Reprinted with author's permission. First published in Transaction World
Show Me The Money- A Conversation with Financier Jim Oberman
WITH THE RIGHT MANAGEMENT TEAM AND RIGHT BUSINESS PLAN, the young Independent Sales Organization (ISO) can find financing, according to industry veteran Jim Oberman, a consultant and director with Retriever Payment Systems, Houston, TX.
Oberman, a 13-year industry veteran, recently discussed ISO financing with Transaction World Magazine. The owners of most ISOs have to provide the initial seed capital themselves because third-party funding sources want to make sure they receive a good return on their investment. So they'll want to start seeing financial reports, as well as projections, before they will commit funds.
However, some private equity sources that specialize in the ISO business may agree to provide financing - in return for a significant stake in the company, which can run anywhere from 20 to 80 percent, Oberman said. Debt financing - where the borrower pays interest on the loan and repays the principle over time - is much less expensive.
Both debt and equity lenders will want to see a very experienced management team before they will commit any resources. So the start-up ISO is usually left with little more than the owner(s) own financial resources.
The good news is that an ISO can start with as little as $20,000 and, by following some good business rules, build to a significant business in a relatively short amount of time. Start-up expenses include office equipment like a computer, fax machine, telephone system, file cabinets and office space. Salespeople can be paid strictly on commission, meaning they earn more as the company earns more.
When they don't have enough capital to open the doors themselves, some seek out family and friends for the initial seed funds, but that's an option that Oberman cautions ISOs to shy away from.
"With family and friends, you don't have the same accountability that you have when you borrow from a third party."
Banks are unfamiliar with the ISO business, and therefore, don't represent a good third-party financing source.
"It's not like financing a building, it's not like financing equipment receivables," Oberman said. "It's not a traditional loan to make."
Instead, ISOs should look to funding sources that are familiar with the industry, such as Chicago-based GTCR, San Francisco-based Gryphon Investors and New York-based Windward Capital.
Before most funding sources will look at an ISO, the company must have 2,000 to 3,000 merchants, but there are a growing number of funding sources that are starting to provide financing for ISOs with as few as 200 to 300 merchants.
When borrowing from third parties such as the above, an ISO must produce regular financial reports and will be held responsible for results. But family and friends don't tend to hold the borrower so accountable.
Without the accountability, the ISO doesn't have the same pressure to perform, and, therefore, doesn't tend to perform as well.
"Financial reporting is an area where many ISOs, as well as other businesses, fall short," Oberman added. Some don't produce the reports on a regular basis. Others produce results that are suspect at best. Financial reports need to be independently audited.
"My experience is that ISOs are run by great entrepreneurs, but they sometimes neglect the basic business discipline of producing monthly financial statements, filing timely tax returns and using outside independent auditors to review their financial statements," Oberman said.
Financial reporting is just one good business practice funding sources expect before lending money, Oberman cautioned. The ISO also needs to have a solid business plan outlining plans for growth and loan repayment.
"The lending business is all about how likely it is you will get paid back," Oberman said.
Funding sources will take a very close look at the ISO's book of business. Among the critical components are longevity of merchants, turnover rate and merchant volume. All figure into the ISO's recurring monthly income stream, which is critical to the ISO's success.
Some ISOs seek cash by selling off portions of their merchant base. While this might provide an influx of cash initially, it isn't a good strategy for the long-term growth and health of the business. By building a good, recurring revenue stream, an ISO can survive a bad month. "The ISO that goes for the fast cash, on the other hand, isn't as attractive because it doesn't have the long-term recurring income stream that is critical to the business," said Oberman.
Slow, steady growth is the best course. "If you stay the course, the business will be there. You don't want to be penny wise and pound foolish."
Funding sources look closely at the cash flow, which is largely dependent on the quality of the merchant accounts. Long-term, active merchants are much less likely to stop transacting. New merchants may be here today and gone tomorrow.
