A Guide for Software Providers Considering the Payment Facilitator Model
Established independent software vendors (ISVs) with mature payments programs and newer entrants in the specialty software space who are looking to improve all or some aspects of their integrated payment programs are examining their program structures (often with encouragement of their payment processing partners) to find the best fit for their business and for their own customers.
There are a number of options – traditional referral relationships, becoming an agent or independent sales organization (ISO), advance residual buyouts, and variations of each. Increasingly, a number of ISVs are contemplating becoming a payment facilitator (PayFac – also known as a merchant aggregator).
The PayFac model is appealing to these ISVs because it ostensibly gives them more control, eases client onboarding, and can potentially boost profits. But becoming a PayFac also requires the ISV to accept higher levels of cost and liability and is certainly not the best solution in all circumstances
PayFacs: An Evolving Market / Is the PayFac Model Right for You?
For ISVs to make an informed decision about whether or not the PayFac model is suitable for them, it’s important to understand what PayFacs are, why this model emerged in the first place, and how it is changing.
PayFac is based on the merchant aggregator model created by Visa/MasterCard to provide support for payment card acceptance in a marketplace environment.
PayPal and eBay are probably the most well-known examples of this type of PayFac, but other marketplace-type providers have also emerged. Uber and Lyft, Etsy, and Airbnb, to name a few, have also established marketplaces where customers can use cards as a form of payment.
The traditional merchant account process was established for brick-and-mortar and e-commerce businesses with clearly defined relationships between merchants and customers (think Macy’s, The Gap, etc.) However, the traditional merchant account was not a good fit for emerging new commerce platforms such as marketplaces, where anyone can be a buyer and/or a seller (i.e., eBay). The merchant aggregator model (PayFac) was created for marketplaces to facilitate payments without requiring each seller or service provider to go through the lengthy process of establishing a traditional merchant account.
In a PayFac structure, a company like Uber or eBay establishes a merchant account with its acquiring bank, and then is able to onboard sub-merchants (Uber drivers, sellers, etc.) under that account.
Operating in the PayFac model allows faster onboarding of merchants. However, with that comes responsibility for controlling merchant funding and setting parameters that govern payment acceptance. PayFacs also assume the majority of the risk and responsibility for the payment process and are fully liable for fraud. Proper operation of a PayFac requires sophisticated technology for both the onboarding and settlement aspects of the business.
The appeal of the PayFac model is that the sub-merchants can bypass most of the traditional merchant account setup process (price negotiation, lengthy applications, proof of business, etc.), which enables much faster boarding. In the Uber example, all of the drivers must be able to accept payments directly. Instead of each of them establishing their own merchant account (a pretty high bar for the typical driver), they can use the payment solution built right into the Uber application.
The PayFac then has all funds processed via the marketplace deposited into its own merchant account and is responsible for disbursing funds to the sub-merchants. This level of control over the sub-merchant funding process helps mitigate risk for the PayFac.
PayFac Responsibilities (shifted from the payment processor to the PayFac):
- Contract with sub-merchants
- Funding to sub-merchants
- Reporting for sub-merchants
- Customer service for sub-merchants
Not all merchants are eligible for payment aggregation. Visa and MasterCard have different volume requirements. For Visa, merchants must sign a direct merchant agreement with an acquirer when annual Visa sales exceed $100,000. In addition, a sponsored merchant can maintain Payment Facilitator relationship for payment services. Mastercard requirements are a bit different, PayFacs are now classified as a type of service provider, rather than a merchant. The permitted sub merchant transaction volume is $1,000,000 in annual MasterCard volume.
PayFac Appeal: Rapid Growth, Faster Onboarding
ISVs are typically drawn to the PayFac model because of the combination of potential hyper growth and instant onboarding of merchants with very little up-front effort. Established ISVs in a vertical who know their customers well see it as a way to facilitate faster growth and make the payments experience more seamless.
The PayFac model is an especially good fit for ISVs with a customer base that functions as a true marketplace – independent housekeepers, health and wellness instructors, personal trainers, pet groomers, etc. These are small businesses that accept moderate volumes of relatively small payments directly from customers.
For ISVs considering making the transition to PayFac, the first question they should ask themselves is, “What does the customer base look like? Do my customers represent a true marketplace?”
That evaluation is critical, as the potential benefits of the PayFac structure point to weaknesses that have emerged in traditional ISV/processor relationships. In some cases, ISVs are being encouraged by their payments provider to adopt the PayFac model in circumstances that aren’t really appropriate.
