Residual-Based Lending Emerges As Funding Alternative for ISOs

A recent string of deals with processors to offer funding to their independent sales organizations has expanded Arlington, Va.-based startup Super G Funding LLC’s reach as a lender. Super G, which was founded in 2009 and has made loans totaling $10 million to about 80 ISOs, is one of only a handful of lenders specializing in this area of finance.

Last month, Super G struck deals with Calverton, N.Y.-based processor Electronic Payments and Long Island City, N.Y.-based CynergyData LLC, to offer loans to their respective ISOs and agents. In June, Super G struck a similar deal with Allentown, Pa.-based processor HarborTouch.

Super G makes loans up to five times the value of an ISO’s revenue stream, with a maximum value of $2 million. Revenues streams include core processing revenues and recurring fee revenues from terminal leasing, prepaid cards, and gateway and check-guarantee services. ISOs can take loans for 12, 24, or 36 months on which they are typically charged an interest rate between 17% and 19%.

Under the terms of the loan, the ISO agrees to have its processor sign an approval to temporarily assign distribution of its residuals to Super G. Upon receiving the residuals, Super G takes its monthly payment, then forwards the remaining balance to the ISO the next business day.

“Because we base our lending criteria on an ISO’s residuals, their credit history is not a factor,” Super G Funding chief executive Darrin Ginsberg tells Digital Transactions News. “Unlike a bank, we look at the past 12 months of residuals, what makes up the residual stream, how those residuals are performing, and then base the risk factor on those criteria.”

Super G’s lending model provides ISOs with an alternative to applying for a bank loan or selling a portion of their portfolio to obtain cash to grow their business. ISOs typically need cash to add more sales agents, purchase POS terminals in bulk, buy out a partner, open a new sales office or call center, or invest in their IT infrastructure.

Although applying for a loan through a financial institution is a traditional route for small businesses to secure additional funding, the potential downside for ISOs is that a financial institution will not have a deep understanding of their business and how to underwrite the risk. That leads to rejected loan applications, observers say.

“Residual streams are not a hard asset that can be collateralized, so that makes it difficult for traditional lenders and their investors to underwrite the risk of a loan to an ISO,” says Harold Montgomery, chief executive of Dallas-based Calpian Inc. “The financial tide for ISOs as borrowers is going further out and the alternative is to find non-traditional lenders.”

Calpian stopped making loans to ISOs when it become a publicly traded company in 2010 and now focuses on acquiring merchant portfolios.

Selling off a portion of a portfolio to raise cash for expansion comes with its own set of problems for ISOs, which must contend with a reduced monthly residual stream and a tax hit on the sale.

“The portion of the portfolio that gets sold has to be replaced as part of the growth strategy,” says Ginsberg. “Taking a loan against residuals allows ISOs to retain full ownership of their portfolio while getting the cash they need to expand.”

Ginsberg got his start as an ISO 23 years ago when he launched a one man shop. He eventually sold his portfolio, later rebooted his ISO business, then repeated the process years later. A non-compete clause after the sale of his last ISO led him into ISO lending and eventually portfolio acquisitions. Ginsberg funded Super G with the proceeds from sales of his previous businesses.

Although Super G receives an ISO’s monthly residuals as part of the loan agreement, there is still substantial risk involved as the ISO’s income stream can decline to the point their processor ends the relationship.

“Lending against residuals is by no means a low-risk proposition,” says Jay Rice, a vice president for Louisville, K.Y.-based Stream Cash LLC, which has made loans to about 10 ISOs and charges interest rates between 14% and 19%, in addition to purchasing merchant portfolios. “You have to know the players involved and who and who not to do business with.”

Lenders also need to be cognizant of how ISO residual streams are evolving to properly manage risk. For example, with margins on core processing services shrinking, more ISOs are growing their recurring-fee revenues. To better manage their risk, lenders need to take that into consideration and make certain ISOs are investing to grow alternative residual streams.

“Any money borrowed needs to be invested to earn a higher rate of return than the interest rate charged over the life of the loan,” says Montgomery. “Lenders, and ISOs, need to be thinking about the importance of that over the entire life of the loan.”