Optimizing Your ISV for Payments Processing
By Adam Hark, Co-Founder, Preston Todd Advisors
Independent software vendors have seen the light with regard to recognizing and appreciating the value of payments processing. Once an overlooked service offering and revenue stream, payments processing has risen to celebritydom in the software community as a way to flesh out an ISV’s existing value proposition to its end-users, and as a long term strategic play for enterprise value creation through the high quality, recurring revenue that it brings to bear. The recognition of the value of payments processing by ISVs has catalyzed vertical integration and strategic partnerships between software and payments companies, and has compelled ISVs to pay much closer attention to negotiating an optimal relationship with their payments processing partners.
But before ISVs and their payments processing partners enter into the discussions about parsing out revenue splits, and which party is responsible for which spectrum of customer service, there’s a more fundamental question all ISV owners should be asking themselves about how best to optimize their platform for payments processing: short of merging with or acquiring a payments processing company, am I better off structuring a strategic partnership with a payments provider, or should I become a payments provider myself?
An important clarification: the term payments processor gets used very loosely in the electronic payments and software worlds. In regular, day-to-day parlance, payments processor refers to any entity that sells payments processing services to businesses or merchants. For the purposes of this article, payments processors refers to the entities which actually process those electronic payments, as well as entities which own and operate large data and communication centers that transmit information and move monies back and forth between issuing banks, sponsor banks, and merchants. Examples of payments processors are Vantiv, TSYS, Elavon, First Data, and Global.
What does it mean to become your own payments provider?
There are three main types of entities on the acquiring side of the payments processing ecosystem with which an ISV can secure a payments processing relationship. In order of their hierarchical standing from top to bottom, they are the payments processor (as defined above), the independent sales organization (or ISO), and the merchant level salesperson (MLS or agent).
The differences between the entities at the top of the hierarchy and those at the bottom are largely attributable to the percentage of the value chain that each entity captures (how much revenue each entity can carve out for itself), and the depth of the relationship that each entity has with its end-user (often measured by whether or not the entity has an ownership interest in the services agreement or contract with the end-user).
In most cases, ISVs with payments integration are set up as agents of ISOs, where the ISO provides a merchant account (to accept payments processing) for the end-user, and the ISV receives a percentage of the payment processing revenue from the ISO for the referral. This type of relationship is called an indirect relationship.
But there are also those ISVs that have elected to become the payments provider themselves, having negotiated a direct relationship with the top level entity in the payments ecosystem hierarchy — the processor. In these cases, the ISV has registered with the card networks (Mastercard and VISA) and a bank sponsor (Wells Fargo, Fifth Third, and US Bank are some of the larger ones) for the right to market and sell payments processing services directly to its end-users. In doing so, these ISVs have full control over the end-user relationships, and because they no longer have to split the revenue with an ISO, they are able to capture 100 percent of the payments processing value chain. In this scenario, the ISV is the ISO.
What are the drivers for an ISV to go direct with a processor and become an ISO?
As I’ve already discussed, two of the most significant benefits to an ISV going direct with a processor and becoming an ISO, as opposed to partnering with an ISO, are the retention of a greater share of the payments processing revenue and a greater depth of ownership of the end-user relationship. But these two propositions aren’t the only factors an ISV must consider. Here are a few more of the higher level considerations ISVs must contemplate, which drive the decision making process:
Pulling the trigger…should I become an ISO?
You’re a large ISV experiencing healthy, double digit year-over-year growth, top-line and bottom-line, and you’re sitting on cash, extra office space, and human capital who possess a working familiarity with payments processing. You’re currently receiving a revenue share from another ISO that is delivering payments processing to your clients. If this describes your organization, you should contact an advisor to help you flesh out the costs/benefits analysis and see if it makes sense to go direct with a processor. As you’re currently constituted, it’s very likely that you’re giving up revenue, and a very valuable ownership interest in the end-user relationship, for no other reason than that you weren’t properly advised of the benefits of going it alone, and provided with roadmap on how to get there.
Adam T. Hark is Co-Founder of Preston Todd Advisors. With over a decade of experience in payments, payments technology, and FinTech, Adam advises clients in M&A, growth strategy, exits, and business and portfolio valuations. Adam T. Hark can be reached at firstname.lastname@example.org or 617-340-8779.