← The Path to Exit
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- [00:02]
A
Welcome to the Path to Exit, a podcast to help software and Internet founders understand the process to raise capital or sell their business.
- [00:19]
B
Hello and welcome everyone. I'm Mike Lyon, founder and managing director at VistaPoint Advisors, and this is the Path to Exit. This show is dedicated to helping founders of software and Internet businesses understand what it takes to raise capital or sell their business and how do it. Well, my guest today is Brian Abernathy, founder and principal of Utopia, which provides advisory and consulting services specializing in the payments industry. He's looked at hundreds of SaaS payment opportunities and has a fantastic playbook for how and when to monetize payments for vertical SaaS businesses. A significant trend in software is integrating fintech products into vertical SaaS businesses, particularly payments. In this episode we will discuss how to think about the payments opportunity, when to pursue it, and why it's valuable to private equity firms and other buyers. We will also talk about how payfacts are responding. Please enjoy my discussion with Brian. One of the reasons we take a look at this topic is a lot of private equity firms are thinking about integrating payments with vertical SaaS businesses. The economic reason behind this is because SaaS businesses are typically high retention rate, high revenue multiple businesses, but not very high in EBITDA margin. A lot of the payments businesses that private equity firms own are kind of the opposite. They're very high margin, but not as sticky. So there's great value in combining this highly profitable business model with this sticky recurring revenue model, which makes both businesses more sticky. So over the past 10 years, we've seen private equity firms run this playbook a lot and it's a big part of transactions. So we wanted to talk about it. Brian, before we get into the details, can you talk a little bit about why you started Utopia and what problem you were trying to solve?
- [01:51]
C
Yeah, absolutely. Mike, thanks for the introduction. I just started to see some issues with how payments were being sold and adopted dating back to my entry in the payment space back in 2017 when I worked at a company called TSYS, where I led their, what they would call ISV business development. But essentially it was B2B partnerships for vertical software companies. And so having sold my product kind of at or towards these entrepreneurs and founders over the years, it felt like there was a disproportionately high amount of bad outcomes happening. We would get together and model out the opportunity. Everyone would get excited. We say, look how much money we can make on this. It's going to add all this value and efficiency and very, very rarely would we actually achieve that outcome for a number of reasons. I think the biggest one was just that the software companies didn't necessarily know what they were getting into. Right. What should I take on in this equation? What should I outsource to my partner? How do I price this? How do I sell payments? How do I support it? How do I have an operations team behind it? And so for quite a while, I felt like there was an opportunity for someone to go on the other side of the table and sit next to these software companies and help them navigate this incredibly complex but highly lucrative opportunity of embedding payments. And so back in early 2022, that's exactly what we did when we started Utopia is we work on all things payment strategy for vertical SaaS companies and have completed over 60 engagements in the past about three years or so.
- [03:13]
B
That's awesome, Brian. Well, thanks for that feedback. And I talked upfront about how we think about the economics of these situations, right? Retention rates, margins, all those things which tend to drive some of the financial valuations in a transaction. But there's oftentimes business and customer experience reasons to integrate payments into your vertical SaaS product. Can you just talk a little bit about that and give us some examples of why that makes sense on the business side, not just on the financial side?
- [03:38]
C
Of course, I think it's an often overlooked but very important piece of the equation. Here is, of course, we get wrapped up in the economic opportunity and what that can do for the value of a business. But at the end of the day, all of that stems from having a compelling product that a small business chooses to use because it creates efficiency and value in their workflows. A couple of examples maybe to characterize this. The first one would be, let's take a restaurant point of sale, for instance. Of course, there needs to be some way to process credit cards as patrons want to pay their bills and settle up with the server. But when you think about trying to create efficiency and value for the restaurant, what an integration would do is when someone closes a check and pays for it, that automatically updates the staff that that table's now open and can be seated again. So now you're flipping tables more quickly, you're driving more revenue, you're moving more guests through your restaurant and hopefully improving the overall performance of the business. Another classic example of this would be in the healthcare space where patient payments are automatically posted back to a patient ledger, making sure that the outstanding balance, if there is one, is always up to date, saving money on stuffing paper statements and sending these very confusing and antiquated bills out to customers who are highly unlikely to pay them anyway because they don't even know if they're final. So the ability to take a credit card transaction and immediately update a patient ledger drastically improves the financial performance of a healthcare practice. So that's just two examples, kind of the North Star of integrating here should always be on creating value and efficiency for your customers. And once you do that, you create the opportunity for your software business to capture revenue.
