Vertical SaaS vs Horizontal SaaS: 8 Differences and Similarities

Software as a Service (SaaS) has made business software more accessible by offering cloud-based, on-demand access to a range of solutions, from project management and collaboration to sales and marketing. 

Thanks to SaaS solutions, businesses can easily scale their workflows, eliminating the need to install programs locally or pay for expensive licenses.

But not all SaaS products are alike. Some solutions, like Slack or Microsoft, are useful for any kind of business. Other types of SaaS are relevant only to companies in specific industries. The former is called horizontal SaaS, while the latter is known as vertical SaaS.

While their target audience and the breadth of their solutions are the key differences, vertical and horizontal SaaS also share many similarities, in particular cloud-based hosting and subscription business models.

In this blog, we’re going to explore the characteristics of vertical vs horizontal SaaS and what SaaS companies should consider as they carve out a space for themselves in a highly competitive marketplace.

TL;DR

  • Software as a Service (SaaS) provides cloud-based, scalable software solutions accessible via subscription models, eliminating the need for local installations or licenses.
  • Vertical SaaS solutions are tailored for specific industries, addressing niche needs with in-depth customization and compliance with industry standards.
  • Horizontal SaaS refers to general-purpose software solutions that are applicable across industries and attract a diverse user base.

What is Vertical SaaS?

Vertical SaaS solutions are SaaS products designed for use by a specific industry or business vertical. This differs from horizontal SaaS solutions, which target numerous industries with a single product.

Vertical SaaS focuses on solving the specific needs or pain points experienced by industries that are often poorly served by general SaaS providers. Some examples of niches targeted by vertical SaaS providers include healthcare, eCommerce, finance, and education.

To achieve this, vertical SaaS products bring in experts from niche markets to develop industry-specific features, ensure compliance with industry standards or regulations, and integrate with key business platforms that are standard within that industry.

What is Horizontal SaaS?

Horizontal SaaS refers to general-purpose software solutions that apply to multiple industries, rather than providing solutions that are relevant to one specific market.

These platforms provide functionalities that a diverse user base benefits from, such as project management, social media, automated workflows, or customer relationship management (CRM). Because horizontal SaaS companies serve both startups and enterprise businesses, scalability is a key selling point. This commonly takes the form of add-on services or multiple pricing plans that offer flexible features, like additional user seats or more storage space.

By serving common business needs, horizontal SaaS platforms have a very wide target audience. One of the most well-known examples of horizontal SaaS is Salesforce, which offers a broad suite of tools to assist businesses with CRM, email marketing, conversion tracking, and more.

Differences Between Vertical SaaS vs Horizontal SaaS

Now that we’ve got the fundamentals down, let’s take a closer look at the factors that differentiate vertical and horizontal SaaS companies. 

Target market focus

Horizontal and vertical SaaS each target a very different customer base. Where vertical SaaS targets specific industries with purpose-built tools, horizontal SaaS companies develop more generic solutions that are relevant to many different types of businesses.

Customization and functionality

Because vertical SaaS models are industry-specific, they typically offer high levels of customization to meet the needs of industries with complex or technical requirements. This could involve building custom workflows or introducing regular updates to keep pace with regulation changes. Because horizontal SaaS products are based around more generic functions, they tend to offer less customization or charge higher prices for customizable features.

Scaling and integration capabilities

Because vertical SaaS has a small market size and narrow product focus, this makes scalability more straightforward than for horizontal SaaS applications. It’s easier to accommodate entrepreneurs to enterprise within one industry than several. Horizontal SaaS, meanwhile, needs to service a much broader range of business types to keep acquiring customers, which can put a strain on development resources.

Market competition and entry barriers

Vertical SaaS providers are designing solutions for a specific niche. As such, they can face less competition because of the high barrier of entry that comes with developing specialist SaaS products. 

Horizontal SaaS, on the other hand, needs to reckon with the relative ease of developing generic solutions with a wide range of use cases. This creates an intensely competitive landscape with a higher churn rate, but greater customer acquisition opportunities.

Similarities Between Vertical and Horizontal SaaS

Horizontal and vertical SaaS businesses can overlap in certain areas. Consider the following. 

Subscription-based model

Subscription pricing is the most common model used by both horizontal and vertical SaaS providers. Users will pay a recurring monthly or annual fee to access a specific set of services. Usually, providers will offer more than one plan at different price points, depending on the number of features or the amount of customer support included. It should be easy and seamless to upgrade once a business outgrows the functionality of one plan, as this helps SaaS businesses boost customer retention.

Cloud hosting and accessibility

Cloud-based technology allows both vertical and horizontal SaaS platforms to scale seamlessly and offer users access to their applications via the internet, meaning they can use multiple devices and access data on the go. This is a big advantage for distributed teams and companies who have multiple locations of business, as programs don’t need to be locally installed.

Importance of user experience and interface

Regardless of whether your SaaS product is tailored to a specific industry or more general use, easy-to-use platforms and intuitive features are paramount to avoid lengthy user training. Dense or complicated programs cause customer dissatisfaction or even early terminations of subscriptions. In some cases, providers may offer an account manager who is tasked with offering demos or providing tailored support for company users, which helps to streamline the transition into adopting new systems or workflows.

Ongoing updates and maintenance

No SaaS company can stand still for long if it expects to attract and retain users. As customer acquisition costs continue to rise, regular updates, new features, and performance improvements are a must for both vertical and horizontal SaaS companies to stay competitive and relevant to their target audience. A good way of doing this is to run regular engagement surveys to find out what tools or features users would most like to see added to your application.

Vertical SaaS Success Story: Veeva

Valued at $33.4 billion, Veeva is one of the best examples of vertical SaaS and how tailored software solutions are gaining greater market share. Veeva is a cloud-based CRM and content management solution built specifically for the pharma and life sciences industry. Among other functions, it assists companies with liaising with healthcare professionals, tracking sales metrics, data analytics, and process documentation.

