A recent study by the Federal Reserve Banks found that debit and credit cards are the most popular payment methods, with 62% of Americans using them to make payments, every month. 

For the first time, cash payments also failed to secure the top spot for transactions under $25. Forbes Advisor further reports not even 10% of Americans use cash to pay for their purchases today. 

The writing on the wall is clear. Not accepting card payments can be detrimental to businesses, which is why software providers are increasingly incorporating payment services into their platforms.  

However, the market is getting crowded, which makes choosing the right payment service provider quite challenging.

In this article, we’ll discuss two of the most common processing models you may come across: independent sales organizations (ISOs) and payment facilitators (PayFacs). We’ll help you understand their similarities and differences so you can make an informed choice. 

Understanding ISOs and PayFacs

Before we delve deeper, let’s examine what ISOs and PayFacs are and their roles in the payment processing ecosystem. 

What is an ISO?

As you might be aware, you or your sub-merchants need a merchant account (a business bank account) to accept customer payments. An ISO is a third party (or sales agent) that essentially “resells” merchant accounts. It acts as an intermediary or middleman between card networks (e.g. Visa, Mastercard, etc.), payment gateways, and merchants. 

Essentially, ISOs facilitate payments and provide merchants with individual merchant accounts but don’t manage or process transactions themselves. They save merchants the trouble of dealing with acquirers and processors directly while providing customer service. 

ISOs handle acquisition for banks and processors (as they don’t directly take on too small or niche businesses because of the complexity involved), leaving the infrastructure and transaction management to them.

Examples of popular ISOs in the market include Clearly Payments, First Data, TSYS, etc.

What is a PayFac?

A PayFac simplifies payment acceptance for merchants by actively participating in the transaction management process. Through its relationship with an acquiring bank, it obtains a master merchant account under which it can aggregate multiple sub-merchants (the PayFac’s customers). 

The PayFac manages risk, payment processing, compliance, fraud detection/prevention, merchant services, and relationships with acquirers. They simplify onboarding for merchants through a swift underwriting process so merchants don’t have to go through the hassle of applying for individual merchant accounts and waiting for them to get approved.

Examples of popular PayFacs include PayPal, Stripe, Square, etc.

Key Differences Between ISOs and PayFacs

Let’s look at the key differences in operation and services between ISOs and PayFacs.

Onboarding and underwriting

As far as onboarding is concerned, ISOs handle only the sign-up process for merchants. Since they resell merchant accounts, their involvement is limited only to getting merchants to sign up. 

They pass on the information to the payment processor, who handles the onboarding process. It is the processor’s responsibility to do the due diligence before approving merchants and this process can take a few days to a few weeks. 

In contrast, PayFacs take a much more hands-on approach to onboarding. They handle underwriting and compliance as well. 

However, most PayFacs (e.g. Square, Stripe, PayPal) don’t undertake a rigorous underwriting process upfront and approve merchants almost instantaneously. The downside is that merchants could be in for sudden account freezes or termination if PayFacs come across any red flags during the underwriting process later. 

Risk and liability

Since PayFacs have greater control over merchant applications, onboarding, underwriting, etc., they assume greater risks like fraud, chargeback, or merchants going out of business. That’s why PayFacs must have stringent controls, and ensure compliance with KYC, AML, PCI-DSS, and other applicable regulations. 

On the other hand, since ISOs are not as involved in payment processing, their risk exposure is low and they can do without any risk management procedures.

Merchant relationship

ISOs typically have relationships with several processors and can offer merchants greater choices. PayFacs, in contrast, have relationships with one or two processors at the most, making onboarding simpler. They can also negotiate better rates for merchants. Preczn can help manage multiple payment providers, negotiate for stronger economics, and create a more unified onboarding experience—ultimately reducing the complexities involved in handling multiple processor relationships

In the ISO model, merchants typically enter into contracts with payment processors. The ISO, if included, remains as a third party or removes itself from the contract completely. On the other hand, PayFacs enter into contracts with merchants directly—with or without the payment processor. 

This also means that PayFacs handle the settlement of funds by themselves. The collective funds (from all sub-merchants) are deposited into the PayFac’s master merchant account by the processor. The PayFac then deposits the right amount into each sub-merchant account. This gives them greater control over the settlement process ensuring quicker settlement and greater visibility (down to the transaction level).  

In contrast, ISOs aren’t involved in settlement or the distribution of funds. The processor handles everything from authorization to settlement so the process can take longer and offer limited visibility. The processor manages settlement reporting and reports typically include bulk settlement amounts only. 