If a portfolio has $100,000 in annual revenue and a 30 percent annual turnover rate, that means the revenue the next year projects to $70,000. When looking at revenues for lending purposes, funding sources don't factor in any future new accounts, Oberman said.
Funding sources shy away from portfolios with a high percentage of low-volume processing merchants. The lower the volume, the more likely the merchant is to stop processing altogether.
Other questions the funding sources will ask include: What is the breadth and depth of the portfolio? How many accounts were added in the last month? A portfolio with 10,000 accounts that have been active for 10 years is more attractive to funding sources than the same size portfolio of new accounts.
What has the historical attrition rate been? What is the reliability of the information supporting that attrition rate - which goes back to the idea of having an independent audit of financial information.
The funding sources will look at the backgrounds of the management team, including who the key individuals are, the companies they've represented and their past success.
"The ISO business needs to have good quality control," Oberman added. "Managers need to question salespeople about the accounts. Did the salesperson make unfounded promises to seal the contract? If so, the account probably won't be active for long."
Establishing and maintaining a good relationship with the lender is also important. Be upfront with funding sources about good and bad news, Oberman advised. "Funding sources don't mind problems, but they can't stand surprises. Don't surprise your funding source. Problems can be worked out, but surprises destroy relationships."
About Jim Oberman
Jim Oberman is a consultant and director with Retriever Payment Systems, Houston, TX, and has more than 13 years of experience in the credit card acquiring and ISO industry.
Oberman graduated from the University of Arizona in 1981 with a business/accounting degree. He worked as a CPA specializing in taxation from 1981 until 1985, when he founded Illinois Capital Group, Chicago, an equipment leasing firm. In 1988 Illinois Capital Group began to focus on the financing of credit terminal equipment leases and in 1990, Illinois Capital became the first company to securitize leases of credit card terminals. This provided significant access to capital because small lease portfolios could be packaged together (securitized) and sold, increasing an ISO's liquidity.
In 1993, Oberman founded Lease Finance Group, Chicago, to become a direct lessor of credit card terminal equipment to fund ISOs. Lease Finance Group is now the microticket lease division of CIT Group, New York. Since its founding, Lease Finance Group has grown to over 200,000 active leases and has become the nation's leader in leasing of credit card terminal equipment for ISOs.
The basis of Lease Finance's growth started with the initial planning.
"We made sure before we added volume that we had strong systems and technology," Oberman said. "We built our systems, then added the volume later. Others try to acquire volume first, then try to catch up with the systems and technology."
The company also started with a solid capital base, provided by Oberman and partner William Brandt. Oberman also recognized that they would need to be able to tap into other sources of financing, so the company securitized its leases, giving it the capital to grow to more than 30,000 merchant accounts.
"It's a very capital intensive business," Oberman said. So the next step was to find a financial partner, which Oberman did in Newcourt Financial.
With the additional funds, the company focused on helping ISOs develop their sales forces. Other companies focus too much on the merchant end and not enough on the ISO end," Oberman said.
By following the above strategies, Lease Finance grew to more than 200,000 accounts.
Oberman on the Future of ISO Financing: Funding sources lost large sums of money when the go-go dotcom companies failed to produce revenues in 2000. But that could be good for the ISO sector, according to industry expert Jim Oberman.
Now funding sources are starting to look at investing in more traditional businesses, such as ISOs, which have a proven industry track record, rather than in the unfulfilled promises of high tech firms.
"They're seeing the credit card acquisition business as more stable, so they'll be looking at ISOs more closely," Oberman said. "There will be more equity capital available."
Though banks for the most part have shied away from the ISO business, Oberman expects to see them become part of the financing options in the next few years.
ISOs also can expect to see the industry consolidation to start slowing down, with more small companies in the picture.
"It's a business of cycles," Oberman said. "We're starting to come out of the consolidation phase. After a period of new companies springing up, there will be consolidation again."
Another factor affecting the ISO business in the future will be the Internet, Oberman said. It will have an impact, though it's difficult to say now what that impact will be.
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