PayFac Sooners and Boomers

Proverbs, by definition, simply and effectively express a concept that is generally accepted to be true and has stood the test of time. One that comes to mind when thinking about the payments industry is “timing is everything.”

Timing was important when merchants started working with banks to sell goods and services on credit, it was important when payment gateways began working with online websites to enable eCommerce, and it was important when ISOs formed partnerships with software companies and introduced merchants to integrated payments.

Fast-forward to today, and these arenas are flooded with well-established companies who have already staked their claim, making it difficult for anyone new to find greenfield opportunities and break into these spaces.

But, depending on who you talk to, Roy Banks, CEO of NMI, says Payment Facilitation (PayFac) may be the next wave of “timing is everything” for the payments industry.

This, he says, could bring a once-in-a-decade opportunity to companies looking to enter these segments by staking a claim on a business model that differentiates them from the myriad of other companies that go head to head with each other, mainly over price.

PayFacs can provide that differentiation. Banks says that rather than price, PayFacs compete on value that can be articulated in several ways.

First and foremost, they offer a less painful application process for merchants. Merchants that apply for an account with a PayFac only have to provide answers to about 16 questions and can expect to receive a decision almost instantly. That’s a far cry from the typical application process with a traditional acquirer that many jokingly refer to as “mortgage-esque,” with a decision that takes several days and, often, many back-and-forths.

PayFacs can also compete on service – and use price as a way to express that value, as well. Instead of the difficult-to-explain schemas of tiered, blended and interchange-plus pricing, PayFacs often use flat pricing based on volume. That has the advantage of being more transparent and for merchants to get statements that are much easier to read and understand.

These seemingly small but important changes could spell big opportunity for both traditional and new types of acquirers who put in the time and effort to establish a PayFac presence.

“As an example,” Banks says “we’re already starting to see new players enter this space, primarily companies who create software for merchants.” Historically, he says, these companies have partnered with traditional acquirers to offer enhanced payment services to their shared merchant customers.

This model – integrated payments – works really well, he says, for a couple reasons. First, the software companies have already established a relationship with a merchant and usually have their trust, which is extremely beneficial. Second, since the software companies know their customers very well, it can reduce risk. These things make software companies excellent candidates to become PayFacs themselves.

Banks also believes that in addition to software companies being a good fit as PayFacs, they can use this model as a way to provide a more merchant-centric service.

For example, many software companies use a pay-for-play billing model— think Amazon Web Services where companies just pay for what they use. Banks says that traditional pricing schemas with their set fees and variable discount rates aren’t very compatible with this model, whereas the PayFac flat fee pricing works very well. He further says that the simplified merchant application process makes it possible for software company merchants to simply answer a few questions and essentially “turn on payments” within their service in a matter of minutes. Banks contends that given these possibilities, it’s not hard to imagine that there could be a shake-up in the very coveted integrated payments space.

With all this opportunity at stake, Banks said that he’d expect to see acquirers making a mad dash to their processors to register as a PayFac. Although the number of acquirers registering has sharply increased, Banks has observed that the registration process still has the feel of a well-guarded secret. He believes that’s because processors view the risk of underwriting PayFac acquirers as fundamentally different than the risk of underwriting traditional acquirers and, as a result, they have been slow to approve new ones.

However, as companies like Square, Stripe and PayPal continue to gain momentum, sponsor banks and processors are increasingly willing to approve PayFacs that tend to serve low-risk verticals and more “reputable” businesses. Banks believes that to those acquirers and software companies that want to provide an experience like a Stripe or Square without actually sending their business away to Stripe or Square, this should be very good news.

Banks says that he often gets asked how one actually becomes a PayFac. He says that it is not as mysterious or complicated as some might like the industry to believe. Prior to getting in touch with a sponsor bank and a processor to take that step, he suggests that a few things must be considered.

First, does the potential PayFac have or could they put in place the infrastructure to be a full liability ISO? Since a PayFac is underwritten as the master merchant, they need to be able to manage the risk. Banks says that it helps to be vertically aligned and know the merchant portfolio well.

Secondly, Banks says that there are issues to be considered with respect to technology. Traditional payment gateways have been engineered linearly to work with traditional merchant accounts and aren’t always compatible with the complex hierarchical structure of a PayFac. One of the things that Banks and NMI have done is create a turnkey solution for PayFacs that expedites that part of the PayFac implementation lifecycle. But, Banks says, whether a company buys or builds the capability, they will need to have a plan for handling the technology requirements.

Banks says that once potential PayFacs have addressed both questions, getting started is as simple as getting in touch with a sponsor bank (like Wells Fargo) and a processor (Vantiv and First Data), who Banks says are quite keen to underwrite new PayFacs.

While only time will tell how big of an impact PayFacs will actually have on the payments industry, it has the potential to be very disruptive. Which brings to mind another proverb: Fortune favors the bold!