- [05:07]
B
Great points. I think as we both talked about, we kind of get caught up in what this means for valuation or the financials or retention, but really it's a better product for your client and also the end consumer and that's a big driver of value as well. So clearly don't forget that. One of the things I wanted to get your input on is how to know if there's really a payments opportunity for your business. How should a founder think about that? Obviously generally the way this goes, founder develops a great SaaS product, selling it to customers that's working and then at some point maybe it makes sense to look at that. But how do you know if there is a potential payments opportunity or other fintech opportunity in your business?
- [05:43]
C
Another great question. I would say the best way to think about this is are there transactions that are happening between your software customer and their end customer? An example of this might be if we just stuck with healthcare. If you have a healthcare practice management software and your customers are say dental offices and those offices are accepting co pays and out of pocket expenses via credit card, you absolutely have payments opportunity. So I think making sure that there are consumers or customers of your customer that are transacting with them via card, virtual card, ach, what have you that defines it? And I think an example of maybe something adjacent and similar that doesn't have a payments opportunity in the healthcare space. Even sticking with a dental example, if you have a software that focuses on insurance claim adjudication, you would see tremendous amounts of volume moving around. Right? The majority of a practice's revenue is coming from insurance remittance, but that that is coming from a customer to B2B. It's likely being paid via wire or via invoice on terms. So you may not have the same opportunity there. It's just important to understand is your customer's customer paying them with some type of credit card? Ach, that should be a good rule of thumb.
- [06:54]
B
And there are some businesses that for the reasons you mentioned, there's just not really a payments opportunity. There could be another fintech opportunity but just want to make sure people are clear about where they might have one and where they may not.
- [07:04]
C
Absolutely.
- [07:05]
B
Let's say you're in the category of it looks like you do have a potential payment opportunity. How do you think about executing on that? There's a point at which you're probably too small. Right? It doesn't make sense to implement this. But what are kind of the stages of scale and when do you think about investing that? Obviously a lot of these founder led businesses have limited time and resources. So they're always doing capital allocation on some of these projects. How should they think about that and when is the time to start thinking about really executing on it?
- [07:30]
C
This can vary by business and it certainly is very dependent upon industry, the vertical that you serve and the size of the customers that you serve. But if you were to use a rough take rate of call it 50 to 75 basis points, the easy calculation would be to figure out how much card or payment volume your customers are doing in aggregate and then apply that take rate. And if that number looks compelling to you, then you should consider investing resource in this. It is very common for a successful payment strategy for a software company to actually be a higher percentage of revenue than the core software revenue itself. And so it is a nice way for a founder led business to improve cash flow and drive incremental revenue from existing customers. I don't want to put a dollar value on it. I would like the audience to do that on their own as they consider how they go about executing on it. I think it's very important to get brutally honest with yourself about what do you want to take on and what do you want to outsource. And there is no right answer to this. The only right one is what's right for your business. There are a range of different, what I call operating models within the space, ranging from a very hands off, very simple, quick to implement referral program where you build an integration between your software and your payment partner's API. And that's pretty much it. You pass off sales, support, risk, underwriting all those things, completely outsource them and you essentially get a royalty check for referring business. Of course you don't have any control over pricing, customer experience or any of those things, but it is an easy way to get off the ground and fairly common, I would say. I think the trend that we see lately is as more software companies identify the opportunity and see how big payments could be for their business, they want to lean a little bit more into owning more of the process. This might mean branding it as your own version of payments, much like someone like Toast does. It might mean bringing the sales process in house, bringing tier one customer support in house to make it feel a little bit more cohesive as part of your software offering and not this kind of appendage, third party referral relationship. And so again, I think it's important to be honest about the resources that you have, the time that you have, development constraints, and say, does it make sense for me to outsource this, or does it make sense for me to own at least part of this? And then from there there are many vendors that can serve one of those models that you can choose from.
- [09:49]
B
I think that's a great way to frame it. And I think the obvious implication is depending on how far you go down the path of that spectrum of how much of it you own, obviously the economics change quite a bit. Right. As you go from just a referral relationship to doing a lot more. And this is maybe a good point to talk about what the private equity playbook can be. So a lot of these private Equity firms own PayFax. They own the entire payment infrastructure. And so their strategy when they acquire some of these businesses, if you already have a little bit of a payments opportunity or you're doing part of that value add, they want to take on all that value add because that allows them to monetize it even further. But maybe talk a little bit about what's a good deal for founders, if they're starting to negotiate some of those value add, if they're taking on more and more of that, how do they know if they're getting a good deal from their partner? I know a lot of times we'll just see founders sign up for whatever the stock terms are with a payments partner. And those aren't always great deals. So how do they do research and understand that and make sure they're getting a good deal?
