If the payments industry held a popularity contest, chances are payment facilitators (PayFacs) would be wearing a sash and a crown right now.
Needless to say, PayFacs are a hot topic, and people from all corners of the payments world seem to be asking the same question: to be or not to be.
As an ISV, this is likely a question you’ve asked yourself — and one you shouldn’t answer lightly.
While there are compelling benefits that come with being a PayFac to be sure, there are also important considerations to think through before jumping in feet first.
In this article, we’ll lay out the reality of what it takes to become a PayFac if you’re doing it on your own — and let you in on an alternative if you decide the traditional route isn’t for you.
Keep reading to find out:
- How the PayFac ecosystem works
- The pros and cons of being a PayFac
- Who should consider the PayFac path
- What it takes to become a PayFac
- How Global Payments Integrated offers an alternative solution
We have a lot to cover, so let’s get started!
Profile of a PayFac
You’ve no doubt heard of PayFacs before now. But what are PayFacs really and what do they actually do? Let’s peek behind the curtain, shall we?
What is a PayFac?
The term “PayFac” holds many complexities, but here’s a basic definition: A payment facilitator, also known as a PayFac, is a merchant services provider that simplifies the merchant account enrollment process and provides front-end payment processing services.
Sounds good, but what does that look like specifically? PayFacs take on the responsibility to underwrite and onboard merchants, provide them with the technology they need to process electronic payments and ensure they receive the funds from those payments.
This might seem simple enough on the surface, but let's get into the nuts and bolts.
How does the PayFac model work?
While there are variations of payment facilitation models, PayFacs essentially offer small business owners a loophole to circumvent the standard process of establishing a merchant account with an acquiring bank directly. It also allows the business owner to skip the legwork of setting up separate relationships with other necessary parties in order to accept payments and settle funds. Instead, the PayFac does the work for them.
Here’s how the traditional PayFac model works:
1. Sponsorship: First, the aspiring PayFac registers with a merchant acquirer that’s licensed by the card networks to establish a master merchant identification number (MID). An acquirer is a financial institution that enables a merchant to accept credit card payments, but for the purposes of this article, we’ll call them the acquiring bank.
2. Underwriting: Once the PayFac gets sponsored by the acquiring bank, they’re free to underwrite merchants on their submerchant platform. This happens in two parts — the merchant applies for a submerchant account, and the PayFac performs a risk assessment. The assessment requires fewer data points than if the merchant applied for their own unique merchant ID, and is approved or declined in real-time with an underwriting tool.
3. Boarding: If approved, the PayFac then boards the merchant as a “submerchant” of their master account. Basically, the PayFac lends their master MID to the submerchant and streamlines the boarding process by allowing them to do business under the umbrella of the PayFac account instead of establishing their own. Whenever a submerchant is boarded, the PayFac takes on all the risk associated with that account and assumes responsibility for monitoring transactions for potential fraud.
4. Managing payments facilitation and funding: The other half of the PayFac equation? Providing submerchants with the technology and infrastructure to accept electronic payments. PayFacs are also responsible for paying out funds to their submerchants and reconciling transactions.
Where do PayFacs fit within the payments ecosystem?
As you've probably gathered, a big part of being a PayFac is setting up and managing relationships the client would otherwise need to establish and maintain themselves.
Think of PayFacs as the link between the submerchant and all the other key players in the payments ecosystem, like acquiring banks, payment processors and card networks. When a small business owner works with a PayFac, they don’t have to establish or maintain those individual relationships. Everything goes through the PayFac who handles it for them. See the appeal?
You’ll be hard-pressed to find one comprehensive, consistent list of a PayFac’s duties due to differing acquiring bank requirements and the evolving nature of payment facilitation, but here's a general summary of the role of a PayFac:
Keep in mind, there are solutions out there that significantly lessen the duties that fall on the PayFac’s shoulders …. (hint, hint). But more on that later!
Pros and cons of payment facilitation
So you’ve got a solid grasp on how the traditional PayFac model works. Now the question is: Why would someone want to become a PayFac if it means more work and risk? To answer that, we’re prescribing a good, old-fashioned pros and cons list.
Offer friction-free onboarding: The merchant onboarding process via the PayFac model is more accessible, easier and faster than getting approved for traditional merchant accounts. This means merchants can get up and running quickly in a matter of minutes instead of waiting days, or even weeks, to get approved. In turn, this speed also allows PayFacs to build bigger portfolios quicker.
Control the payments experience: By integrating payment processing, reconciliation and disbursements, PayFacs have total control over the payments process. This provides a seamless end-to-end customer experience — and gives PayFacs more control and flexibility over how and when to distribute funds to submerchants. That control includes the ability to do things like pay out biweekly instead of next-day, or limit the payout amount if a submerchant hasn’t yet proven they’re reliable.