What makes Veeva distinct from more general project management solutions is that it’s built to accommodate niche needs like coordinating clinical trials or regulatory compliance, things that more generic cloud-based solutions are not configured for. Some of its biggest clients include Pfizer, Johnson & Johnson, and Merck, who require the seamless scaling made possible by cloud-based technology.
  

Horizontal SaaS Success Story: HubSpot

HubSpot has probably the greatest name recognition in the SaaS industry, in part because it services such a broad range of different industries. Their inbound marketing tools, which include CRM, email marketing, content creation, and lead generation, are adaptable to virtually any business.

This set of SaaS tools gives HubSpot a simple but powerful value proposition; it’s the engine for your entire inbound marketing strategy. The HubSpot of Startups program offers significant discounts to enterprise-level products if businesses meet certain criteria, which it leverages to share compelling success stories about enabling businesses to scale with confidence.

 

The company is also very open to user feedback, emphasizing that understanding customer needs is the key to continuously improving its products. HubSpot’s acquisition of chatbot system Motion AI, for example, was a response to growing customer demand for on-demand communication systems.

What’s Next for Vertical and Horizontal SaaS Companies?

The vertical software market has developed much more slowly than horizontal software. This is due to the smaller market size and longer development time needed to create tailored industry solutions. 

Not only that, but many industries are subject to strict local and national regulations, which can be onerous to comply with. For example, accounting software like QuickBooks needs to comply with Generally Accepted Accounting Principles (GAAP) and International Accounting Standards (IAS).

Because horizontal types of SaaS applications are more straightforward to develop and support, the market has undergone rapid expansion over the past decade. However, growing competition, combined with the difficulty of trying to serve so many industries with one product, has caused the growth of horizontal SaaS to stagnate in recent years.

As more industries begin to recognize the value of tailored solutions, vertical SaaS is experiencing significantly higher growth and investment. Features such as pre-built integrations, deep integration, industry compliance, and advanced analytics capabilities that use AI and machine learning are more common in enterprise-level vertical solutions, which gives the market an edge over horizontal solutions.

This being said, established horizontal SaaS companies with good market share are well-placed to accommodate this shift by trying to break into the vertical SaaS market. Augmenting their current platforms with industry-specific tools is faster than developing a vertical product completely from scratch, which may give existing horizontal SaaS providers an edge over vertical SaaS newcomers if they can recruit the industry expertise required.

Final Words

Both vertical and horizontal SaaS offer different challenges and opportunities that software providers need to consider carefully when developing a product. While horizontal SaaS offers a much larger target market, the market is intensely competitive because the barriers to entry are lower. This can make it difficult for providers to stand out and retain customers. Vertical SaaS helps providers to gain a valuable competitive advantage by ‘niching down’, but typically requires much longer development timeframes and has more limited use cases.

To select the right SaaS model, you’ll want to determine which aligns better with your software features, target audience, and brand messaging to stand out in an increasingly saturated marketplace. By considering the characteristics of vertical and horizontal SaaS as presented here, you can make the right decision that means better growth opportunities for your business.

And if you’re planning to offer credit card processing services with your software, be sure to partner with a solid payment facilitator like Stax Connect. With Stax Connect, you can quickly fuel the growth of your platform and enable payments for your users. Plus, our custom revenue-share opportunities allow each partner to monetize transactions instantly, growing enterprise value.

Contact us to learn more about Stax Connect.

FAQs about vertical SaaS vs horizontal SaaS

Q: What is vertical SaaS vs horizontal SaaS?

Vertical SaaS refers to software solutions that are tailored for specific industries or business verticals, focusing on solving the unique needs or pain points experienced by those industries—e.g., healthcare, finance, education. Horizontal SaaS, on the other hand, provides general-purpose software solutions applicable across multiple industries. These platforms offer functionalities like project management, social media management, automated workflows, or customer relationship management (CRM), benefiting a diverse user base. 

Q: What is an example of a horizontal application software?

Salesforce is one example of horizontal SaaS. It offers a broad suite of tools to assist businesses with CRM, email marketing, conversion tracking, and more, making it applicable to various industries.

Q: What is an example of a vertical market software?

Veeva is an often spotlighted vertical SaaS success story. It’s a cloud-based CRM and content management solution built specifically for the pharma and life sciences industry, addressing niche needs like coordinating clinical trials or regulatory compliance.

Q: Is horizontal SaaS better than vertical SaaS?

There’s no one best answer to whether or not horizontal SaaS is better than vertical SaaS software. If you’re choosing between the two, the best route is to determine which aligns better with your  business needs and target customers, then compare solutions from there. 

ISV vs PayFac: The Similarities and Differences Between Independent Software Vendors and Payment Facilitators

The world is increasingly moving towards becoming cashless and there are numbers to prove it. According to the Pew Research Institute, in 2022, a whopping 41% of Americans said they don’t use cash at all for any of their weekly purchases—a significant jump from 29% in 2018. 

FIS Global reports that in Norway, Sweden, and other Scandinavian countries, more than 90% of transactions processed at point-of-sale (POS) in 2023 were cashless. Further, Statista projects that the value of global digital transactions will exceed $11 trillion in 2024. 

The writing on the wall is clear—businesses need to start accepting digital payments and software providers need to start offering payment services one way or another. In this article, we’ll break down two popular terms used in the payment processing industry—ISV and PayFac—and see what they exactly mean.

TL;DR

  • An independent software vendor (ISV) develops and sells software applications independently of hardware manufacturers. ISVs create software platforms for various industries, including business management, healthcare, and finance.
  • There are two main ways that an ISV can become a payment provider—by adopting the ISO model or the PayFac model. In the ISO model, an ISV partners with a third party that handles merchant account setup, payment processing, risk, and compliance. The ISV has little control over the end user’s payment experience or the processing costs.
  • In contrast, an ISV can partner with a PayFac to offer an integrated payment experience to its users. This gives them greater control over the customer experience and an opportunity to generate additional revenue.

What Is an ISV vs PayFac?