- [10:47]
C
Absolutely. So there's a few components to this. The first one, of course, is the commercial terms. Understanding what your percentage of the take should be. I would say that the market would bear around kind of 40 to 60% for that basic referral. Right. So call it 50 50. If you were to just build an integration between your software and your partner and flip leads over the fence to them, you should expect to earn around half of the profit. There will be some buy rates in there, so it might net out to like a 60, 40%, but let's call it 50, 50. As you begin to take on more and more responsibility, say that you Take on sales. Now you absorb the sales, acquisition cost and compensation for your own team. That should look more like 70 or 80% coming to you because you have more of the work to do. If you start taking on support, that should tick up a little bit higher. All the way up to like as you mentioned, working in one of these, either fully registered payfac or payfac as a service model where it's not uncommon for software platforms to be earning 90 or 95% of the overall economics because they're really doing all the work right, they're supporting it. They might even be taking on the risk and liability of the transactions. They don't have to, but they could. And so it can get that high. That's on the commercial term side. I think you made a really good point Mike, about just kind of accepting the boilerplate agreements. I run into this all the time where a founder decides that they want to implement payments, they sign up with someone, say they choose Stripe or they do some research and they end up working with someone and signing an agreement. Those agreements can become quite a problem down the road. If you do choose to take on investment and your new investors want to pivot your strategy. That's really where my firm, where utopian comes in quite often is company takes on a new round of investment, they see that there's a payments opportunity and they need someone to help execute capture that. Where we run into roadblocks is a lot of those contracts can be fairly restrictive in terms of what you're allowed to do. So let's say that three years ago you signed an agreement with a processor and didn't realize that it was exclusive and it had a five year term. So now you have two years where you can't do anything but work with them. Be very careful of those types of clauses. Another one would be some sort of non solicitation, meaning that you can build this portfolio, but even when you end the agreement, you can't touch this set of merchants for say, well, 18, 24, 36 months. Meaning that the incremental value you could get by moving further into one of these more hands on models moving from 50 to 90%. Well now that's only on your organic growth. You can't touch your install base, which of course is going to dramatically affect your valuation from your repayments portfolio. So there are contractual terms above and beyond the actual rates themselves that are very important to consider to make sure you don't get boxed in down the road.
- [13:24]
B
I want to triple underline this point because how this has evolved in the market is call it five or six years ago PE firms were buying these SaaS businesses running their payments playbook and the way the contracts worked with the existing payfact was in place, they could basically just lift and rip these customers out. And there were huge synergies in being able to get that increased margin. Not surprisingly, these payfacts who've had their business taken from them have gotten much smarter. So what they've started to do is maybe give slightly better economic terms to these founder led SaaS businesses, businesses up front, but lock them in. And I've worked on several deals where because the way the contract work, a particular buyer who was maybe looking to exit the business in a year or two couldn't pay the same multiple for our client because they had no way to see the lift in monetization. So be focused on the economics but I think also be focused on the flexibility of the contract. Particularly if you think you're going to go through some transaction for two or three years because if you get slightly better economics but you're locked into a bad contract that could actually destroy value rather than having maybe slightly worse pricing, but knowing who you're selling it to is going to be able to negotiate pricing up or basically just take the whole business themselves. So I think that's really important and something to really watch out for and think about what your likely exit horizon is and do some modeling around that to make sure you're not putting yourself in handcuffs basically around an exit. So I think a great point. What are some other things, you know we talked about pricing and contract terms. What are some other things you should look for in terms of the right partner for you? If you're looking at partnering going down that spectrum of value add, it's important.
- [15:00]
C
To understand the technology that's going to be required to deliver value to your customers. So again, this is a highly vertically specific question, but certain processors have feature sets that might align better to one use case than to another. For instance, if you are a gym membership software and the vast majority of your transactions are card not present or recurring membership subscriptions, you might look for a processor who has advanced features such as maybe network tokenization, which is the most cost effective and comprehensive way to process recurring transactions. Not all processors have that. So for someone who that type of use case is very important to I think you need to look as you evaluate your potential partners, does their tech stack fit. Conversely, if you are a retail point of sale system where a hundred percent of your transactions are face to Face you would want to have a partner who has a very robust and reliable terminal solutions. So what types of hardware do they offer? Do those price points match the expectations and ability to spend that your customers have? Do they have up to date technology like Tap to pay? Are they able to adjust for tips, these types of things? And it feels very in the weeds. But it's so important during the vetting process to map out exactly what it is that you need to deliver the value that we talked about off the top and map that back to your potential partner's feature set. That should leave you with, in my experience, a pretty obvious answer of one or two companies that you should work with. But the technology piece, it's not just about processing transactions that's relatively commoditized. It's the featured sets that align to your software that create value and efficiency for your customers. That's where the magic is unlocked. And so I can't underscore enough that the technical diligence side of this is extremely important as well.
