If we’ve learned anything from the COVID-19 pandemic, it’s hard to predict the future. For most payment professionals, the pandemic took a major toll on retail merchants and, in turn, your residuals. March sparked new life into your cash flows as businesses opened back up and were bustling with customers. Now, the summer is winding down and there’s a new foe looming over your shoulders, it’s the Delta variant.
We aren’t trying to be glum here but, as we head into the colder months, we all have to be concerned with more government shutdowns. Hell, we certainly are. The reality is most people don’t know what’s going to happen with this pandemic. The government recently printed nearly 4 trillion dollars to combat the virus. Unfortunately, the virus doesn’t seem very fazed by the US governments excessive spending. That begs the question, will the government print more money and bail out our businesses should they decide to shut us down again? Again, nobody knows what’s going to happen.
The best thing you can do for your business is plan for the worst. If you don’t have at least 3 months of runway, you could be closing your doors for good. This presents a specific challenge for most payment companies. If you run a notable payments ISO, you likely have a large monthly nut to cover your expenses before realizing your profits. When your monthly revenue is directly correlated to the revenues of your merchants, the pandemic is far more devastating than even the likes of a financial catastrophe like we had in 2008. At least during a recession consumer spending on credit cards actually increases.
These uncertain times provide ISO owners an opportunity to reevaluate their business models while times are still good. One of the biggest reasons that payment portfolios trade at multiples ranging from an average 2-4.5x annual revenues is due to the unpredictability of these portfolios. Most payment companies largely sell their services on price as opposed to technology. There’s nothing inherently wrong with this, many other industries like insurance and mortgage brokers have been doing this for years.
The challenge is, for an outside investor, purchasing a payments business is far riskier when compared to purchasing a software-as-a-service portfolio (SaaS). When it comes to payment portfolios, there are much more variables added to the equation making it difficult to forecast future revenues and calculate overall risk.
Unlike traditional payment residuals, SaaS metrics offer investors more visibility into the assets they are seeking to acquire. For example, it’s easy to calculate the lifetime value (LTV) of a typical customer using SaaS metrics. This allows an investor to forecast very accurately when they will turn profitable on their investment.
Since all customers in a SaaS portfolio are on the same product, it eliminates much of the variables you would get with a payment’s portfolio. For a payment’s portfolio, many of the customers will be on different products, which leads to different customer experiences, and thus more unpredictability for investors.
If ISO’s and payments brokers were to adopt an opt-out strategy in which they could auto-enroll their merchants into a value-added service, this would eliminate a lot of the uncertainly surrounding their portfolios and provide future investors better insights into the health of their businesses. Not to mention, adding a SaaS component to your payment’s portfolio ensures you have consistent monthly income in the event a global pandemic decides to show its face, again.
Just imagine for a second, if you had a product that benefitted your customers for $25-30 per month bolted onto your payments, how much more income would you have had during April of 2020? Let’s run some numbers and see where we land.
Let’s assume you have a vendor cost of $15 for your SaaS product and you are marking it up to $29 leaving you with $14 per MID in margin. Here’s what this would look like for your retail merchants:
Earlier we referenced that payment residuals trade at an average of 2-4.5x annual revenues. According to SaaS Capital, the median privately owned SaaS company was trading at a 12x multiple as of December 31st, 2020. Aside from the fact that SaaS revenue reduces the overall risk of running a payments business, we need to consider what this does for the valuation of the business.
Let’s consider the average ISO catering to brick and mortar has an average monthly recurring revenue of $1,500 per merchant. Should that same ISO enroll that merchant into a value-added service for $29 per month or $348 per year, their SaaS to payments revenue would be somewhere around 20% software and 80% payments.
For the sake of conversation, let’s pretend we had a retail ISO with 1,000 merchants in their portfolio. Prior to adding integrated technology, they receive a very favorable 3x on their portfolio. Here’s how the math breaks down:
1,000 merchants x $1,500 average ARR = 1.5MM ARR x 3 = 4.5MM
Now, let’s consider that same portfolio enrolled their merchants using an opt-out program. The way this works is simple, you find a value-added service that will deliver at least more value to your merchant than what it costs them on a monthly basis. You send out a mass-email alerting your merchants they will be auto-enrolled. The merchants who don’t want to participate can opt-out. On average, roughly 10% of your merchants will opt-out of billing.
Let’s run some quick math and see how the company can be valued adding our SaaS component to our 900 merchants (1000 x 0.10% opt-outs). Here’s how the math breaks down:
1,000 merchants x $1,500 average ARR = 1.5MM ARR x 3 = 4.5MM
900 SaaS merchants x $348 average ARR = 313,200 x 12 = 3.75MM
Not every SaaS product will trade as high as 12x and it’s important that the product you offer your merchants brings durable ROI, has easy onboarding, and provides value is some sort of automated fashion. If you check all these boxes, your merchants will be happy to participate and any churn you experience will be trivial compared to the financial benefits of adopting an opt-out program for your ISO.