compete, non-solicit language and portability. Any product reseller agreements, gateway agreements etc should also be part of this review.
Letter of Intent
This agreement is prepared by the buyer, whether the deal is a portfolio or entity sale. The basic terms of the agreement are documented in this agreement and cover items like what is being sold ie assets vs equity, economic terms of the deal, proof of funds, diligence required and timeframe to complete, exclusivity term of the LOI, date by which buyer must respond to the offer, NDA language etc. The LOI is typically non-binding on both parties, either side can walk away from the deal, except for NDA and non-compete/non-solicit language.
Asset Purchase Agreement (APA)
The APA is based on terms agreed in the LOI. Once the LOI is signed the buyer will begin diligence. The buyer will give the seller a list diligence items required and the seller’s advisor will facilitate completion of the diligence items and building of the data room for buyer review. During diligence the buyer will identify questions it has about the book or the business and includes anything from merchant concentration to seller’s sales model, products used, attrition issues, risk questions, PL issues, chargebacks etc. Anything that has an impact on current and prior years PL, as well as anything that could impact future new business will need to be discussed and addressed. All of these will be documented in the APA and the Seller will be required to disclose all pertinent information about the business and sign off on Reps and Warranties in the agreement. Non solicit and non-compete language are also critical pieces of the APA and are often very detailed and specific.
Buyers
Buyers can be anyone in the Payments space ie other ISOs, Processors, ISVs, PE firms or another company who would like to get into the vertical. Industry buyers typically are very well versed in Payments and know what they’re looking for and why. They’re often interested in something that can help them grow the size and value of their existing business. This could be new products, verticals or geographic locations to expand their market. It could also be a purchase to help them expand their current portfolio in a way that cleans up an issue they have ie balance the risk profile of their existing book. They want to increase revenue and profits certainly, but they’re also thinking about a potential sale of their business in the future and the benefit of this purchase on that. They are hoping to get an arbitrage benefit ie buy something for a multiple which will yield a higher multiple by virtue of increasing their EBITDA or giving them products to sell. PE firms follow this model as well. They buy a “platform” business, then look for complimentary pieces to enhance the value of what they have. They invest in additional sales channels or products to grow and leverage the management team they got in the initial deal. They think of a 3-5 yr timeframe to do this and a seller can often take some equity in the newco and earn a multiple on their sales price.