Generate more revenue: In return for underwriting submerchants, PayFacs get to set their own transaction fees. PayFacs also receive a recurring revenue stream from each client who processes payments with them — clients they’re more likely to retain. The more services they provide, the fewer relationships the submerchant will have to form with separate vendors, and the stickier the PayFac’s portfolio will be. Beyond retention, the simple, all-in-one package PayFacs offer lends a competitive advantage to winning over new clients as well. And as the PayFac builds their revenue streams, they’ll also increase their business valuation.
Take on additional risk: The trade off for making more money, is assuming more risk for financial loss. Since PayFacs hold the master merchant account, they are liable for each submerchant in their portfolio. For example, if they accidentally underwrite a merchant that isn’t a legit business or applied for an account with a stolen identity, the liability for that mistake would fall on the PayFac. The PayFac is also responsible for developing underwriting guidelines, merchant risk analysis processes and ongoing monitoring procedures. If something goes wrong with a submerchant account — like chargebacks, non-payments or fraud — the PayFac will be the one dealing with the fallout.
Incur higher costs: The price of offering all that functionality in one solution is putting more skin in the game. To manage ongoing payment infrastructure support, PayFacs need to staff full-time employees. And as their payment volume grows, they’ll need to keep hiring more staff and investing more money in their infrastructure and technology systems. Being a PayFac entails additional upfront and ongoing costs that can tally up to hundreds of thousands of dollars, including card brand registration, annual renewal fees, compliance, risk mitigation and more.
Maintain sponsorship and compliance requirements: While the submerchant gets to skip the rigamarole of setting up a merchant account, the PayFac doesn’t. As a PayFac, obtaining sponsorship from an acquiring bank in order to operate can be an arduous process. And it doesn’t end once they get sponsored. PayFacs have to keep up with the ongoing requirements of both the acquiring bank and card networks, and undergo an annual PCI audit to ensure their business — and their submerchants — are fully compliant.
So, what’s the verdict? Is becoming a PayFac worth the trouble? Well, only you can answer that. But before you do, there are a few more factors you’ll need to consider.
What type of business could benefit from becoming a PayFac?
At this point, we hope we’ve made it clear — the traditional route to payment facilitation comes with extra responsibilities and costs. So, how do you know if you can handle it? As with any business venture, there are no guarantees. But if the following applies to you and your business, you’ve got a shot at making it as a PayFac:
- Your client base can withstand high margins: To offset the costs of the facilitation process, you’ll likely need to charge your clients higher payment processing fees. Revenue comes from the difference between your buy rate and sell rate. So you’ll need to sell your clients on a reasonable margin, usually 2% or higher. With so many payments providers in the industry and readily available information about rates, merchants are more payments savvy and rate-conscious than ever before. Getting new clients at above market rates could be challenging in certain verticals.
- One price and point of sale device will meet the needs of most of your clients: Many PayFacs offer a simple flat rate fee structure to cover processing costs on each transaction. In the same vein, standard POS systems are usually the name of the game instead of customized solutions. If a simple pricing and POS model works for most of your clients, you’re in a good spot.
- You have a sizable portfolio: Without enough clients, you won’t generate enough revenue to make a profit as a PayFac. You’ll need hundreds of submerchants who generate high transaction volume and/or high average ticket amounts. Merchants who don’t bring in high values on their average ticket and process few transactions per month won’t be sustainable in this model.
- You’re managed by private equity (PE) or looking to be acquired: Having PE backing or an influx of cash from an acquisition could give you the financial cushion you need to handle the cost of getting started as a PayFac.
If you’re thinking payment facilitation makes sense for your business, your next step is mapping out the road to get there.
What it takes to become a PayFac — the traditional way
We won’t sugarcoat it, checking all the boxes to reach PayFac status can be a bit of an uphill journey if you go the traditional route. We’re talking potentially a six-plus month timeline and easily upwards of $100K in startup and legal costs. (If that’s a nonstarter, feel free to skip to the end to discover an alternative option.)
But if you’re still interested in finding out what the traditional path looks like, buckle up. Here’s the roadmap to becoming a PayFac:
1. Pass the acquiring bank’s review process: As we mentioned earlier, before you can start operating as a PayFac, you’ll have to approach an acquiring bank and go through the underwriting process with them before they agree to sponsor you.
This includes a significant amount of vetting, including a review of your business operations model, estimated transaction processing volumes, financial credentials, payment infrastructure and technology, systems and processes, as well as your procedures to underwrite transactions, prevent fraud and handle chargeback disputes. After you get approved, expect an annual review from your sponsor.
2. Register with the card brands: In addition to registering with your acquiring bank, you’ll also have to complete an extensive registration process with the card brands. Registering requires a significant investment in both time and money. You’ll need to build the required infrastructure to get approved, and once you do, card networks like Visa and Mastercard each charge $5,000 a year in registration fees. Annual renewal is required.