- [16:40]
B
Something interesting to think about that could rapidly change. Both presidential candidates have talked about not taxing tips. And so that could change the landscape dramatically if that got passed through in terms of payments and opportunities and how much tips you see flowing through the system. We talked a lot about payments, credit card payments, ach. I did just want to touch on lightly some other fintech products that you see in vertical SaaS businesses. And so an example of that, we worked with a client a couple years ago that was basically selling a field services product for the roofing industry. So imagine you're a tech out in the field trying to sell a new roof to a client. And obviously roofing's a pretty big ticket item. Not everyone is going to be able to put that on a credit card. So their big innovation, which their customers love, is they were able to quickly, with the roofing tech at the kitchen table with the potential client, get them approved for a loan on the spot. So enter in minimal information, they would go, run it through their loan network and get approval. As you can imagine, this totally changed the ability to close out that client on site and was really a big value add for the industry. So just think about other potential fintech products. Sometimes it's a little bit harder to get that up and off the ground. Obviously putting together a loan network is a little bit easier than plugging into a plug and play payments processing, but I just want to make sure people think about that and there's some real value add. Anything else you want to add around that or some innovative fintech you've seen other than just the traditional payments as a general framework.
- [18:06]
C
When founders think about this, just remember that you, as the system of record for these businesses, are actually in a stronger position to underwrite and tailor offers for financial products than almost any traditional financial institution. And you could take your own experience as a consumer to verify this, right? I just bought a home earlier this year and when you apply for a mortgage, they ask you for a couple of PDFs and some pay stubs, tax returns, and they make their decision right? And that's good enough for them. I would argue that your ability to see the performance of a business historically and in real time puts you in a very advantageous position to not only underwrite and tailor terms, but to offer them at the right moment to your customers. For example, if you were to offer some sort of lending product to say it's a restaurant point of sale and you see that sales are down, that maybe cash flow is poor, you can right within your UI offer them a $25,000 merging cash advance where the manager logs in and says, this is a lifeline to get me through the next two weeks of payroll. Incredibly powerful. Even on the roofing example, Mike, that you gave, think about credit card issuing or prepaid issuing. What if the roofing company that uses that software has the ability to push wages to their frontline workers? The moment that they clock out on a Friday or over a weekend, they have their wages on a prepaid debit card. That happens automatically and the software company is actually making part of the interchange when that employee then goes and spends that on groceries or whatever they do. Another example might be something like insurance. Say it's a behavioral health platform and a new therapy practice signs up as a customer to offer them professional liability insurance and renters insurance right within the signup process. A lot of small businesses don't have the time to manage vendors and different fintech products like this, and they'd rather get everything from one customer and you as the system of record. Again, you have the rights to present those options to them. And in my experience, you have a very good chance of driving adoption assuming that you have the right partners on the back end and the proposal is compelling.
- [20:04]
B
Thanks for bringing that up because I know we get focused on just pure payments, but there's obviously lots of other opportunities out there. In today's episode, we talked about some of the common questions we hear from SaaS founders and how to integrate payments into their solutions and be really strategic about that as you think about your ultimate exit. By addressing a lot of these key aspects of payment integration proactively, vertical SaaS founders can better position their companies for success in this evolving market, which is changing pretty rapidly. And Brian, you maybe want to share your email address and website so they know how to get in contact with you?
- [20:34]
C
Yeah, absolutely. And listeners can feel free to reach out to me at Brian B R I A N Utopia IO that's U T O P A Y A I O Or feel free to reach out to Mike and his team and they can get you in touch as well.
- [20:47]
B
Brian, thanks so much for joining us and walking through this big opportunity for SaaS founders.
- [20:52]
C
Thanks for the opportunity Mike. Really enjoyed the discussion.
- [20:55]
A
VistaPoint Advisors is a founder focused investment bank that advises software and Internet founders through M and A and capital raised transactions. We are a fully unconflicted investment bank who only works for founders on the sell side, so you know that we're always representing your best interests. Security is offered through VistaPoint Advisors member Finra Sipic. This has been provided for informational purposes only. It is not intended to address all circumstances that might arise. Testimonials from past clients may not be representative of the experience of other clients and there is no guarantee of future performance or success. Clients are not compensated for their comments. If you have any questions about the process of selling your business or raising capital, reach out to a member of our team or check out the four Founders section of our site by visiting four Founders Guide.