So You Want to Tag Along?
You are a small sales agent trying to make ends meet when a larger ISO calls on you with an interesting proposition. The ISO says it will give you “tag along” rights in the event that the ISO sells its portfolio of merchants. The ISO goes on to say with the “tag along” rights the sales agent will be able to sell its portfolio for double or more the price the sales agent could get on its own. Sounds like a great deal for the sales agent right? But what are tag along rights and do they work?
Tag Along Rights:
Tag along rights generally refer to the right to sell your portfolio of merchants together with other merchants in order to increase the purchase price you are paid. A sales agent of a particular size can expect to get paid a certain amount if it sells its portfolio. For the most part sales multiples have stayed in a fairly narrow range over the years. But that adage “bigger is better” is true when selling portfolios. So for the most part when a portfolio is sold, the larger portfolios get paid a higher multiple of the monthly revenues than smaller portfolios. All things being equal, you can get a lot better price by way of a higher multiple if you are selling $100,000 in residuals than if you are selling $5,000.
So to entice a sales agent to enter into such a proposition, a larger ISO will promise that (i) the ISO has every intention of selling its portfolios when the time is right (sooner being better) and (ii) that when the ISO does sell out, it will get the buyer to pay the sales agent the same multiple and price that the ISO is being offered. The theory goes that if the ISO is able to sell its portfolio along with the sales agents right to residuals the overall portfolio size will be bigger, the multiple will be better and the sales agent will be able to get this much better price than it could if the sales agent sold its portfolio on its own.
Benefits to the Tag Along:
Both the sales agent and the ISO can benefit if the tag along right works as advertised. The clear benefit to the sales agent is that in many cases it could get double or more than it could if it sold its portfolio of merchants separately. Multiples for smaller portfolios have consistently been as little as half that a larger portfolio could command. On the surface then, for the sales agent the benefits are tremendous.
For the ISO, the benefits can also be considerable. One perk that most ISOs require if they provide a tag along right is for the sales agent to exclusively send all business it originates to the ISO. Although common 10 years or so ago, today I rarely see any exclusive arrangements. Almost no sales agents will agree to an exclusive relationship unless they are given something of significant value, which arguably could be a tag along right. So for the ISO that can lock up a sales agent’s production for many years and thereby implicitly increasing its value, granting tag along rights is a sure bet.
The value of the ISO also can increase because it is able to sell a larger portfolio. Most sales agents get 50% of more of the profits derived from the merchants. So by selling the merchants piece of the pie also, the ISO can double the amount of monthly residuals it has up for sale. Assuming the “bigger is better” theory is true, the ISO will be able to increase the multiple it receives for the portfolio it is selling. All this sounds great in theory for both parties but will it work out in practice?
Will It Work?
For the sales agent, a lot of things have to go right for this to all work out. First of all, there has to be a buyer out there willing to purchase the sales agents residuals along with the ISOs portfolio which is not a sure thing. Buyers of large ISOs are mainly looking to buy the ISOs portion of the income made from the merchants and the merchant relationship which is controlled by the ISO. The ISO has infrastructure, employees and other assets that are the real value to most buyers. The sales agent only has the right to get paid certain residuals, so why would the buyer want to pay the sales agents all this additional money at an inflated sale price when it can buy a different ISO that has not granted tag along rights to its sales agents?
Another thing the buyer may not like is that by paying the sales agents all this money, it dis-incentivizes them to send more new business to the ISO in the future. A sales agent that is not bought out when the ISO sells still has a residual payment coming to the sales agent every month. In order to protect those residuals, it is natural that the sales agent will continue to send more merchants to the ISO. So the buyer is being asked to pay a large amount of cash to the sales agents with the prospect that the sales agents will send the ISO less business in the future.
From the sales agents perspective all this is a big risk. The ISO may say that it has plans to sell but many factors can influence that decision. The markets are volatile and as we saw in the recent financial crisis, the market for portfolio sales can come to a standstill for a while. Some ISOs have unrealistic expectations of what they should get paid that could lead them to not sell their portfolios. Also, the sales agent is betting on the financial viability of the ISO and although infrequent, there have been ISOs that have gone bankrupt or been put in financial distress for violations of various laws.
The sales agent is also taking the risk that the ISO can find a buyer willing to pay the sales agent the tag along price. By trying to sell with tag along rights an ISO is logically making the pool of potential buyers much smaller which will make a sale all that more difficult. And the sales agent generally has to continue to exclusively send all its business to the ISO after the sale. In the end, the sales agent may be left with a portfolio that given the circumstances, is worth far less than it would be had the sales agent not decided to take the tag along rights.
Tag along rights have been touted as a way for sales agents to get more value for their portfolios. However, there are not many examples I know of where the theory has turned out to result in a successful sale. The concept has many good attributes and seems like it could work, but for me more transactions need to be closed before the concept becomes a proven commodity.
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.
