Everything You Need to Know About Embedded Payments, but are Afraid to Ask

August 15th, 2022

Illustration of a woman with a question mark in a thought bubble over her head.

Embedded payments has become a hot topic in the SaaS world. Many SaaS leaders don’t understand what embedded commerce is, why investors are interested in software companies that are embracing it, or how to create a strategy that generates the results they desire.

The payments industry is not easy to navigate. There are many different types of embedded payment models and each has its own unique challenges. We have seen countless companies select a model that goes against their ultimate goals. Leaders get distracted by promises of “quick integration” and “risk free payment processing” and forget to think about their goals five years down the road.

The decisions you make about payments today will impact your options tomorrow. This article discusses the pros, cons, and associated risks of the four major embedded payments models. We hope to show you how payments can be a strategic asset that maximizes revenue and enterprise value.  But first…

What is embedded payments and why is it important?

The payment industry is not very creative with its naming conventions. Embedded payments is exactly what it sounds like: payment processing that is built into — or embedded in — a larger software application or platform (e.g. business management software, travel software, etc.). You will also see embedded payments referred to as embedded commerce. It’s the same thing, just a different word.

Merchants (i.e. your customers) actively seek out software with embedded payments because it:

  1. decreases the types of software merchants need to purchase in order to run their business.
  2. gives merchants access and control over all aspects of their transactions

Investors actively seek out SaaS companies that have embraced embedded payments because they can:

  1. maximize new revenue opportunities, which leads to greater profits for all parties involved.
  2. increase the stickiness of the software and generate consistent revenue.

Where do I start?

We’ve noticed a lot of SaaS companies making quick decisions and implementing an embedded payments solution without understanding the consequences. The payments industry is complex, fragmented, and ever-changing. This is not a situation where you want to try running before you can even walk. The decisions you make today will impact your options in the future. Take your time and do your research. Otherwise you risk making payments a growth blocker instead of a revenue driver. Before you even look at potential embedded payment models, ask yourself the following questions:

  • How much risk and liability are you willing to take on?
  • What earning potential are you hoping for?
  • Can you afford to take on additional operating expenses?
  • How quickly is your business growing?
  • Are you hoping to be acquired in the near future?

The answers to these questions are what will determine the right choice for your business.

A quick note on being acquired:

Monetizing payments can either positively influence your business’ valuation, or have no impact at all. If you want to increase your exit multiple, you need to think like a strategic buyer. In many cases, investors want to work with payment providers that are already in their network. You need to find an embedded payments solution that gives you ownership and control over your payments portfolio. This will allow investors to migrate to whatever payments provider they prefer without causing disruption to your customers or revenue streams. Owning your payments portfolio is key to negotiating a higher exit multiple.

What are my options?

There are four main embedded payments models and each option has its own unique benefits and drawbacks. This following information provides a high-level overview of each embedded payments model, including the pros, cons, and associated risks for each.

Referral Partner

Becoming a referral partner is the most risk-free way to get to revenue fast, and is often considered the “entry level” for monetizing payments. Typically, you will set up a referral relationship with a registered ISO (independent sales organization). When your customers express interest or a need for a payments service, your team refers them to the ISO — which provides sales and support. If your customer is successfully onboarded and starts processing payments, you are paid a percentage of the revenue generated from that customer’s transactions. The primary benefit in this model is that you gain a new revenue stream with little to no operational expense.

Pros

Cons

  • Quick speed-to-market and time-to-revenue Since you are only referring leads to the ISO, there is no software that needs to be developed or integrated. You simply need to train your team on the proper hand-off procedure and you’re ready to go. 
  • ISO owns the payments portfolio As part of the contractual agreement, the ISO retains your customers’ processing data and payments services contracts. This severely limits your asset value from a payments perspective. 
  • No risk or liability The ISO handles all of the sales and support for the payment processing service. Your company is not responsible for any risk or liability associated with payment processing. 
  • Most ISOs have non-compete clauses in their contracts If you decide to change payment partners (or evolve into a payments company) you will not be able to migrate your customers to the new payments service. 
  • No underwriting or compliance management Because the ISO is responsible for sales and support, you do not have to bring any aspect of payment processing in-house.
  • Profitability is limited by revenue share The amount of revenue you’re able to bring in as a referral partner is completely dependent on the revenue share in your contract with the ISO. 

 

  • Less control over the user experience Once you refer a merchant to the ISO, you have no control over the experience they have. A poor customer experience with the ISO could reflect poorly on your brand. 