The payment processing industry facilitates electronic transactions between merchants and customers, spanning online, mobile, and in-person payments. It involves a complex ecosystem of financial institutions, including acquiring banks, payment processors, and card networks, alongside technology providers and regulatory bodies.

Payment processors handle transaction authorization, settlement, and security, ensuring seamless and secure payment experiences.  

An independent software vendor (ISV) develops and sells software applications independently of hardware manufacturers. ISVs create software platforms for various industries, including business management, healthcare, and finance. They often customize and integrate their applications to meet specific client needs and market demands.

Now, there are two ways that a software service provider can become a payments provider. They can adopt the independent sales organization (ISO model) or the payment facilitator model (PayFac).

In the ISO model, an ISV partners with a third party that handles merchant account setup, payment processing, risk, and compliance. The ISV has little control over the end user’s payment experience or the processing costs.

In contrast, an ISV can partner with a PayFac to offer an integrated payment experience to its users. This gives them greater control over the customer experience and an opportunity to generate additional revenue.

Payfacs simplify payment processing for small businesses by aggregating transactions under their master merchant accounts. SMBs get access to payment processing services without the need for individual merchant accounts. PayFacs also provide a streamlined onboarding experience, manage underwriting, and handle compliance for its sub-merchants. 

Independent Software Vendors (ISVs)

ISVs create software applications tailored to specific industries or business needs, such as point-of-sale (POS) systems, eCommerce platforms, or accounting software. One of the biggest advantages of an ISV is that they often offer customization options to meet the unique requirements of different businesses. 

Their software solutions can even integrate with existing hardware and software architectures of clients, making ISVs a great option for large companies looking for payment processing applications. As ISVs develop and maintain their software, they have complete ownership of their software as well as all related intellectual properties. 

Payment Facilitators (PayFacs)

Software companies that do not want to get into the payment processing business themselves can opt to work with a PayFac. Oftentimes in the ISV vs PayFac debate, the cost of developing, marketing, and maintaining payment processing software can be overwhelming. Also, companies may choose not to become an ISV in the payment processing industry as they do not want to stray too far from their core business. 

In such cases, collaboration with a PayFac offers the best of both worlds—SaaS providers can offer payment processing to their clients without taking on the huge financial and resource burdens of developing a payment processing application. 

PayFacs facilitate credit card transactions between merchants and payment processors. They handle merchant onboarding, including underwriting and meeting regulatory requirements like Know Your Customer (KYC) mandates. Additionally, PayFacs conduct ongoing monitoring of merchants to ensure compliance with Payment Card Industry (PCI) regulations post-onboarding.

Similarities between ISVs and PayFacs

Now that we understand what they mean, let’s take a look at how ISVs and PayFacs are similar.

Allow businesses to achieve the same goals – In the payment processing ecosystem, both ISVs and PayFacs essentially allow businesses to accept digital payments. Both aim to provide seamless, efficient, and user-friendly payment experiences. Moreover, they also allow businesses to not only monitor electronic payments but also obtain helpful data and trends. 

Overlapping customer base – ISVs and PayFacs can have overlapping customers, particularly businesses seeking integrated payment solutions. ISVs offer software with built-in payment processing capabilities, while the PayFac model simplifies payment acceptance for merchants. Both cater to businesses looking for streamlined and efficient payment solutions within their software applications. Both ISVs and PayFacs also often collaborate with other stakeholders in the payment processing ecosystem, such as payment processors, acquirers, and financial institutions.

Regulatory compliance and security standards – ISVs and PayFacs prioritize compliance and security in their respective roles. ISVs ensure software solutions meet standards like PCI DSS (Payment Card Industry Data Security Standard). PayFacs implement strong security measures for payment transactions, complying with regulations to safeguard customer information.

Differences between ISVs and PayFacs

All said and done, there are significant differences between ISVs and PayFacs. Let’s take a look.

Same goals, different methods – Although ISVs and PayFacs both allow businesses to accept electronic payments, they take different paths to achieve the same goal. ISVs focus on the development and customization of payment processing software. PayFacs focus more on reducing the administrative burden of accepting payments by handling all the paperwork as well as the payment processing. 

ISVs develop payment processing SaaS or APIs that merchants can buy and implement in their own companies. Once the software has been integrated into the merchant’s existing software ecosystem, they can accept various payment methods seamlessly. On the other hand, PayFacs offer payment processing solutions to sub-merchants by aggregating transactions under their own merchant accounts and simplifying onboarding processes. 

Business model and revenue streams – ISVs generate revenue through software sales, licensing fees, and subscription models. PayFacs earn money by charging merchants processing fees per transaction, often a percentage of the transaction value. Additionally, Payfacs earn from setup fees or monthly fees for access to their payment processing services.

Underwriting and merchant accounts – ISVs don’t handle underwriting or merchant accounts and focus only on software development. PayFacs, however, underwrite merchants, vetting their eligibility for payment processing, and aggregating transactions under their master merchant accounts, simplifying the process for businesses to accept card payments.

Case Studies

Successful ISVs include Salesforce and Shopify, offering robust software solutions with payment processing being one of their core functions. Salesforce’s CRM is ubiquitous and as of 2023, it has a 23.8% market share in the CRM software industry. Shopify dominates eCommerce as it allows customers to create their own eCommerce websites. It has user-friendly platforms and extensive customization options for online stores.  

PayFacs like Square and Stripe have revolutionized payment processing, providing easy-to-use platforms for businesses to accept payments online and in-person, disrupting traditional payment methods. 

The ISVs mentioned provide comprehensive solutions tailored to specific business needs, while the PayFacs prioritize simplifying payment processing through user-friendly platforms, reasonable pricing, and efficient merchant services.

Final Words

Before choosing to offer ISV or PayFac type of model to your customers, you need to assess your business’ technical capabilities, resources, client base, and capital at hand. Payment technologies are evolving rapidly so both ISVs and PayFacs have a huge potential for growth in the future. 