“The consolidation in the payments industry has not served ISVs well. In many scenarios, all but the largest ISVs see service levels decline as partner programs become siloed and disconnected,” says Brock Robertson, president and chief marketing officer at Paragon. These consolidated payment providers are seldom truly integrated, and their various subsidiaries or divisions often have competing priorities, poor communication, and solutions that aren’t fully interoperable. For the ISV, transitioning from one payment model to another often means working with a completely different set of employees with no knowledge of the ISV’s business or existing payment offerings. When ISVs say they want increased control of the payment process, this often reflects the lack of support available from the current payments partner – both for the ISV and for the merchants. They may be frustrated that their current provider isn’t adequately supporting their needs (and those of their customers) and feel that the only way to solve the problem is by owning more of the payment process.
Becoming a PayFac can eliminate service headaches by pulling more functions in-house, but for many ISVs, PayFac is not the best way to maximize revenue from transaction processing because of the significant up-front investment required. There are better solutions and boutique providers that can build highly customized programs to deliver the support and service ISVs are looking for.
PayFac Pros and Cons
“Becoming a PayFac can be ideal and even highly lucrative for some ISVs, but it isn’t a fit for everyone. Companies like Square and Uber are successful PayFacs with their own settlement platforms, each carrying all the risk and liability around payments. Not too many ISVs are willing to sign up for that kind of risk,” says Roy Bricker, Paragon CEO.
Further, the costs associated with being a PayFac can easily offset any margin gained by taking control of the payments process. Those costs include:
- Staffing – PayFacs need full-time employees to handle compliance and maintenance.
- Ongoing Costs – Payment facilitation, engineering, maintenance, and other activities will require a significant amount of capitalization.
- Volume – Because the costs are so high, a PayFac needs a sufficient client base and high payments volume to create enough offsetting revenue.
A hybrid PayFac model has emerged, though, that can offer the benefits of frictionless boarding without the risk and liability. In this case, the ISV partners with the payment processor, who handles the underwriting and movement of money, while still providing the ISV with the seamless payments experience it wants for its merchants.
This model can be an especially good fit for ISVs that are already working with a low-risk client base and those that work with merchants with more standardized charge profiles and predictable volumes.
However, many ISVs don’t properly consider the makeup of their merchant base when considering becoming a PayFac. “Not all merchants are going to want to switch to a flat-rate pricing scenario just to streamline the boarding process. Larger clients are going to want to negotiate their rates,” says Bricker.
This is where a hybrid approach can pay off. By partnering with the right payment provider who understands the industry and can provide customized programs and hybrid PayFac partnerships, software providers (and their customers) who fall into this category will be better served. Taking this approach also allows the software provider to offer a more competitive payment solution while not taking on unnecessary risk/liability or making expensive investments in staff and infrastructure.
“Boutique payments processors can provide the flexibility and support this class of ISVs is looking for, particularly when it comes to more customized programs,” explains Eric Hoke, vice president, business development at Paragon. For ISVs that offer different platforms or that service multiple, distinctive merchant groups, these boutique providers also provide a more compelling way to create multiple payment offerings on an integrated platform.
As processors consolidate, revenue is shrinking and software providers and their customers are suffering the effect as service levels degrade.
The PayFac model offers a way to give ISVs more control over payments, increase revenue, and improve service, but at a very high cost in terms of development, infrastructure, risk, and liability. For many ISVs, those costs are too high to be sustainable. ISVs should search out a payments partner who has the necessary understanding and expertise to navigate this decision and select the program structure that best aligns with their business and strategic objectives.
If your application or client base isn’t an obvious fit for a PayFac, innovative payment providers now offer options that provide the benefits of a PayFac, but without the potential downside when it comes to investment.
For ISVs with the right client base, the hybrid PayFac model is emerging as a better option. ISVs get faster onboarding and better service but without all of the cost and risk. Partnering with a processor that can support a variety of customized payments programs, while also offering reliable support, can take the pain out of payments and help ISVs accelerate growth.
About Paragon Payment Solutions
Headquartered in Scottsdale, Arizona, Paragon Payment Solutions is an integrated payments boutique and Top 50 U.S. processor. The company, which securely manages over $3 billion in volume annually, is committed to delivering tailored solutions and strategic partnerships that help software providers and their customers excel. Only with Paragon can software providers integrate to a single platform, purpose-built to support all payments program types, including traditional referral relationships, registered ISO/agent programs, and PayFac models. Look to Paragon’s single team of integrated payments industry experts to provide the support and expertise ISVs and merchants deserve throughout the life of the relationship. To learn more, visit www.paragonsolutions.com.