PayFac vs ISO: What’s right for your SaaS platform? 

July 10, 2024

Patrick Huynh

As a growing software company, you may feel you’ve reached a point where you’re ready to start taking your payments seriously.

But you might be feeling confused by the different payment models out there. You’ve seen businesses like Square thrive on a PayFac model. Does this mean that your business should become a PayFac as well? Or is an ISO model a better choice?

To help you make a decision, we’ll run you through the differences between PayFac and ISO, three common misconceptions about PayFacs, and how Fiska can help you elevate your payment strategy. 

In this article: 

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What’s the difference between a PayFac and an ISO? 

Before deciding on which model is best for our business, it’s important to fully understand what a PayFac is and how it differs from an ISO. 

Here are the differences at a glance:

Feature PayFac (Payment Facilitator) ISO (Independent Sales Organization)
Speed of onboarding merchants Fastest. Onboards merchants in real-time, allowing them to start accepting payments almost immediately.
More control over onboarding. Creates sub-merchant accounts under a master merchant account, providing more control over the merchant experience and processes.
Usually slower. Requires sponsor bank to underwrite each merchant account before processing, which can take 24-72 hours.
*ISOs with liability, who do their own underwriting can on-board merchants very quickly.
Less control over onboarding. Facilitates separate merchant accounts with acquiring banks, which means bank policies (such as pricing) impact merchants more significantly.
Level of risk management More risk. Underwrites merchants after they start processing payments, such as customizing onboarding procedures, setting transaction limits, and managing payouts directly. Less risky. Acquiring bank handles most risk. Underwriting must be completed before merchants can process payments.
Revenue potential Equal. Directly collects fees from sub-merchants, offering more control over pricing and revenue streams. However, an ISO can often end up being more profitable due to the high operating costs of being a PayFac.
If you use a PayFac-as-a-service provider, their high rates can lead to reduced revenue.
Equal. Earns residuals from transaction fees but usually has less control over pricing.
Some ISOs can earn as much (and more) as PayFacs.
Operational complexity Higher. Full responsibility for underwriting, compliance, and risk management, making operations quite intensive. Lower. Bank handles underwriting and compliance*, simplifying operations.

*Unless they’re an ISO with liability.

Flexibility of funding cycles More flexible. Can manage merchant funding more flexibly, offering customized pricing and funding cycles (such as funding your merchants weekly instead of daily). Less flexible. Merchants receive funds directly from the acquiring bank, with less flexibility in funding cycles.
Compliance requirements Extensive. Has extensive reporting requirements to ensure compliance and provide visibility into sub-merchant activities. Standard. Must co-brand with the sponsor bank and adhere to registration and reporting standards, which is mostly managed by the sponsor bank.

*Unless they’re a Registered ISO (registered with the Card Association).

Operating costs Higher. High initial setup costs ranging from $30,000 to $50,000, plus additional compliance and ongoing platform fees. Lower. For registered ISOs, initial registration costs of $10,000 per card brand (Visa and Mastercard) and an annual fee of $5,000, with lower ongoing operational costs.

Referral ISO’s don’t need to pay these fees.

What is a PayFac?

A payment facilitator (PayFac) acts as a large-scale merchant account. When a software company becomes a PayFac, they become the master merchant account (merchant of record) and can onboard their customers that receive sub-merchant accounts under their umbrella. Adding a new merchant just requires assigning them a Merchant Identification Number (MID).

Even though as a PayFac you would still use your sponsor banks to process transactions, you are responsible for compliance with regulations and managing the risks associated with sub-merchant transactions. You would also have to submit monthly (or sometimes quarterly) reports to Mastercard and Visa.

For example, Square operates as a PayFac. When merchants sign up, Square creates a sub-merchant account under Square’s master account. This allows merchants to start accepting payments quickly without establishing a direct relationship with a bank or a traditional payment processor.

Another significant advantage of being a PayFac is the ability to onboard merchants rapidly, with underwriting typically occurring after the merchant is onboarded (although this isn’t necessarily a good idea. More on that later).

payfac explained 

Image by Matt Brown 

What is an ISO?

An Independent Sales Organization (ISO) acts as an intermediary between merchants and payment processors. Unlike a PayFac, an ISO doesn’t create sub-merchant accounts for their merchants. Instead, as an ISO you serve as a reseller for an Acquirer, a sponsor bank. 

There are three main types of ISOs:

1. Referral partner: At the most basic level, an ISO works as a referral partner, marketing its services with its sponsor bank. All marketing materials will disclose the sponsor bank’s name (such as ‘Powered by Bank X’).

As an ISO, you refer your customers to the bank and then receive revenue as a percentage of each transaction. Compared to a PayFac, this model can lead to longer merchant onboarding times, as the sponsor bank needs to underwrite and approve the merchant before they can start accepting payments.

Setting up as a referral ISO is simple, and there’s no cost to get started – you don’t even have to register with the card associations. Starting as an ISO can be a great way to test and learn about payments without worrying about risk and compliance.

The downside of a referral ISO is that you lose some control and visibility over the payment process.