However, as an ISV looking to facilitate payments for its users, you can drastically reduce your costs as well as your time-to-market by partnering with a PayFac like Stax Connect. Easily monetize payments while leaving the heavy lifting of onboarding, risk management, and compliance to us. Contact us today for a consultation and learn how we can help.

ISV vs PayFac FAQs

Q: What is the difference between PayFac and ISOs?

PayFacs act as intermediaries between merchants and payment processors or banks. They are registered with major card brands to onboard merchants under their master merchant account, simplifying the merchant account application process. 

Meanwhile, ISOs are third-party agents or companies that partner with banks or payment processors to sell merchant accounts. Unlike PayFacs, ISOs do not onboard merchants under a master merchant account but instead facilitate the setup of individual merchant accounts with banks or processors.

Q: What is the difference between ISV vs PayFac?

ISV (Independent Software Vendors) develop and sell software applications, which can range from retail management systems to healthcare record systems. PayFacs, on the other hand, are entities that have taken on the role of facilitating payments for merchants.

Q: What is the difference between PayFac and payment aggregator?

Payment aggregators are companies that allow multiple merchants to accept payments under a single merchant account. They aggregate the payments processed for these merchants, simplifying the onboarding process and reducing administrative overhead. PayFacs also enable businesses to accept payments under a master merchant account, but they typically offer a more comprehensive suite of services, including merchant onboarding, risk management, and settlement services. 

Q: Is a PayFac a payment processor?

Yes, in a broad sense, a PayFac can be considered a type of payment processor because it processes payments on behalf of its merchants. However, it’s more accurate to describe a PayFac as a facilitator or intermediary that provides access to payment processing through its master merchant account, rather than being a processor in the traditional sense. 

What Every ISV and SaaS Company Needs to Know When Switching to a New Payments Partner

Innovative ISVs and SaaS companies know that one of the best ways to provide value to merchants—while improving your bottom line—is to provide integrated payments.

For example, if you’re an invoicing software provider that lets SMBs manage their billing, then it makes sense to add payment processing tools to your platform. Doing so not only streamlines the payment process for your merchants but also opens up a new revenue stream for your company through transaction fees or value-added services.

That’s why it’s not uncommon for SaaS companies and ISVs to find payment partners (like Stax Connect) who can help them implement payment services. 

Of course, not all integrated payment providers are created equal. Sometimes, a partner may not be equipped to handle sub-merchants needs. Or, they might lack the flexibility to adapt to your evolving business.

If you find yourself in this situation and considering switching payment partners, this guide can help. We caught up with Stax Connect’s payment experts to shed some light on everything you need to know when switching to a new payments partner. 

Watch their discussion on demand below or read on to see the highlights of their conversation. 

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Why Saas and ISVs Look for a New Payments Partner

According to Tommy Avers, VP of ISV Sales at Stax, the most common reason companies switch payment partners is because they’re unhappy with the features or services of their current integrated payments provider. 

“A lot of times, they’re coming to us from a place of not being very successful in what they originally had sought out to do. So, that could be anything from a technical limitation to underwriting or risk concerns or having a tough time getting merchants through the enrollment process.”

Ricky Dunbar, Stax’s VP of Professional Services, agrees and adds that while the specifics can vary, the primary purpose for switching typically boils down to one of two things: the company is either running towards something (i.e., to get better features) or they’re running from something (i.e., to avoid pain points).

“It’s more often they’re running from than they’re running to,” he says. “It’s either something was oversold, or expectations weren’t set appropriately.”

That’s why Ricky emphasizes the importance of managing expectations. “It’s super important for both parties to be transparent about what they’re trying to accomplish and what those goals can be today versus what can be accomplished later.”

Signs It’s Time to Make the Switch

Is it time for you to flip the switch? Here are a few signs that you should consider a new payments partner for your SaaS or ISV business. 

The existing provider can’t support your business goals

Ultimately, the decision to move to a different payments partner comes down to whether or not a provider can effectively serve your company and sub-merchants. And the only way to determine that is to have clarity on your business goals. 

As Tommy points out, “It’s impossible not to know when the right time is if you don’t have clear objectives and goals set up for what success is defined by in your organization.”

So, regularly evaluate your business objectives and align them with the capabilities of your payment processing partner.

Already have those clear business objectives in place? Look at your vendors. If they inhibit growth for your platform or your core product is potentially at risk, these are clear signs to consider a different provider.

Sub-merchants are having a poor payments experience

Another tell-tale sign of having a sub-optimal payments partner is if your customers (i.e., sub-merchants) are having issues with integrated payments. Maybe they’re experiencing downtimes or facing difficulties with transaction processing, such as delays or high rejection rates. 

Whatever the case, these problems can significantly impact your reputation and the satisfaction of your software users. The last thing you want is for them to churn due to a poor payments experience. 

When is the Right Time to Switch Integrated Payment Partners?

Timing is another crucial consideration when switching to a new provider. For some SaaS companies, the right time to find a new vendor is determined by their product roadmap. Perhaps there are specific features or user experiences that your current payment solution cannot support. 

In some cases, it’s a matter of seasonality. 

As Tommy illustrates, an EdTech platform primarily operational during the school year should start searching for a new provider in the winter. This allows for initiating the migration process during the summer break, minimizing disruption. 

The bottom line is that the optimal time to switch payment partners hinges on a blend of strategic planning and practical circumstances. Whether driven by product development needs, customer experience improvements, or operational timing, the decision should be rooted in what best supports your company’s growth and aligns with your specific operational cycle.

Preparing to Make the Switch: Look at Your Contract

So, you’ve decided to make the switch, determined the best time to do it, and now you’re ready to start the process.

Before diving in, Tommy recommends closely examining your contract with your current vendor. 

“The first thing to consider is term length. Are you coming up on the end of that contract? And if you’re not, do you have any penalties for terminating the contract early?”

The second thing, he says, is to see if there are any data or customer migration clauses.

“Look out for terms like ‘portability of customers’ or ‘non-solicitation’ against customers you brought to that vendor.” 

