The payments industry is booming, and it seems like every software company wants to become a payment facilitator. A payment facilitator is a type of payments intermediary that signs up merchant customers ("submerchants") to process payments through the payment facilitator's account with a sponsor bank, directly or through a payment processor. While integrating payment facilitation into a software offering has many advantages, including the ability to provide a critical service to customers, greater control over customer relationships, and an additional source of profit, it also presents a number of regulatory, contractual, and operational challenges and risks.
In this first article, we provide an overview of the top five issues that a software company should consider before diving into payment facilitation. In subsequent articles, we will address these issues in greater depth to provide a roadmap for successfully integrating payments into a software platform. While the concept of becoming a payment facilitator is simple in theory, there are a number of regulatory, contractual, and payment network requirements that require careful planning.
- Develop a compliance infrastructure. The starting point for launching any new line of business is the development of a business plan and the hiring (or training) of management and personnel. For software companies in particular, this is a critical step, as most software companies do not have compliance programs designed to address the unique challenges presented by payment facilitation, including risk underwriting, due diligence, and monitoring functions. As a payment facilitator, you incur responsibilities for underwriting and monitoring the submerchants that you bring into the payment system. These responsibilities are intended to protect the payments system from financial risk of loss and to guard against reputational and regulatory risk that may be caused by a submerchant's marketing or business practices. In addition, your sponsor bank may impose contractual compliance obligations on you, based on its own legal and regulatory requirements, including anti-money laundering requirements, as well as those required by the operating rules of the card networks. While some underwriting and monitoring functions may be automated, you may be limited in how much you can automate your risk management tools by your acquiring partner or the nature of your submerchants' lines of business. Implementing a robust compliance program is not just about managing financial risk—federal and state regulators have been aggressive in bringing enforcement actions against payments companies that fail to adequately underwrite and manage their merchant portfolios.
- Choose an acquiring partner carefully. You'll need an acquiring bank or other acquiring partner that can help get you registered as a payment facilitator and provide processing and settlement functions through the card networks. Fortunately, there are many to choose from. However, there may be differences in how each acquirer manages its program that may impact your business goals and needs. Some have different products for settling funds. Others may require exclusivity. Of course, pricing is always a consideration. You might also consider whether you need your acquiring partner to handle (for a fee) certain other responsibilities that you might incur as a payment facilitator, such as 1099-K tax filings and escheat reporting for unclaimed submerchant funds. Some acquirers may be more accustomed to your business vertical than others. You will also need to consider how you will be paid for the payments services you are providing. Will you invoice your customer for fees, obtain your fees via an ACH debit to the customer's account, or have the acquiring bank withhold your fees from settlement and deposit those fees into your account? Regardless, you'll want to be sure your contracts with your acquiring sponsor and your customers clearly cover all of the issues associated with settlement and fees. Thus, it is worth checking around and comparing the differences to find the right partner.
- Solve the money transmission licensing conundrum. The payments ecosystem has many layers, and a payment facilitator's role in the flow of funds may subject it to licensing requirements and regulations governing money transmission. If you take deposit of your customer's sales proceeds into your account first, and then pay out your customer, you may be viewed as a money transmitter under the laws of several states. Obtaining money transmission licenses is a costly and time-consuming process—many acquirers now provide the option of settling funds directly to your submerchants, so that the payment facilitator never takes custody of those funds. This arguably means that the payment facilitator is not engaged in money transmission and is not required to obtain licenses.
- Develop solid agreements with your submerchants. Once you have signed on with an acquiring partner to sponsor your payment facilitator program, you'll need terms and conditions for the payments services that you will provide to your customers. In some cases, your acquiring partner may have terms and conditions that you can use or adapt that cover the operating requirements of the card networks. You'll likely want to supplement those terms with additional provisions that protect you from the submerchant's failure to operate its business in a manner that complies with applicable laws and regulatory requirements. You may also have certain business and other terms to include in your version based on the broader suite of services you offer to your submerchants. You may add payment services terms as an addendum to your existing master services agreement or start with a new agreement altogether. For customers that process more than $1 million annually in Visa or Mastercard transactions, the submerchant will need to enter into a direct agreement with your acquiring partner (in addition to any terms and conditions you impose). For smaller submerchants, some states, including Maryland, Arkansas, and Tennessee, impose specific requirements on issues like termination rights and early termination fees for certain types of submerchants. In sum, the customer agreement needs careful attention to ensure it is effective, comprehensive, and compliant.
- Consider your data rights and obligations. One of the core benefits of integrating payments into an existing software platform is that it provides the software company with additional data and insight into its customer's activities. This, in turn, allows the software company to better serve its customers, including by offering new and expanded services. To take advantage of these opportunities, however, your company will need to make sure it retains control over (or at least access to) the submerchant data in its bank sponsorship agreement. The flip side is that the more data a company collects, the more it is subject to regulatory requirements. This includes compliance with federal, state, international, and network laws and requirements, such as the federal Gramm-Leach-Bliley Act, the California Consumer Protection Act, the GDPR, and PCI-DSS.
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Considering the various complexities of setting up a payments program, having or hiring a qualified payments expert to manage the process and program may be a good investment. Expect it to take some time to launch your payment services—negotiating with an acquiring partner can take months. Even if you get a head start by drafting your risk management policies and customer-facing agreements early, those may be impacted by the requirements of your acquiring partner. Depending on your line of business, you may want to use this time to revisit your other services agreements to ensure that they align with the new payments services you will provide. In the end, getting your payment facilitator program up and running should be a worthwhile endeavor, with benefits to both you and your customers.
Stay tuned for future articles that take a deeper dive into these key issues that a software company should address before beginning payments facilitation.