2. Registered ISO: By registering with the Card Association, an ISO can market its payment solutions under its own brand, creating a more customized, white-label solution that appears as its own. The contract still involves a sponsor bank in a tri-party agreement (with the bank, the ISO, and their merchants). Unlike with a PayFac, as a registered ISO you don’t need to report monthly to Visa and Mastercard.

Each merchant account operates independently, with Visa and Mastercard maintaining visibility. Registration involves a comprehensive review of your company’s business plan and a financial and background check of the owners. This registration costs $10,000 per card brand (Visa and Mastercard) and requires an annual fee of $5,000 to maintain.

3. ISO with liability: To underwrite merchant applications and assume liability, an ISO must undergo a rigorous review process to demonstrate that they have a secure payment system that complies with relevant rules and regulations. ISOs are often required to provide a cash deposit to their sponsor bank to offset any potential losses from their merchants’ activities.

A key benefit of this process is faster merchant onboarding. As an ISO with liability, you don’t need to wait for the bank to do the underwriting: you can do it yourself. Your company is responsible for managing risk and covering potential losses in its portfolio.

However, this also brings additional operational costs. You need to invest in the right personnel and tools for underwriting and risk management. This includes systems for real-time transaction monitoring and hiring staff to review exceptions.

iso explained image

Image by Matt Brown

Three common misconceptions about PayFacs

At Fiska, the software companies we talk to often have several misconceptions about what it takes to be a PayFac, and the benefits of doing so.

Here are the three most common misconceptions we hear: 

Misconception 1: It’s easy to become and maintain a PayFac

Many software companies think becoming a PayFac is straightforward and easy to manage. This belief stems from the success of PayFacs like Stripe. 

Stripe is known for its ease of use and seamless merchant onboarding process (although if you want to take your payments to the next level, you’ll eventually want to move away from Stripe).

However, this ease of use on the user side doesn’t translate to easy and simple back-end processes of becoming and managing a PayFac.

In reality, setting up a PayFac can be a long, costly, and resource-heavy process. The registration process alone varies significantly in complexity and requirements. At a minimum, you’ll need to:

  • Demonstrate a clear understanding of what a PayFac entails.
  • Provide a detailed business plan.
  • Develop and present a comprehensive risk management plan.
  • Prove your ability to comply with Visa and MasterCard requirements.

After set-up, ongoing responsibilities include:

  • Completing monthly (or quarterly) reports for Visa and Mastercard. 
  • Being able to prove that every account remains compliant. This requires investing in tools to be in in place to be able to ensure compliance. 
  • Ensuring timely funding of your merchants.
  • Monitoring and minimizing chargebacks.

If you underwrite your sub-accounts and fund your clients directly, the compliance requirements become even more stringent. This involves a full background check on yourself and your business and a deposit to your sponsor bank. All of these tasks are time-consuming and expensive, which if you aren’t a huge SaaS platform, could be a huge drain on your resources

Misconception 2: When you become a PayFac, you’ll earn more revenue from payments

For small to mid-sized software companies, being a PayFac can actually be more costly than being an ISO. The total initial cost to set up as a PayFac can range from $30,000 to $50,000. Additionally, you’ll likely need to hire a payments compliance expert to navigate the registration process.

There’s also the option of using a ‘PayFac in a box’ service, which provides everything needed to become a PayFac, including registration, risk management, and reporting platforms. However, this service can be very expensive, sometimes exceeding six figures in platform licensing fees.

Growing SaaS companies often focus on the perceived higher revenue percentage but overlook the substantial fixed costs. In our experience, these fixed costs – including registration, maintenance, reporting, and staffing costs – far exceed the revenue benefits.

Misconception 3: To compete and onboard merchants quickly and efficiently, you need to become a PayFac

Many successful businesses never become PayFacs. The onboarding speed as an ISO isn’t necessarily much slower and can depend on the industry type and associated risks. Depending on whether you’re an ISO with liability (and can do your underwriting) and the business type of your merchants, onboarding can range from near real-time to up to 48 hours.

For example, a quick-service restaurant with low transaction sizes can be quickly underwritten. However, a merchant selling event tickets with high transaction amounts may take up to 48 hours for underwriting.

Many large and successful companies don’t operate as PayFacs despite their size. Becoming a PayFac requires an enormous scale to justify the operational costs. Take Shopify, a very successful PayFac. While Shopify will incur huge operational costs, the instantaneous onboarding of merchants is crucial to its business model. 

But this only works at a massive scale. Shopify handles an astronomical transaction volume, with over $45 billion of gross processing volume in Q4 2023 (compared to $34 billion in Q4 2022), on their platform. This model doesn’t make as much sense for the 99% of SaaS businesses that aren’t handling such a high volume. 

Both PayFac and ISOs have their merits, but becoming an ISO is a better first step 

Becoming a PayFac isn’t as simple as you might have heard. It’s time-consuming and expensive to set up and manage. While you might make more from your payments as a PayFac, the extra revenue will likely be eaten up by the highest management fees. 

In our experience, an ISO is a better first step for SaaS businesses looking to start taking their payment strategy seriously. It’s simple and cheap to set up, giving you valuable payment experience without investing too much time and money.