Mark Dunn
January 26, 2023
min read

In seventeen years of consulting and coaching developers, payfacs, ISOs, and independent agents selling merchant processing, I’ve always explained that there are two paydays in the payments business.  The first payday is the monthly check you get – most folks call this the residual.  The residual is the difference between A) what you are charging the merchant for processing and B) the cost you’re being charged for the processing of the merchant’s transactions, times C) the percentage of the residual share that belongs to you under your agreement with the processor.  The result is your residual.

Expressed as a formula:  (A-B) x C = Residual

Before we get into the second payday, let’s look carefully at the components that go into the formula for the monthly residual.  First, consider part A) – what you are charging the merchant for processing.  How do you know how to price payment processing services to the merchant?

If you’re a developer and just starting in payments, you won’t have many solid indicators of how you should set your price for payment processing to the user of your software.  First, the best advice I can give here is to look at your competition.  How do they price payments processing?  Second, find a friendly user of another software and get a copy of their processing statement.  You may have to work with a payments consultant to help you determine what the rates and fees are.  Third, take your cues from a big player and come in a little under them.  If the large competitor is pricing transactions at 2.9% and 30 cents a transaction, price your processing a little under that.  Remember that the value-added nature of your integrated software and payments will allow you to charge a little more than plain vanilla payments processing.

The second component of the residual formula is the cost you’re being charged for processing the merchant’s transaction.  For the ISO or independent agent, these costs are most often given on Schedule A attached to the ISO or independent agent agreement.  Schedule A can be divided into three types of fees:  1) Transaction related fees, 2) Monthly fees, 3) Per Incident fees, and 4) Program or product-related fees.

Transaction-related fees include authorization, capture, settlement, address verification fees, and other transaction fees.

Monthly fees include an account on file, statement fees, remote access system fees, etc.

Per incident fees include back-office fees, chargeback and retrieval fees, ACH reject fees, and so forth.

Program and product fees include such things as PCI data security fees, terminal or POS product fees, and so on.

The Schedule A of the ISO agreement usually states that the interchange, dues, and assessments billed by the card brands to the financial institution – the sponsor bank, if you will – are passed through to the ISO or agent at cost.  Pass-through means they are not marking up the interchange to you.  Then the Schedule A lists the cost for risk – most often identified as the BIN sponsorship fee and expressed as a certain number of basis points, for example, 1.5 BP, or 0.015%.  After that, Schedule A usually lists the cost of authorization and capture of the individual transaction, expressed as cents per transaction, for example, 3.5 cents.  Sometimes the cost for authorization and capture will include the cost of settlement of the transaction.  However, settlement of the transaction is often listed as a separate fee, for example, 1.0 cents.

The third element of the formula for your residual is the share percentage (item C above).  If you are a registered payments facilitator or a registered ISO, your share percentage will probably be 100%.  That means you keep all of the gross profit.

However, many “payfac as a service” users or smaller ISOs may have a residual share in their agreements.  Typically, these will run between 70% to 90%.  This means the software developer or small ISO will get this percentage of the gross profit, and the services provider or processor will keep the rest.  

So, thank you for your patience as we finally get to the second payday.  The second payday is the cash payout when you sell the merchant accounts portfolio or sell the entire business.  The merchant portfolio has a value of all of its own.  This is usually expressed in terms of a multiple of the monthly residual.  A multiple of 42 for a portfolio with a monthly residual of $100,000 means the valuation is set at $4.2 million.  

Many factors can affect the valuation of a payment portfolio.  The three most important are 1) the size of the portfolio – the number of merchant accounts, the total monthly processing) 2) the profitability of the portfolio – the number of basis points of profit per volume of processing and 3) the merchant attrition – expressed as loss of merchant accounts, loss of dollars of processing.

To maximize the second payday, you will need to make sure you understand who owns the rights to sell, to whom you may sell, whether you need the approval to sell, whether your processing agreement is assumable by the buyer and many other factors.  All of these will be spelled out in the payfac or ISO agreement.

To sum up, pricing policy, profitability, and maximizing your paydays are complex subjects.  You can learn a lot by doing your research.  But you should seek help from an independent payments professional.

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