Processor Contract Terms Impacting Value of Merchant Acquiring Portfolios
In the sale of an ISO or acquirer, merchant agreements, which are intangible assets, are a key element of what the buyer is buying. Moreover, asset purchase structures are quite common in this industry, and frankly, most of the strategic buyers (as opposed to financial buyers) are ‘platform players’ in the sense that they will wish to convert the underlying merchants to their own platforms. ISOs and acquirers with agreements with third-party processors should be aware there are certain terms in those agreements that can impact the valuation and/or the sales process of merchant assets. Key terms directly related to ownership of the merchant relationship have the most dramatic impact on valuations. However, there are tangential terms, some of which are more obvious than others, related to ownership that can meaningfully impact asset valuations and potentially hinder a sales process.
More Obvious Terms Impacting Value and Process
1. Specific ownership language. Specifying the ISO/acquirer owns the merchants agreements (either upfront or at end of term) can be a key driver of value. Technically, the requirement that the Sponsor Bank be a party to the merchant agreement creates ambiguity with respect to who has what rights under the merchant agreements. It is the agreement between the ISO and the Sponsor Bank (directly or through the arrangement with a processor) which determines who controls (and effectively ‘owns’) the merchant agreements.
In the event the merchant ownership language is unclear, the value of the asset may be diminished.
2. Specific right to transfer the merchants to another processor. The right to transfer the residuals should be specified at a minimum, but to attain full value, the agreement should provide the ISO or acquirer the right to trigger the assignment of the actual merchant contracts from the current sponsor bank to a new sponsor bank. Further, a portability/transfer/assignment right that is subject to a payment from the ISO or acquirer to the processor is a conditional form of ownership in addition to being a financial issue. Finally, a portability/transfer/assignment right that only becomes active at the end of a processing agreement term poses significant practical problems, and represents a cloud on the title of the assets in time periods other than at the natural expiration of the contract. Note that the terms “portability” and “transfer” do not have objective meaning – the terms mean whatever the contract says they mean. So if the contract does not define these terms, there will be a core ambiguity on who has what rights and, again, effectively a cloud on the title of the assets.
In the event transfer rights are unclear or undefined, this may pose challenges (e.g., contractual dispute, delays in conversion, etc.) with the existing processor when the owner wishes to convert the portfolio to another third-party processor and may be viewed as an impediment to a sale by prospective buyers.
3. Non-solicit and non-compete clauses. The value of the assets can be diminished in a sale if the ISO or acquirer does not have reasonable non-solicit protections in its processor agreement. If the processor can directly solicit the merchants in the sold portfolio after the sale, the buyer runs the risk of having higher than normal merchant attrition. Additionally, if the buyer assumes a processor agreement that has tight non-compete provisions, for example, restrictions on the territory in which the ISO/acquirer can operate, the buyer may find that the restrictions impede its own business.
Non-solicit restrictions on the processor in a contract can enhance the value in a sale while the non-compete obligations of the ISO or acquirer can negatively impact value or impede a sale.
4. Portfolio segregated at processor in unique BIN/ICAs. All merchants added to the ISO or acquirer portfolio on the processor should ideally be placed in a unique BIN/ICA so that a mass conversion is smoother and quicker when necessary.
In the event the merchants are co-mingled with other ISO or acquirer BIN/ICAs, this may delay and increase the expense of the conversion.
5. Transfer rights of unique BIN/ICA to another acquirer. Without the right to transfer the BIN/ICA’s to another acquirer, having unique BIN/ICAs in the first place may be a moot point. Ideally, an ISO or acquirer should have the contractual rights to cause its Sponsor Bank to assign the BIN/ICA to another bank.
In the event there are no transfer rights, at a minimum this may delay any conversion and may even prevent a conversion as the owner of the BIN/ICA may not willingly transfer the rights to another party.
6. Assistance from processor for de-conversion. There should be, as specific as possible and practical, language that commits the processor to assist in any de-conversion. Additionally, specifying contractually the cost of de-conversion the processor will charge will take an unknown variable out of the equation and can help improve the valuation a buyer may put on the table.
In the event there is no contractual commitment for de-conversion assistance, this may delay and possibly increase the expenses associated with a conversion.
Less Obvious Terms Impacting Value and Process
7. Rights of First Refusal. A Right of First Refusal is a term whereby the ISO or acquirer has an obligation to bring any offer to purchase the ISO or acquirer’s portfolio (or residual stream) to the processor and if the processor meets the terms of the purchase offer, the processor has the right to purchase the assets. On the surface, this appears to be a reasonable term – as the ISO or acquirer is typically interested in maximizing value, regardless of the entity purchasing the assets. However, practically speaking, potential bidders may be uncomfortable spending time developing a robust bid simply to see the third-party processor meet the bidder’s offer.
This may result in either (i) lower valued offers from bidders, and/or (ii) may result in a lower number of offers from prospective bidders. The ISO or acquirer may opt to get the third-party processor to waive its rights upfront, though this will let the third-party processor know the ISO or acquirer is looking to divest its portfolio. The ISO or acquirer may not wish the processor to know this for various reasons in the event a sale does not go through. This will certainly create a condition to closing the buyer will require and may delay closing.
A variant of a Right of First Refusal is a Right of First Offer. This should be more palatable to a seller as it provides the processor with the right to make an offer for the assets, but the ISO or acquirer is not contractually obligated to accept the offer.
8. Short time window for conversion. In the event the ISO or acquirer has clear ownership rights and transfer rights, and there is a clear path for conversion, there should be no terms that obligate the ISO/acquirer to convert the portfolio within an unreasonably short time frame. For example, the processor may seek to impose a specified time window on completing the conversion and in the event the conversion is not complete within that time period, certain terms come into effect (e.g., higher pricing on merchants left, conversion assistance is withheld, merchant ownership rights are terminated, etc.). There are a number of factors that come into play in determining if a conversion is going to be successful or not (e.g., number of merchant relationships, if multiple front-end and/or back-ends are used, if there are any differences in services offered to merchants on the go-to-platform such as settlement windows, reporting, pricing structures, etc.) and make the conversion process highly variable and often unpredictable. Conversions are either ties or negative outcomes – they are rarely wins.
Depending upon the terms related to conversion, this can have a detrimental impact to the value of the assets or, at a minimum, cause the bidder to structure the offer in a way that reduces the conversion risk (e.g., earn-outs based upon successful conversion, etc.).
In order to maximize the long-term value and divestiture process of a portfolio of merchant-related assets, ISOs or acquirers should attempt to keep these contractual terms and their impacts in mind when negotiating agreements with processors. Of course, there are the day-to-day aspects of agreements that impact value (e.g., pricing, servicing, etc.), but there are merchant ownership and related terms that can get overlooked by ISOs or acquirers at the outset when negotiating their third-party processing agreements. There are always gives and takes in negotiations, but if an eventual sale is a possibility for the ISO or acquirer, these guidelines will only help achieve optimal value and improve the chances of a smooth divestiture.
For more information, please contact Scott Calliham, Principal, specializing in Merchant Acquiring, firstname.lastname@example.org.
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