Revenue and fee structures

PayFacs generally have a flat-fee structure when it comes to pricing. This is better suited for businesses with low transaction volumes since the breakdown is simple to understand. 

ISOs, on the other hand, have more complex fee structures. However, businesses can negotiate better rates (depending on transaction volumes) as ISOs offer more options. As mentioned earlier, Preczn can assist in managing and optimizing these fee structures by leveraging its platform to negotiate favorable fees and provide a more streamlined, unified payment experience.

Technology and integration

Since ISOs rely entirely on the payment processor’s technology, they don’t need to invest in tech or infrastructure. 

In contrast, PayFacs require proper technology and infrastructure to manage payments, onboarding, and underwriting. They may choose to build in-house tech solutions which can be expensive and complicated as they’ll need to develop payment APIs, secure payment gateways, reporting, and onboarding capabilities among others.

Similarities Between ISOs and PayFacs

Despite the differences mentioned above, ISOs and PayFacs are similar to each other in several aspects. Take a look below.

Payment processing capabilities

Acquiring banks typically don’t work directly with smaller and high-risk merchants. PayFacs and ISOs act as intermediaries and make payment processing more accessible to these businesses. These merchants don’t need to go through the trouble of approaching acquirers directly to start accepting card payments. 

Revenue generation

Both ISOs and PayFacs charge merchants for their services — on every transaction. Typically, the commission could be a percentage of every transaction or a lump sum (subscription-type).

Payment support and services

Customer support for any payment-related issues is typically provided by ISOs and PayFacs themselves should merchants have any queries or run into any issues.

Factors to Consider When Choosing Between ISOs and PayFacs

Both ISOs and PayFacs have their strengths, but you should always consider your unique business needs before choosing one. Here are the factors to consider:

Business model and size

Smaller businesses with low transaction volumes may find PayFacs to be a better option due to the simplicity and convenience of their flat-fee pricing structures. ISOs are typically better suited for bigger businesses with high transaction volumes.

Cost and profitability 

Cost is an important factor to consider when choosing between the ISO or PayFac models. As discussed earlier, PayFacs generally offer flat-fee structures. Those with low transaction volumes and tight margins might prefer this type of pricing due to its simplicity and predictability. 

Larger businesses might be better off with the services of an ISO because of the pricing flexibility they offer. These businesses could even benefit from better rates depending on their transaction volumes (or top-line revenue).

Control and flexibility

Think about the level of customization and control you need in your payment processing. While ISOs may be the better option if you’d like specific services, terms, and rates, PayFacs can give you the ease of use you may be looking for in the form of a plug-and-play solution. 

PayFacs can also provide greater flexibility in designing your payment experiences as they manage their infrastructure and tech in-house.

Setup and settlement time

Since ISOs simply sign merchants up and then pass on their information to the processor for underwriting and approval, they do not have control over how long sponsor banks take to approve merchant accounts. 

In contrast, PayFacs have more control over the process and can approve merchant accounts at their discretion — typically instantaneously. However, bear in mind that your merchant account could be suddenly suspended or terminated if the PayFac comes across any red flags during their risk assessment at a later stage.

In the case of ISOs, settlement is managed by processors and could take longer. If you want a quicker settlement, a PayFac model might be the better option.

Risk appetite

PayFacs, due to their hands-on involvement in transaction management, assume greater risk but offer more control over the payment process. This includes dealing with fraud prevention, chargebacks, and compliance with regulations like PCI-DSS. If your business has a higher risk tolerance and you prefer direct control over these aspects, a PayFac might be the better choice. Conversely, ISOs carry less risk since they are not as involved in processing, making them a safer option for businesses with lower risk tolerance.

Uptime and approval rates

Another crucial factor to consider is the uptime and approval rates associated with each model. PayFacs typically offer higher uptime due to their direct control over the payment infrastructure, leading to fewer disruptions. They also tend to have quicker approval rates for new merchants since they handle underwriting internally. However, this speed can come at the cost of potential account freezes if any issues are flagged later. 

ISOs, on the other hand, may have slower approval times due to reliance on third-party processors, but this thorough vetting process can result in more stable long-term operations. If uptime and quick approval are critical for your business, a PayFac might be more suitable, whereas an ISO might be better for those valuing stability.

Final Words

By now you should have a fair understanding of ISOs and PayFacs and their roles in payment processing. Before choosing a model, analyze your unique business needs (size, costs, control, ease of use, time to setup, etc.) and make an informed decision. If you need a platform that unifies all your fintech providers, services, and data in one place for easier access, look no further than Preczn. For more information, contact us today.