Risks

There is very little financial risk associated with being a referral partner. However, if you decide to end your relationship with the ISO for any reason, you will experience a significant loss of revenue (at first). As mentioned above, most ISOs have non-compete agreements, so you are unable to transfer your customers to a new payments provider. This means you lose any payments related revenue from these customers.

Even if the ISO you’re working with doesn’t have a noncompete clause, you will be forced to create a new payment service application for (i.e. rewrite) every single merchant account you want to switch over. Your merchants can choose to stay with the current ISO, look for another payments provider, and/or renegotiate contract terms to be in their favor. You should only expect to maintain 10 percent of your revenue margin if you decide to end your relationship with your payments provider.

However, you may be able to recoup your lost revenue if you make a strategic move to a better partnership and/or embedded payments model. If a different model will give you increased earning potential, it may be worth the initial revenue loss.

PayFac

When compared to being a referral partner, becoming a payment facilitator (PayFac) not only increases revenue, but also gives you more control over the relationship with your merchants. However, there are considerable operational costs when implementing this embedded payments model.

The initial registration and onboarding procedure to become a PayFac takes over a year to complete. You need to register with a sponsor bank in order to get a shared bank identification number (BIN) for you and all of your customers. Your business acts as the master merchant account and your customers become sub-merchants under you. As a PayFac, you are responsible for managing risk and compliance. The primary benefit of this model is that it circumvents the need for every customer to obtain an individual merchant identification number (MID). This creates an awesome customer experience by saving them time and frustration.

Pros

Cons

  • Increased revenue opportunities — Unlike a referral partner, you don’t have to share revenue with another company. All the revenue generated from onboarding merchants goes straight to your accounts.
  • Slow speed-to-market and time-to-revenue —The process of becoming a PayFac is long, frustrating, and full of red tape. It will take more than a year before you can start earning revenue from payment processing. And even longer to break even.
  • Rapid customer onboarding — Because you share a BIN with your customers, you’re able to onboard them quickly. The more customers you onboard, the faster you can recover the upfront costs of becoming a PayFac.
  • Increased operational costs — Because your sub-merchants are sharing your BIN, you are responsible for every aspect of payment processing for your customers. You will need to hire more staff, invest in technology and software, and stay up-to-date with all the advancements in the payments industry. 
  • Control over customer experience — You are providing all the sales and support for your customers. You have complete control over processes, standards of service, and all other aspects that create a great customer experience. 
  • Risk and compliance management — The responsibility to manage risk of all your sub-merchants is now yours. If a sub-merchant violates laws or policies, you bear responsibility as the PayFac. 

Risks

Whereas a referral partner has no risk attached, a payment facilitator must intensely manage risk, liability, and compliance for every sub-merchant they onboard. This requires very robust technology for underwriting, and dedicated staff to undertake this endeavor. You are responsible for paying the chargeback and decline fees for the sub-merchants you have functionally vouched for. Failure to properly manage the risk of your sub-merchants will result in mounting costs that can swiftly outpace any revenue you hoped to make in the first place.

Becoming a PayFac requires a substantial investment of both time and money. It is difficult to recover financially if this model does not deliver your desired results. In many ways, it is a one-way road that you can’t come back from.

PayFac-as-a-Services

PayFac-as-a-Service is essentially a white-lable version of a referral partnership under a PayFac. However, it does require a little more effort upfront. Typically, your company will be registered under the PayFac as a sub-merchant. From there, the relationship with the PayFac acts like a referral partner. The primary benefit of this model is that you can onboard customers rapidly without taking on the risk and liability of a PayFac.

Pros

Cons

  • Quick speed-to-market and time-to-revenue — While your company does need to go through an underwriting process, most PayFacs will get your payment processing service live in 30-60 days. Many PayFacs split up the underwriting process, allowing you to complete it over time instead of all at once.  
  • PayFac owns the payments portfolio — Since you are registered under the PayFac’s shared BIN, they retain your customers’ tokens and payments services contracts. You will not be able to migrate your customers to the new payments service. 
  • No risk or liability — You are registered as a sub-merchant under the PayFac. They maintain all the risk and liability of payment processing for you and your customers.
  • Transaction and volume limits are set by the PayFac — PayFacs split up the underwriting process in order to make it less labor intensive upfront. There are often transaction and volume limits associated with these breaks in the underwriting process. The more transactions your sub-merchants have, the more information the PayFac requires. This often results in some form of continuous underwriting, which can frustrate your customers.
  • No underwriting or compliance management — The PayFac is responsible for managing all compliance and underwriting needs. You do not need to bring any aspect of payment processing in-house.
  • Payment holds and disruptions — PayFacs frequently will place a hold on sub-merchant accounts. These payment disruptions are often related to compliance or risk management, but it can be extremely detrimental to merchants that rely on those funds being available in order to pay bills and payroll. 
  • Fast and frictionless customer onboarding — Because your customers don’t have to obtain a MID, you can onboard them in a matter of minutes.  
  • Less control over the user experience — You have very limited control over your customers’ payment processing experience. If your customers deal with frequent payment holds or disruptions, it could reflect poorly on your brand. 

