The Faustian Bargain: If What A Buyer Is Offering You For Your Merchant Portfolio Or Merchant Residual Sounds Too Good To Be True, It Is!
As a mergers and acquisitions specialist in the payments processing and payments technology industries it’s my job to help connect (match) buyers and sellers of payments related properties. No match and no deal works unless it benefits both parties involved, and that includes the seller. I genuinely care and want to help these sellers execute a transaction as the purpose of which is usually to help grow their business or fulfill some form of personal financial need. Because of this, it upsets me when I hear about buyers pitching offers to sellers that are substantially above market valuations. I get upset because a) once you get beyond the money component of the offering and take a closer look at the structure and terms of the deal it’s often times potentially hazardous to the seller, and b) these ‘hot shot’ buyers are artificially manipulating the marketplace which serves as a detriment to all other good faith sellers and buyers. As a payments professional, I feel it’s my duty to alert you, especially you sellers, of the Faustian Bargain (pact with the devil) that has pervaded our industry.
The valuation of every merchant portfolio or merchant residual property being acquired is based on the buyer’s assessment of the risk associated with the acquisition. Risk factors include attrition, merchant count, revenue concentration, age of the accounts, account composition, contractual terms, and sales agent structure. These factors, along with others, get figured into a buyer’s determination of what a given merchant processing opportunity is worth and constitute the inherent valuation, or the part of the valuation often determined by quantitative analysis. Combined with market forces (supply and demand, or the qualitative analysis and component of the valuation), these analyses determine what these properties are worth; better said, what a buyer would be willing to pay a seller. On the surface, nothing unusual as it pertains to the normal course of mergers and acquisitions for these types of payment processing properties.
Now enter the devil…
Because of my business and my company’s positioning in the marketplace, I get a pretty good read on the what the market is paying for which type of opportunity with which types of attributes at any given moment. So when I hear of a buyer coming in and making offers to sellers that are well above market valuations I know one of 2 things is usually going on; either the buyer has no idea what they’re doing (which is entirely possible and I’ve seen this happen before), or the buyer is limiting their risk somewhere else in the deal, most likely with the purchase and sale agreement. Recently I came across a buyer who was offering well above market valuations to sellers by limiting the risk in 2 ways.
First, their purchase price wasn’t all cash. Buyer was protecting their risk exposure by offering 1/3 to 1/2 the consideration paid in the acquisition in stock. I don’t know about you, but unless the buyer is a publicly traded mid-cap listed on a major stock exchange (sorry OTCBB, just doesn’t cut it for me), that’s a sub-par offer. Cash is king and OTCBB or privately issued stock is a big fat ‘might be worth something someday’. The fact is almost all of these types of transactions are cash deals and SELLER is taking on a lot of risk on a big payday if such a substantial portion of the consideration is paid in stock.
Second (and admittedly this one floored me), the buyer was limiting their risk by requiring the seller to collateralize their business and business assets, including other merchant processing portfolios and residuals seller was a party to, against the portfolio being sold in order to guarantee the residual amount. This collateralization of the seller’s business and business assets as security for the residual being sold is simply not done with these types of transactions. Not only do I find this to be overkill and exploitative (buyer is offering you a high multiple because it’s a veritable no-risk transaction for them when collateralized against your entire business), I find it reprehensible. Why? Buyer buried the securitization and collateralization of the residual stream in the purchase agreement. It was never discussed as a material business term when the offer was made.
In addition to the aforementioned items, the inevitable, insidious result of the Faustian Bargain is market manipulation. Both good faith buyers and sellers are negatively affected because these pacts artificially manipulate (raise) merchant portfolio and merchant residual valuations, leaving buyers and sellers at loggerheads when trying to get a real deal done. This is a great disservice to our industry and honest hard working buyers and sellers alike.