When you’re in the clear, you can start planning the transition and ensure a seamless shift for your business and customers.

Best Practices to Make the Process Go Smoothly

Once you’ve engaged with a new payments partner, you can take several steps to get up and running efficiently. 

Leverage your existing payment knowledge and foundation (if available)

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If you’ve worked with another provider in the past, it may help to leverage that knowledge and even infrastructure when moving to a new provider. 

Karina Mills, Senior Manager of Solutions Engineering at Stax, says those who previously worked with other payments companies have a leg up both “on the payments experience side of things and the technical side.”

“There’s definitely a component where there’s reusable code. You don’t have to start from scratch if there’s already a foundation of what needs to be built,” explains Karina.

She continues, “I should add the caveat that sometimes the previous processing build was from a few years ago, so you may not have exactly the same team members—but hopefully they’re in there maintaining it. Assuming that’s the case, then the foundation is already there, as well as the knowledge and understanding of the technology and the code itself.”

Get clear on the features and functionality you need

Another important step is to dial in on the exact features you need and when. Work closely with your new provider and be transparent about your needs and expectations to ensure a smooth integration process that aligns with your company’s objectives.

“And once you’ve nailed down what features you’ve decided to build, things should flow from there. Is it one-time payments and tokenization? What did it look like in the previous processor? What does it look like in the new processor? And just build out all of your tickets,” says Karina.

“Have your developers look into the API documentation, figure out what exactly it’s going to take, and build out your project plan for implementation.”

Don’t overlook the operational aspects of making the switch

Karina cautions against rushing through the code or building process. 

“A lot of times, our partners will be ready to just build, build, build, and go straight into that move. They’ll switch over and not necessarily think of those different operational things that come later in the process.”

One common operational component, shares Karina, is managing two processors simultaneously while making the switch. 

“In some ways, you have to do that because you can’t force the merchants to move over immediately, and there’s not really an easy way to do a 100 percent cut-off date. But then, if you are supporting multiple payment processors, at what point will you stop supporting the previous?”

“And there are things like refunds if there are payments that a merchant has made in an old processor. Will they be able to refund those payments in the new software? Or will they go to their previous processor and manually make those refunds through a dashboard somewhere outside of the partner’s ecosystem?”

These are some things you should consider when planning the logistics to ensure a smooth transition for your team and your customers.

Organize your data

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Submitting merchant applications and migrating their data can be cumbersome, but they are part of the territory when you move to a new integrated payments partner. 

As Tommy puts it, “Anytime you’re switching from one vendor to another, that new vendor will need to go through underwriting and receive a filled-out merchant application to our terms and conditions.”

The good news is you can take steps to make this process a bit easier. 

Know what data you have on hand

“The vendors that are set up best for the merchant migration of the application are those with a lot of data on their merchants,” explains Tommy. 

“They have their EINs, address, the principal signer, etc. These are things we could pre-populate in the application for that cutover time to go through our underwriting.”

Ricky echoes this and adds that the first thing the Stax Connect team does is ask questions about what data the ISV has about their customers. 

“We want to determine how much of this we can reuse. We want to make the enrollment process as streamlined and frictionless as possible. That starts with reducing the amount of input or the amount of activity the merchant has to go through to ultimately get there.”

Work with an implementation manager

Another thing you could do is to work with an implementation manager who can facilitate the process. 

This is what Karina specializes in at Stax Connect. 

“We have APIs where the partner can build a tool that sends the information to start that application process and build in those automations,” she explains. 

“They could also build notifications to understand whether the merchant has been pending or approved and ready for payment processing. That tends to help not just in switching payment processors but in the overall payment implementation experience.”

Communicating to Sub-Merchants

Next up, ensure you have a communication plan in place. Consider the following best practices. 

Be clear and deliberate

The main people whom this change will impact are the sub-merchants. So, it’s immensely important to be on the same page as your customers. 

Ricky’s advice? “Be very clear and deliberate in your communication.” This is vital, especially when communicating:

  • the merchant’s responsibilities
  • the steps they take 
  • how the change will affect them 
  • key dates

Work with your support and marketing team

Map out the above ahead of time and craft a communication plan that outlines what channels you’ll be using and when your messages need to be sent. 

For best results, work with your marketing and support team, ensuring they’re fully aligned on the change.

 “If the team understands it, then they can communicate it effectively to the merchant and then the merchant is going to feel really good about the process,” says Ricky.

Find a Vendor That Can Guide You Through the Change

Implementing integrated payments is a smart play for ISVs and SaaS companies. But it’s all about finding a payment partner that aligns with your goals. If your current one isn’t cutting it, consider making a move.

Stax Connect stands out as an expert in this realm, offering the flexibility, support, and capabilities you need to succeed. 

If you’re ready to flip the switch, reach out to the Stax Connect team for guidance on making a seamless transition to a payment partner that truly supports your growth.

Payment Facilitator vs Payment Gateway: Key Differences and Similarities

1.1 Trillion. That’s not a typo; we’re talking about a trillion with a T. That’s the value of eCommerce transactions that took place in 2023 in the U.S. alone, according to a report from Insider Intelligence.  

Now what if we told you that number is expected to grow by 50% by the year 2027?

In a world where we’re spending more and more time online and every click is a potential transaction, it’s no surprise the eCommerce and digital payments sectors are experiencing exponential growth. Each day, it becomes increasingly crucial for every business to accept online payments in order to remain competitive and avoid being left behind. And, in that same vein, understanding the nuances of the different payment systems required to set up eCommerce capabilities is no longer a luxury; it’s a strategic necessity. 

In this article, we’ll dive into the intricacies of two types of players in the eCommerce ecosystem: payment gateways and payment facilitators. You’ll learn the similarities, differences, and when and where to employ each type of solution for your business.