Risks

PayFac-as-a-Service is a quick and easy way to get started and gain revenue. However, it is not designed to adapt or change with the needs of your company. If you need to change providers — or if you want to become a payments company — you would have to go to every single customer and ask them to rewrite their merchant account. Just like a referral partner, you can expect to maintain roughly 10 percent of your revenue margin if you decide to terminate the relationship with your payment facilitator.

However, this loss does not have to be permanent. Making a strategic transition to a different payments model can help you recoup the revenue you lost and/or create greater earning potential for your business.

Wholesale ISO

Becoming a Wholesale ISO grants you significant control over your customers, but restricts your autonomy in other ways. As an ISO, you become the frontline sales and support arm for one or more sponsor bank(s). There are strict financial guidelines and merchant requirements issued by the sponsor bank, including the credit policy (i.e. underwriting criteria) for each merchant you onboard. You are required to follow every guideline, rule, and requirement the sponsor bank puts in place. However, the sponsoring bank maintains responsibility for chargebacks, decline fees, and other risks associated with payments. The primary benefit of this model is a larger revenue share with minimal risk.

Pros

Cons

  • Increased revenue share — Because you partner directly with the sponsor bank, you are able to collect more revenue for each sale.
  • Slow speed-to-market and time-to-revenue — It takes at least six months (usually longer) to become an ISO. The process is not as rigorous as becoming a PayFac, but it does require you to commit to upfront costs.
  • Control over customer experience — You provide the frontline sales and support for your customers. You control most of the customer-facing processes, services, marketing, etc. and can curate an incredible experience.
  • Increased operational costs — Depending on your sponsor bank, you may need to hire a support team and/or increase the size of your sales team. This will naturally increase the revenue you need to generate just to cover your operating costs.
  • Minimal risk and liability — Becoming an ISO requires you to take on more risk than a referral partner or PayFac-as-a-Service, but not as much risk as a payment facilitator.
  • Mandatory card brand registration — ISOs are required to pay $10,000 every year to each card brand their payment processing supports. Most merchants need to accept the three major card brands (i.e. VISA, MasterCard, and American Express). You should plan on an extra $30,000 per year for operating expenses.
  • Dynamic operational responsibility — Different sponsor banks have different requirements for the ISOs they partner with. If the sponsor bank has a robust support team, you may not have to create an in-house team.
  • Sponsor bank is the ultimate authority — The bank has the final say on what merchants get approved. Even if you’ve made a sale, the bank can choose to reject the merchant if they don’t match the bank’s underwriting criteria. This can be very demoralizing to your sales team.
 
  • Required revenue goals set by the sponsor bank — Part of your contract includes a monthly revenue goal, which is set by the sponsor bank. If you do not meet that goal, the difference is deducted from your residuals (i.e. revenue share).

Risks

Becoming a Wholesale ISO is a substantial financial commitment. While you do not take on the risk and liability of payment processing, there is still significant financial risk due to your contract with the sponsor bank(s). The industry standard is a five-year contract. As mentioned above, part of that contract includes revenue goals that are set by the bank. The annual revenue goal increases each year of your contract. For example, you might be expected to pay $50,000 in year one, $75,000 in year two, $100,000 in year three, and so on. If your revenue goals are not met, the difference will be deducted from your residuals (on a monthly basis). This can create a significant domino effect where a bad month for sales prevents company growth, or even forces lay-offs and other financial problems. Companies can get caught in a downward financial spiral that leads to bankruptcy. 

What is the right embedded payments model for my business?

That’s the million dollar question, isn’t it? Honestly, there isn’t one correct answer. The right choice for you depends on what you’re hoping to accomplish. Remember those questions we told you to think about? This is why we said you need to answer them before you start looking at different embedded payment models.

risk and liability earning potential diagram

Most companies want an embedded payments solution that gives the highest earning potential, with the least amount of risk and liability. Unfortunately, that’s not how these four models work. If you want low risk, you have to accept low earning potential. If you want more earning potential, you have to take on more risk. And once you pick your model, you can’t change your mind without severe consequences.

