How Well Do You Understand Payments Processing?

By Adam Hark, Co-Founder, Preston Todd Advisors

I recently had the opportunity to attend a Business Solutions Magazine-sponsored conference for ISVs, VARs, and MSPs. Though not an owner/operator of the aforementioned business types, I do have a keen interest in the goings on of these businesses.

I am a consultant and strategic advisor to payments and payments technology companies and have been on a self-imposed mission to better understand the ISV, VAR, and MSP points of view on payments. Collectively, these business types have become the new darlings of the payments processing industry in its insatiable thirst to sustain growth (and arguably viability) through the value added products, services, and distribution which ISVs, VARs, and MSPs bring to bear.

Through the eyes of a payments consultant, it was encouraging to see how the ISV, VAR, and MSP community has adapted to the changing times and embraced payments. And not just from a tactical perspective, where the immediate value of payments processing translates into a revenue lift by fleshing out the existing suite of products and services, but also from a strategic perspective whereby ISVs, VARs, and MSPs understand the recurring nature of payments processing revenue and that this type of revenue will ultimately bolster the value of their businesses when they exit the market or seek investment capital in the future.

What I also learned at the conference from my discussions with various ISV, VAR, and MSP owners is that, although they clearly have a high-level appreciation and understanding of the added value of payments processing, it’s not clear whether they understand the business mechanics of payment processing: the revenue model, the players in the ecosystem, and the relationships among those players and their integrated software, value added reseller, and managed services partners.

I attribute this observation largely to self-interest of the payments processors. In fact I’m not convinced payments processors even want the ISV, VAR, and MSP community to fully understand the mechanics of payments processing. I drew this conclusion largely from the presentations of the payments processors at the conference. I felt much of the information they offered to the attendees was heavy on sales pitch, but light on education. This is not to suggest the payments companies were doing anything nefarious — they weren’t — but at the end of the day, in a high-interaction environment where the ISV, VAR, MSP, and payments communities are co-evolving and integrating with one another, both at the technology and business level, understanding the nature of one another's businesses is a necessity.

In an effort to shed some light on the mechanics of payments processing for ISVs, VARs, and MSPs, I started thinking of a short list of questions I would ask my payments processing partner in the event I were evaluating a new relationship. With an emphasis on the business mechanics enumerated above (not technical mechanics and integrations where I think the payments processors continue to excel at providing helpful and transparent information flow), I thought of the primary data points I would need as an owner/operator to successfully forge a mutually beneficial relationship.

Question 1: Are you an ISO or an agent?

The answer to this question speaks directly to understanding the payments processing ecosystem and value chain. To best understand your standing with your payments provider, it’s critical to first understand its standing. There’s a payments processing hierarchy, and the position of your payments processor in that hierarchy will dictate how much of the value chain it can capture and the contractual relationships it can have with an end-user. Thus, your payment processor’s standing in the ecosystem in turn dictates what part of the value chain you can capture, and the nature of the end-user relationship you can affect. Because ISOs are positioned above agents in the hierarchy, they have greater revenue generating potential and typically own the end-user relationship, which among many other benefits gives them the right to sell complementary products and services to those end-users. Agents on the other hand are limited in these capacities.

Question 2: What’s my revenue share and why?

As discussed above, the first determinant of how much revenue you can generate from payments processing is your payment processor’s standing in the payments processing ecosystem. The second determinant of how much revenue you can generate from payments processing is the revenue share you negotiate with your payments provider. This is an area where it’s essential you understand the value each party brings to the table. I continue to consult for far too many ISVs, VARs, and MSPs who walk blindly into this negotiation and get burned. Had they come to me first, they would have saved themselves a significant amount of time and money.

As a general rule, I can tell you payments processors are aggressively courting new relationships with ISVs, VARs, and MSPs. The main driver is distribution, although in many cases, particularly with ISVs, it’s the technology. So when you evaluate your next payments provider, go into the process under the assumption that you need it as much as it needs you, and make sure to clearly understand which products and services each party is providing to the end-user. Once you’ve mapped out and understand the value each party is actually bringing to the table, you’ll be in a much better position to properly negotiate and equitable revenue share with your payments processing partner.

Question 3: Will I still own the end-user/client relationship?

To an M&A advisor like myself, no question is more important to ask your payments processor than this. I advise company executives every day on value creation, valuations, acquisitions, and exits. In my line of work, the relationship a company has with its end-users/clients is a primary component of value creation and a tier one driver of a company’s worth, particularly in segments where a company’s relationship with its end-user is contractual, as with ISVs, VARs, MSPs, and payments processors. Owning the end-user relationship is critical to a company’s worth. As both the payments and ISV/VAR/MSP communities continue to thrive in economic mutualism, the question as to which party owns the end-user relationship is now becoming a front and center issue.

Payments processors have historically been very adept at contractually securing the end-user relationship through the merchant agreements they employ, and rightfully so in a recurring revenue model. VARs and MSPs in particular, many of which have been inured to a time and money (T&M) revenue model for break/fix and project work, are just starting to embrace recurring revenue and its importance in creating enterprise value. Because of this, they are just now getting comfortable with, and seeing the value of, long term, contractual relationships with their clients. Thus, there exists an informational asymmetry with the payments processors that can be hazardous and detrimental to the value creation of ISVs, MSPs, and VARs: if the payment processor is securing contracts directly with their end-users, those end-users are now the payment processor’s clients too, which can devalue the former’s business’ worth.

Take Aways
Independent software vendors, value added resellers, and managed services providers are in the payments processing game, and payments processors are in theirs. This is as much a reality today as the earth revolving around the sun. What is not yet a reality though is a balance in value creation across both communities. I would argue that the cause of this imbalance, which at the moment favors the payments community, is largely attributable to a developing but not yet complete understanding of the mechanics of payments processing by their ISV, VAR, and MSP partners.

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 adam.hark@prestontoddadvisors.com or 617-340-8779.