TL;DR

  • Payment gateways and PayFacs are both players in the digital payment process with similar goals in mind: secure and low-risk payments while providing seamless, fast, and positive customer experiences. 
  • The high-level difference is when and how to deploy them as part of the payment process. A payment gateway handles the customer’s relationship with the merchant, an individual transaction at a time. A PayFac, by contrast, handles the bank’s interaction with a number of merchants.
  • Because they handle different parts of the payment process, payment gateways and PayFacs can be used in tandem.
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Payment Processing and the Payment Processor Ecosystem

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Before getting into the specifics, let’s take a moment to give ourselves a high-level view of online payment processing. In every eCommerce transaction, payment processing acts as the invisible force that enables transactions to occur seamlessly across the globe. At its core, payment processing involves various players and technologies to facilitate the movement of funds from customers to merchants securely and efficiently. And, as a result of payment processing, businesses are not only able to conveniently accept credit card payments and other digital payments from anywhere across the globe but also verify and process card transactions in mere seconds—as quickly as exchanging cash in person. 

Digital payments only take a few seconds, but they flow through many different layers of partners and technology. Consider the following:

  • Merchants are the sellers, businesses, or service providers seeking payment for their offerings. 
  • The acquiring bank (or issuing bank or acquirer) is the financial institution that enables merchants to accept payments, transferring funds from customers to the merchant’s account. 
  • The payment gateway acts as a virtual bridge, securely transmitting payment information between the merchant, customer, and acquiring bank. 
  • Payment processors are the behind-the-scenes entities that handle the authorization, capture, and settlement of transactions. 
  • Payment facilitators simplify the process for smaller businesses, aggregating multiple merchants under their umbrella and managing payments on their behalf. 

Understanding the roles of these players is essential for businesses, as it empowers them to navigate the complex landscape of different payment systems, make informed decisions, and optimize their financial processes for success in the digital marketplace.

What is a Payment Gateway?

Most simply, a payment gateway is the interface a company uses to collect payment information and transmit that information to the financial institutions and processors involved in the transaction. 

A payment gateway can be the POS system where you swipe your card in-store. Or, in eCommerce and online transactions, this can be as simple as your website’s checkout page. This interface connects to the financial institutions handling the transaction, securely sends your credit card, debit card, or other electronic payment information, and then informs you of the result of the transaction.

How it works:

  • First, the buyer selects a product to buy from your website.
  • Then, the buyer moves to check out and enters payment information, such as credit card information, into the checkout page. This is the payment gateway.
  • When the information is submitted, the payment gateway securely transfers your information to the payment processor or bank. The payment processor or bank will attempt to verify the information to authorize the payment.
  • That transaction is then approved or declined, and the payment processor or bank sends the information back to the payment gateway, where it informs both the buyer and the vendor of the result.

What is a Payment Facilitator (or PayFac)?

A payment facilitator, on the other hand, can be a little more complicated to understand. While a payment gateway handles the “front end” of an eCommerce transaction, many interactions happen in the “back end” of the transaction. 

A payment facilitator, or PayFac for short, acts as a partner to handle a number of these back-end interactions to make this easier for merchants, especially smaller merchants.

Normally, each merchant that offers digital payments must have its own merchant account with the acquiring bank. But the money transfers between the merchant account and the acquiring bank that are involved in digital purchases can be a tangled web of interactions and regulations, slowing down transactions and racking up costly fees. That’s where a PayFac can step in.

How it works:

A payment facilitator acts as a payment aggregator partner to smaller merchants. It manages payments and transactions with the bank for a number of smaller merchants, streamlining the process, decreasing the workload, and mitigating risk.

  • First, instead of going directly to the acquiring bank, a small business can instead enter into a relationship with a PayFac. The PayFac streamlines the onboarding process for the merchant, allowing merchants to start accepting payments very quickly.
  • The PayFac has a master merchant account with the acquiring bank and serves as an intermediary between several individual merchants and the acquiring bank. The merchants then act as sub-merchants and operate under the PayFac umbrella.
  • Each time a transaction is made, it flows from the merchant, through the PayFac’s system, and to the acquiring bank.

In a payment facilitator model, the PayFac benefits the merchants by handling payments, streamlining onboarding paperwork, reducing the workload on smaller merchants, and underwriting transactions to allow a faster and more seamless experience for the merchants’ customers. The PayFac benefits the acquiring bank by assuming the risk for a large number of smaller merchants, continuously monitoring merchants for security and compliance, and ultimately reducing the burden on the bank.

Gateway or Facilitator: What’s the Difference?

Payment Gateway Payment Facilitator (PayFac)
Primary Role Handles customer-merchant transactions Handles bank’s interaction with merchants
Relationship Focus Customer’s relationship with the merchant Bank’s interaction with multiple merchants
Usage in Payment Process Individual transaction processing Manages overall payment process, may have in-house processing and gateway platforms
Pricing Model Subscription-based or flat rate per transaction Revenue-sharing, taking a percentage of each transaction
Integration Options Offers many integration options like API, plugins Streamlined integration solutions, often industry-specific
Compliance Maintains PCI DSS compliance Maintains PCI DSS compliance
Security Focus High-security standards for customer information High-security standards for customer information

 

Payment gateways and PayFacs are both players in the digital payment process with similar goals in mind: secure and low-risk payments while providing seamless, fast, and positive customer experiences. 

Both payment facilitators and payment gateways are committed to flexibility and security for merchants and customers alike; both support a variety of payment methods while remaining committed to high-security standards, safeguarding sensitive customer information, and maintaining PCI DSS compliance.

But the high-level difference is when and how to deploy them as part of the payment process. 

When to use each option:

A payment gateway handles the customer’s relationship with the merchant, an individual transaction at a time. A PayFac, in contrast, handles the bank’s interaction with a number of merchants.

Because they handle different parts of the payment process, payment gateways and PayFacs can be used in tandem. Regardless of whether or not a company uses a PayFac to manage their payments, they’ll still need to use a payment gateway to collect the information and process payments. It’s a required part of the online payment process. 

On the other hand, a company does not necessarily need to use a PayFac to manage the payments themselves, though they might find outsourcing those payments to a PayFac to be much simpler for their business. 

