Increasingly, agents are being paid more and more for the merchants that they place with larger ISOs and credit card processors. How can these purchasers continue to increase the price they pay for merchants and how do they justify these purchase prices? Below I will provide answers to these questions and also some thoughts about the future of this practice.
How Much to Pay For a Merchant?
The amount of revenue a sales agent can expect to receive for placing a merchant with an ISO has increased greatly over the years. The first company I worked for in the industry was paid $5.00 per merchant per month in residuals for the merchant’s credit card processing, regardless of how much the merchant processed. Later, ISOs would typically pay a sales agent 50% of the profits derived from the merchant after deducting an inflated set of costs of processing, interchange and dues and assessments. That percentage paid to sales agents increased to a maximum of approximately 70% before ISOs became more creative and started paying up-front bonuses to sales agents to get the sales agents to submit merchants to them.
Now, companies are advertising that they will pay bounties of $1,000.00 to sales agents for merchants. How do these ISOs justify these large up-front bonuses and why does it make sense for them to pay these bonuses?
The answer to those questions lies in the value of a merchant to an ISO. In a previous article, based on then current information, the public market valued merchants at anywhere from $2,300.00 per merchant to $6,350.00 per merchant for the selected companies. See “Portfolio Valuation Techniques,” Transaction World Magazine, March, 2005. (www.transactionworld.net) Based on that information, if an ISO pays $1,000.00 for a merchant, the value of the merchant to the ISO is much greater than the price paid. For example, if a company over time invests $10 million to purchase merchants from various agents at $1,000.00 per merchant, the ISO is hoping to sell those merchants for a higher price. Even at the low end of the expected value range, if the ISO can sell the merchants for only $3,000.00 per merchant, those same merchants it bought for $10 million it can sell for $30 million, or a $20 million profit.
This example is simple in that it does not take into account the price the ISO has to pay for the cash it uses to buy the merchants and the value of the merchant’s ongoing residual stream to the ISO, among other things. However, this example does illustrate the huge
profits that can be made even when paying $1,000.00 for a merchant.
For most ISOs, they will realize the value per merchant in the $2,300.00 to $6,350.00 range upon the sale of their company or if they go public. So, they can build up the value of their company through this process of purchasing merchants and make a tidy profit when they sell or go public.
Why Not Pay the Merchant?
I believe that ISOs are paying about as much as they can for the merchants they purchase from ISOs. Given the cost of money to fund these purchases and other risk factors, it does not make sense to pay much over the $1,000.00 mark to sales agents for a merchant. But that does not mean that the ISOs cannot find new and innovative ways to buy merchants. To me, the next logical step is to pay the merchants and not the sales agents to purchase the merchants.
By going direct to the source, ISOs can pay a lower price, at least initially, to the merchants to change their processing over to an ISO. This process may start out where an ISO is only paying a few hundred dollars to a merchant to switch its processing over. Given the competitive forces in the industry, it is likely that the price paid directly to merchants will eventually go up to the price the ISOs are now paying sales agents. However, for the short term at least, buying merchants by paying the merchants directly, offers a new way for some innovative ISOs to gain a competitive advantage and buy merchants more cheaply.
Termination Fees:
One of the biggest threats looming on the horizon to the practice of paying for merchants is the laws limiting termination fees. In order to preserve the value of their investment, many ISOs charge hefty termination fees to merchants that want to terminate their merchant agreements and move their processing to a competitor. Most ISOs charge a termination fee of about $300.00 to a merchant that wants to move its processing to a competitor.
However, many other ISOs charge “lost profit” type of termination fees where the ISO takes the lost profits the ISO is missing out on because of the merchant terminating the merchant agreement before the initial term of the agreement is over as a termination fee. These lost profit type of termination fees can mean that a simple restaurant is charged as much as $10,000.00 or more to terminate its merchant account. Many ISOs don’t collect the termination fee but instead use it as a way to force the merchant to keeps its credit card processing with the ISO. Although it is a questionable business practice, these types of lost profit termination fees have been used effectively to keep merchants from switching their processing.
However, new laws limiting termination fees may make it much harder to keep merchants from moving their processing to a competitor. In the first law of its type, Arkansas just implemented a law limiting termination fees to $50.00. Also, upon termination there is a limitation that the merchant cannot continue to be charged any monthly minimum fee for more than 1 month after the agreement is terminated. These limitations should effectively make it impossible to charge more than a $50.00 termination fee. Arkansas’ law is far from an anomaly, as many other states are contemplating and are sure to be implementing such laws.
If these laws become standard throughout the country, it could make the practice of paying for merchants economically unsound. If merchants can leave pretty much whenever they want and move their processing at will, it will be much harder to justify paying an agent or the merchant $1,000.00 in order to move their processing to a particular company, if the company has no way of ensuring it gets a return on its investment. It may not be an intended consequence of these termination fee laws, but they could mean the end of paying for merchants.
The information contained herein is for informational purposes only and should not be relied upon in reaching a conclusion in a particular area. The legal principles discussed herein were accurate at the time this article was authored but are subject to change.
Please consult an attorney before making a decision using only the information provided in this article.
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