It is a fundamental flaw in the payments industry that companies are not able to transition between embedded payment models. Ideally, you would start as a referral partner and transition to an ISO or PayFac as you gain the necessary experience. However, current contracts with payment providers make transitioning to different models extremely difficult. You risk losing substantial amounts of revenue and disrupting service to your customers every time you change providers. If only there was a model that allowed you to evolve strategically and at your own pace… Oh wait, we do that!

What is Nexio and why should I choose it over other models?

The issues with the other embedded payments models revolve around the ownership of the payments portfolio. Owning your portfolio is what enables you to adapt and change your payments service. Historically, you have to become a PayFac or ISO to have control over your portfolio. We’re changing that.

Our contracts ensure you maintain ownership of your payments portfolio. This not only establishes you as an equal partner in our relationship, but also allows us to provide customized solutions and scale at a pace that works with your business. Instead of implementing an embedded payments model, Nexio empowers you to implement an embedded payments strategy.

Typically, we advise SaaS companies to start out in a similar role as referral partner. It acts as a proof of concept and allows you to earn additional revenue quickly. You can evolve from there to take on more operational responsibility and increase your earning potential as it makes strategic and financial sense for your company.

Pros

Cons

  • Quick speed-to-market and time-to-revenue — We have streamlined our development and integration processes. Most of our clients can push their payment processing service live between 60 to 90 days.
  • Designed for ambition — Our platform was designed to help tomorrow’s innovators reach their goals. If strategic thinking and planning is not in your wheelhouse, Nexio is not the right choice for you.
  • Rapid customer onboarding — We offer the same rapid customer onboarding experience as the PayFac-as-a-Service model, without the drawbacks.
  • Requires attention to detail — Nexio is meant to help you drive conversion of your payment services at profitable margins. But you have to care about the details to get the best results. This is not a solution you can “set and forget” if you want to maximize your revenue potential.
  • Strategic transition between models — Because you maintain ownership of your payments portfolio, you are able to make adjustments to your payments strategy at your own pace.
  • Needs a collaborative mindset — We know payments, you know your software. The quickest path to success starts by working together to create a strategy to reach your ultimate goals.
  • Dynamic operational responsibility — Take on sales, support, and underwriting responsibilities, or don’t. You decide what operational responsibilities you do or don’t want at the times that make sense for your business.
 
  • Payment portfolio ownership — Owning your payments portfolio gives you a level of control and adaptability over your payments strategy that will build asset value and command a higher exit multiple.

Risks

There is always risk associated with payment processing. You can’t get away from it. But Nexio is specifically designed to minimize the risk and increase your opportunities for success. You are able to learn about the payments industry and take on additional risk and responsibility when it makes strategic sense. You do not have to take on any additional responsibilities or operational expenses until you are financially and operationally prepared to do so.

Nexio is meant to make your commerce future strategic—because a strategic future means your options will never be limited.

risk and liability earning potential diagram

Glossary of Terms

  • Bank Identification Number (BIN): The first four to six digits of a credit card. The bank identification number identifies the institution issuing the card. Acquiring banks are also assigned a BIN number to distinguish them from each other.
  • Card brands: VISA, MasterCard, American Express, etc. They are the governing body of payments.
  • Chargeback: The result of an action taken by a cardholder who disputes a credit card transaction through their credit card issuer. The card issuer initiates a chargeback against the merchant’s account. The sale amount of the disputed transaction is immediately debited from the merchant’s bank account. Merchants typically have 10 days in which to dispute the chargeback. This may be accomplished by providing the card issuing bank with a proof of purchase by the cardholder. This could be a signature or proof of delivery. A chargeback fee is generally assessed to the merchant account by the merchant bank for the handling of this process.
  • Merchant: A buyer and seller of commodities for profit.
  • Merchant Identification Number MID: The unique authorization number issued to each merchant by their payments processing provider. This is required to accept payments.
  • Payments portfolio: Your customers’ payments service contracts. Ownership of the payment portfolio depends on your contract with a payments provider.
  • Risk: The likelihood an onboarded merchant will be subject to high quantities of chargebacks or declines, such as being in a more scrutinized industry or subject to frequent fraud that might indicate they are not taking measures to secure their own business effectively. Continual victims of these problems will likely need to be removed from the payments service.
  • Risk management: Mitigating the risk of chargebacks, declines, and fraud.
  • Sponsor banks: CBCAL/CHES/Merrick/DB, etc. In order to be able to board merchants you need to be able to have a sponsor bank that is supporting you, with a BIN to place them in. They take a small amount of your revenue and ensure your relationship with the card brands is solid.
  • Underwriting: The process of assessing financial risk of merchants to ensure they are legitimate, stable businesses.

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