Know Your ISO
One of the questions I am often asked by sales agent is if the ISO paying them residuals has some financial difficulties does this put the sales agent’s residuals at risk. The answer to that question is yes, the financial strength of an ISO is of paramount importance to all the ISO’s sales agents. There are a number of things that can cause an ISO financial harm and there are certain precautions a sales agent can take to protect those residuals.
What is the Risk?
The risk we are talking about is a situation experienced by the ISO that could cause it to be unable to pay residuals to its sales agents. This can take a number of different forms. One of the most common is where a large merchant goes out of business, leading to substantial chargebacks and other merchant losses to the ISO. For instance, a few years ago two airlines serving Hawaii went out of business. Airlines usually take large number of bookings for tickets that may not be used for months. So, when the airline goes out of business all those pre-booked trips on the airline will never happen and as a result the people who paid by credit cards will initiate chargebacks. If the airline has no money to pay those chargebacks the ISO that accepted the merchants, assuming the ISO took that risk, would have to make good on all those chargebacks. Those merchant losses could be big enough that the ISO would be unable to pay them resulting in that ISO’s sales agents’ residuals being put at risk.
Another risk factor that I have seen is the risk of seizure of by various governmental offices, mainly as a result of questionable sales practices. For instance, there have been two companies in our industry seized be the Federal Trade Commission (“FTC”) for such practices which were mainly the result of making misrepresentations to merchants. The federal government came in, seized those companies, put new management in place and eventually sold off the ISOs to the highest bidder. Such a seizure could result in the termination of residuals to some, if not all, the sales agents of the ISO.
Also, simple mismanagement can result in a sales agents residuals being put at risk. I have seen instances where an ISO was used to support a certain lifestyle for its owners. When the ISO experienced some financial hard times, the owner of the ISO instead of ramping down spending will often look to its sales agents to make up the difference. This can take the form of finding ways to reduce the sales agents’ residuals or just plain terminating those residuals in certain circumstances.
Another common threat to residuals is the specter of your ISO declaring bankruptcy. If that happens, the sales agent’s residuals could be subject to termination. As these are unsecured claims, there just may not be enough money to pay residuals. Or, through the bankruptcy process, the ISO often has the option to terminate its contracts with sales agents and also to terminate any further residual payments.
How Has It Played Out:
The good news is for the most part, whenever one of these types of events leading to the demise of the ISO has happened, is has not caused too much hardship for sales agents. In the case of the FTC actions, the companies in question were eventually sold for many millions of dollars. That is because for the most part many of their merchants were internally generated by the ISO’s questionable sales practices. Thus, after the ISO was seized by the government, the merchants were provided compensation and the opportunity to terminate their contracts. As a result, after that process was completed the remaining merchants were those that likely would stay processing with the ISO for the foreseeable future. Those types of merchants are valuable and hence were attractive to certain buyers.
Another reason most ISOs continue to pay residuals even if there are subject to governmental seizure or bankruptcy is because if any large ISO were to just stop paying residuals to all its sales agents, most sales agents would go in and move as many merchants as they could. This would make that portfolio of merchants worthless to a buyer. So, in order to preserve the value of the portfolio to sell it off, the FTS or the bankruptcy court has to make some accommodation to the sales agents. The sales agents may not get everything they were entitled to under their previous agent agreements, but they will get enough to keep them from pillaging the merchants so that the bulk of the value of the portfolio to the ISO can be maintained.
How To Minimize Risk:
There are a number of things you can do to reduce the risk of having your residuals terminated because of financial problems at your ISO. One of the first and probably most powerful things you can do is to do your own due diligence on the ISO. Ask people in the industry if the ISO has a good reputation for paying sales agents and for making sound business decisions. There are industry consultants, accountants, attorneys and industry veterans you can ask for their opinion about an ISO. Also, industry trade publications, forums and trade organizations are another place to learn about an ISO and internet searches can let you know about how merchants view the ISO. You need to confirm that the ISO is reputable and run by people that have a stellar reputation in the industry or it may be best to find another business partner.
Another issue to inquire about is the underwriting practices of the ISO. You may not realize it, but you are becoming part of a community when you start writing for an ISO. You are going to be part of a community of merchants and other sales agents all dependent upon that ISO for their livelihood. If that ISO takes on other sales agents that are lying to merchants, that could come back and result in an FTC action that could impact your residuals. Likewise, if the ISO does not have good underwriting in place and effective risk monitoring, then your residuals could be at risk if there is a large merchant loss. As a sales agent, you may like the fact that your ISO will take just about any merchant. However, such lax underwriting could backfire and cost you your residuals.
The main lesson to be learned is “know your ISO.” An ISO is not going to provide you with financial statements, so the best thing you can do is to find out everything else you can about it. Does the ISO has a reputation for honesty, is it well respected in the industry and does it have a strong financial backer like a publicly held parent company? Ask these and as many other questions as you can think of before you commit to sending your business to an ISO that will in essence be in control of the livelihood that supports you and your family.
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.