It’s important to note that a PayFac may have its own in-house payment processing and even payment gateway software platforms for their partners to use. And while some businesses might find this frustrating, others might be relieved not to string together a payment processing software stack themselves.

Some key differences:

As a result of their different roles in the process, you’ll find some key differences in how PayFacs and payment gateways operate. Because they focus on the individual transaction and operate more as individual software platforms, payment gateways frequently employ a subscription-based pricing model or charge a flat rate per transaction. 

On the other hand, because they operate more as a partner, PayFacs commonly employ a revenue-sharing pricing model, taking a percentage of each transaction they process. 

Likewise, as individual software solutions, payment gateways frequently offer many ways to integrate with other solutions to build a payment processing software stack, such as an API or plugins. As a partner, however, it’s more likely that PayFacs offer streamlined integration solutions for smaller merchants, often catering to specific industries.

Decision-Making: Choosing the Right Option for Your Business

When choosing the right payment system for your business, there are a number of factors to consider. 

Business size and transaction volume 

Consider whether the payment solution aligns with the scale of your business and anticipated transaction processing volume. Payment facilitators, for example, follow a model that is specifically designed for smaller merchants and may not be a good fit for larger businesses.

Customization and scalability options

Evaluate the customization options and scalability features offered by the payment solution to ensure it can adapt to your evolving business needs. 

A PayFac, for example, may offer more tailored options for your industry at a high-level, but may be harder to customize the individual details. Because a payment gateway is just a piece of the puzzle, however, it may be easier to build a fully-customized stack around the individual solution you choose.

Conclusion

To take advantage of the enormous growth in the eCommerce economy, understanding the nuances between different payment solutions is a necessity. And the importance of choosing the right payment solution for your business cannot be overstated. Whether you opt for the streamlined approach of a payment facilitator or the individualized service of a payment gateway, your decision will impact not only the operations of your eCommerce capabilities, but also the payment experience of your merchants and customers. Only you can assess which option is the right one for your business. 

FAQs about Payment Facilitator vs Payment Gateway

Q: What is a payment facilitator?

A Payment Facilitator (PayFac) is a model where a business (the facilitator) signs up with a bank or a larger merchant acquirer to provide payment processing services to other smaller businesses or sub-merchants.

Q: What is the difference between a payment facilitator vs payment gateway?

A Payment Gateway is a service that authorizes and processes payments in online and offline transactions. It’s responsible for securely transferring key payment information from the merchant to the acquiring bank and payment processors. 

A Payment Facilitator (PayFac), on the other hand, is a service that simplifies the merchant account enrollment process. PayFacs handle the bank’s interaction with multiple merchants, essentially serving as a master merchant that facilitates payment processing for its sub-merchants. 

Q: What is an example of payment facilitators? 

An example of a Payment Facilitator is Stax Connect. Stax Connect offers a platform for software companies and SaaS providers to integrate payment processing capabilities into their offerings. It enables these companies to become payment facilitators for their clients, allowing them to manage payments seamlessly within their ecosystems. Stax Connect provides the infrastructure and tools necessary for these companies to handle transactions, manage sub-merchant accounts, and ensure compliance, all under their brand.

Q: What is considered a payment gateway?

A Payment Gateway is considered a technology or service that facilitates the transfer of information between a payment portal (like a website or mobile phone) and the Front End Processor or acquiring bank. It plays a crucial role in the e-commerce transaction process, authorizing the payment between the merchant and customer.

 

What Is an ACH Payment Facilitator?

Automated Clearing House (ACH) payments are a type of electronic bank-to-bank payment system in the US. Unlike payments facilitated by card networks like Visa or Mastercard, ACH payments are managed by a body called the National Automated Clearing House Association (NACHA).

In Q3 of 2023, the total volume of payouts on ACH networks reached 7.8 billion. This was 3% higher than the volume from the same quarter in the previous year. Clearly, ACH transactions are one of the fastest-growing modes of electronic payments in the world.

This also signifies the growing importance of ACH payment facilitators in the digital payments landscape. In this article, we’ll discuss everything you need to know about the ACH payment facilitator model and how SaaS companies can go about facilitating ACH payments easily.

Let’s get started.

TL;DR

  • A payment facilitator (PayFac) is essentially a SaaS vendor or software provider that enables its users (businesses) to accept online payments from their customers through the platform itself. An ACH payment facilitator, therefore, is simply a PayFac that allows users to accept payments through an electronic bank-to-bank network.
  • ACH transactions are one of the fastest-growing modes of electronic payments in the world due to the convenience they offer, low processing costs, and enhanced security. This makes ACH PayFacs a desirable option for small businesses or start-ups.
  • The great thing about an ACH PayFac solution like Stax Connect is that SaaS companies or ISVs can embed ACH payments in their software easily and own (also, white label) the payment experience. All this without having to invest time and resources in partnering with an acquiring bank or building an elaborate payment infrastructure.
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Understanding ACH Payment Facilitators

A payment facilitator (PayFac) is essentially a SaaS vendor or software provider that enables its users (businesses) to accept online payments from their customers through the software platform itself. As such, an ACH payment facilitator is simply a PayFac that allows users to accept payments through an electronic bank-to-bank network.

PayFacs typically partner with a payment processor or a bank to provide merchant services. This enables business owners to accept payments directly through their SaaS platform without needing a Merchant ID (MID)—as is the case with traditional merchant account providers. Instead, the PayFac uses its master merchant account to facilitate payments for its sub-merchant accounts.

Instead of going through a third-party payment gateway, your ACH PayFac will allow the use of its own platform to process your payments. This is pretty much similar to the service that PayPal offers.

Most ACH PayFacs offer instant onboarding, making it quick and easy for merchants to start accepting payments. On the other hand, applying for a traditional merchant account requires submitting extensive documentation. After this, it usually takes about 3-5 days to get approvals post the underwriting process.

This makes ACH PayFacs a desirable option for small businesses or start-ups.