3. Hold the risk for submerchants: Assuming risk for fraudulent transactions, fraudulent merchants and merchants going out of business is at the core of payment facilitation. If there’s a loss, the PayFac will be held accountable for that. So it’s important to be careful to only board lawful businesses you can trust to comply with card network and acquirer rules.
How? You’ll need to develop underwriting policies and systems to screen and verify merchants’ backgrounds and identities, assess their financial health and risk, perform Anti-Money Laundering (AML) checks, and ensure they meet Know Your Customer (KYC) requirements, US Office of Foreign Asset Control (OFAC) requirements and aren’t on Mastercard’s Member Alert to Control High-Risk Merchants (MATCH) list.
4. Ensure ongoing oversight, compliance and governance: Beyond the initial vetting process, PayFacs also need to have systems in place to perform due diligence of monitoring submerchant activity for things like money laundering and terrorist financing. Failing to perform ongoing risk assessment could sink your ship fast.
To keep a good relationship with your sponsor, you must establish and maintain a risk management policy that’s approved by the sponsor bank. This policy typically includes complying with AML laws, identifying suspicious activities and filing Suspicious Activity Reports with the Financial Crimes Enforcement Network or acquirer. You’ll also have to validate your level 1 PCI DSS compliance every year by submitting reports to the card brands or undergoing an onsite audit.
5. Meet regulatory requirements: In addition to compliance, tax reporting requirements come with being a PayFac as well, including generating and distributing 1099s annually, or other tax forms, as needed. Keep in mind, if you file a 1099 incorrectly, you could find yourself on the wrong end of a $250 fee.
And if you’re wanting to take a step further and control the flow of funds, or pay your submerchants directly, you’ll also need to apply for a Money Transmitter License (MTL) in every state in which you do business. This, too, requires technology infrastructure to manage — plus fees to obtain and renew your license every two years.
6. Develop merchant acquiring capabilities: Finally, PayFacs need to be fully capable as a merchant provider. This includes handling account servicing, integrating a payment gateway to allow merchants to accept popular payment methods like credit card, debit card and ACH transactions, managing submerchant funding, payout systems, billing, reporting, chargeback disputes and resolutions, and exceptions management — in addition to marketing to and supporting submerchant customers. It’s a lot. But after all, that’s what makes PayFacs so attractive to customers.
So is the traditional PayFac path right for you? Take the quiz:
- Are you staffed to support new merchant underwriting?
- Are you staffed to manage risk and maintain compliance?
- Do you have the technology and infrastructure required to enable submerchants to accept payments?
- Can you hold liability?
- Can you manage merchant contracts?
- Are you staffed to handle billing and collections?
- Are you staffed to take customer support calls?
- Are you staffed to provide marketing support, including direct mail, email, webinars, etc.?
- Are you staffed to handle retention?
- Do you have sufficient capital to fund upfront and ongoing expenses?
- Do you have a big enough client portfolio to generate profit?
- Can your clients handle high processing rate/fee margins?
- Can your clients go without customized pricing and POS solutions?
If you answered no to any of the above questions, don’t throw in the towel yet. The best part is coming up right now.
Payment facilitation the easy way
If it seems like the path to payment facilitation is paved with a huge amount of money, time and scrutiny, that’s because if you go the traditional route, it is. But we have good news. Really good news.
Global Payments Integrated offers a better alternative: Our Embedded Payments program provides ISVs like you with most of the capabilities and advantages of being a PayFac without the burdens and expenses:
With Embedded Payments, using our ProPay® payment facilitation registration, we hold the master merchant account. So you board submerchants and appear as the payment provider to your clients, but you don’t have to go through the time and expense of becoming a registered PayFac yourself. Instead, we handle all the details from simplifying the merchant enrollment process, to processing and directing payments, to managing risk and taking on liability for losses.
At Global Payments Integrated, we offer two program options: Embedded Payments and Payment Facilitation. Here are some broad strokes about what Embedded Payments offers:
- Easy boarding: Establish new accounts in minutes. Merchants are boarded immediately upon completing a short-form application.
- Flexible funding: Set disbursements to automatically deliver from each day’s card activity or use APIs for more ways to customize the funding process.
- Revenue sharing: When your customers accept and process payments, you share in the revenue that’s generated.
- Service and support: Our experts can help with customer concerns, including chargebacks and settlements. We’ll manage cardholder calls, but if you prefer, your team can handle them.
- Billing: We take the complexity out of billing by collecting fees and direct payments, and providing a monthly summary of transactional data.
- Split-payments: Using our split-payments feature, you can collect fees due at the time of transaction. Our disbursement capabilities also make it easy to pay commissions to third parties.
- Sales and marketing support: Our team of experts with 30+ years of experience are here to listen, educate, consult and support you along the way.
Best of all? When you use our Embedded Payments program, you still have the option to transition to becoming a registered payment facilitator yourself.
Contact us today if you’re ready to start your PayFac journey the easy way.
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