Benefits for SaaS Companies and ISVs

For a SaaS company or an independent software vendor (ISV), ACH PayFacs offer a host of benefits besides allowing them to add a new revenue stream:

Streamline the payment process

ACH payments are convenient for both you and your customers. You can process one-time as well as recurring payments without any checkbooks or other cumbersome means. You no longer need to go to your bank, issue paper invoices to your customers, or maintain records. With ACH payments, money is transferred electronically saving you all the headaches of physical checks, record-keeping, and tallying.

Reduce processing fees and costs

ACH payments cost much less compared to credit card payments. Card transactions are, in fact, the most expensive mode of payment as fees are calculated based on a percentage of the transaction. Paper checks, on the other hand, are the least expensive but have hidden costs for merchants in terms of labor and time. That leaves ACH as the preferred mode of payment. While this may not seem like much, when your transaction fees start adding up, the cost reduction can be quite significant.

Enhance the customer payment experience

Your customers will no longer have to sign checks and mail them. With ACH payments, they can simply make a one-time payment or set recurring payments for your services. Consistent and branded payments enhance your reputation and offer a seamless checkout experience to your customers.

Provides compliance and security advantages

ACH payments are one of the most secure payment options your customers can have. Since it has no intermediaries, the risks of tampering and fraud are reduced manifold. Since ACH payments require an ACH form for authorization of payments, customers feel more secure using this payment method. This has been one of the biggest factors behind the success of ACH payments.

How ACH Payment Facilitators Operate

To understand how ACH PayFacs operate, imagine you have payment processors on one end of the spectrum and merchants on the other. A PayFac sits right in between the two and provides payment processing services through sub-merchant accounts.

ACH PayFacs may seem to be somewhat similar to independent sales organizations (ISO). The main difference, however, is that ISOs repackage and sell payment processing services on behalf of a different, possibly larger company. On the other hand, ACH PayFacs process payments directly.

How ACH PayFacs Integrate with SaaS or ISV Platforms

Using PayFacs to receive payments has become one of the most favored options for many eCommerce platforms. This is because of their unmatched ability to sync payments with these platforms. Online marketplaces like Amazon and eBay have used the PayFac model with astounding levels of success.

The great thing about an ACH PayFac solution like Stax Connect is that SaaS companies or ISVs can embed ACH payments in their software easily and white label the payment experience. All this without having to invest time and resources in partnering with an acquiring bank or building an elaborate payment infrastructure.

How to choose the Right ACH Payment Facilitator

With the countless options available, you might feel overwhelmed while choosing an ACH PayFac for your business. But remember, not all PayFacs are created equal. Keep the following tips in mind when shopping around.

  • If you’re on a tight budget, partnering with  an ACH PayFac that operates on a custom revenue-sharing model would be the best option.
  • If you have just started a business, look for a PayFac that offers POS, exclusive ACH processing, and reporting features. This will help you save money by eliminating the need to look for different systems of payment processing.
  • If you’re running a high-risk business, make sure you have a PayFac with strong security features and a fraud management system.
  • If you’re only looking to process cards, get a PayFac that integrates with your website.
  • In case you’re dealing in international transactions, you’ll need a PayFac that processes global currencies and multiple payment types.

Put simply, choose your PayFac with your business needs in mind. Whether it is security, financial constraints, know-your-customer (KYC) compliance, or processing international payments, ensure that the payment services of your ACH PayFac are in line with your needs.

Challenges and Considerations with ACH PayFacs

SaaS companies and ISVs operate in a highly competitive marketplace and a dynamic payment ecosystem. When it comes to payment processing, they face several challenges that can seriously affect their business by causing significant customer churn.

Customer experience

A poorly designed interface or lack of convenience can be quite off-putting for a user. Besides, recording customer payment information manually is time-consuming and in huge volumes, simply impossible! To offer great customer experiences and maintain KYC records, crafting a tailored interface with a robust CRM system is important.

Unsuccessful transactions

Failed transactions are a huge menace to SaaS companies and ISVs. These cause serious loss of time and money if they’re identified in the first place. Make sure you have a system that provides an overview of transactions, pricing plans, and failed transactions in real-time.

Cross-border payments

SaaS companies and ISVs are increasingly offering their services across the world. This provides great opportunities for businesses but at the same time poses challenges with regards to the acceptability of different currencies and modes of payment. Having a PayFac that takes care of local preferences but also offers global adaptability is important.

Security

Payment processing involves the exchange of sensitive customer data. Any breach can cause a big dent in your reputation. Make sure you have a secure and encrypted payment processing system in place.

Customer churn

The most common cause for customer churn is when card details have expired or the payment has failed. Acquiring new customers can be quite costly as compared to keeping existing ones. That’s why having a billing solution that avoids customer churn especially due to the above reasons is a must.

Integrations

As your business grows, you will want to explore new possibilities. This means you need to have the ability to integrate with new third-party applications. Find a payment solution that integrates seamlessly and enables you to benefit from new opportunities.

Overcoming the Challenges

The above challenges can be a serious roadblock to success for any SaaS or ISV company wanting to become an ACH PayFac. The key lies in having the right PayFac solution that can effectively avoid or mitigate the impact of these challenges. To learn how Stax Connect can help, contact the team for a consultation now!

Future Trends in ACH Payment Facilitation

A range of new technologies are about to shape ACH payment facilitation:

3D Secure 2.0

This provides an additional layer of security. It initiates data exchange among the merchant, card issuer, and customer to validate the payment. The technology aims at providing a smooth user experience and payment acceptance with better security.

Authorization rate optimization

Past data and Machine Learning technology enable sellers to increase their revenue by reducing the rate of payment declines. With a high authorization rate and zero declines, you can expect to add significantly higher levels of revenue.

Application Performance Management 

This tool helps monitor and optimize the performance of your apps and hence boost the user experience. It covers areas like app metrics, code-level performance, network-based performance, etc.

Open banking

This is a system that uses APIs to provide third parties access to customers’ financial data. Customers usually grant access by checking a box online or signing terms of service. This will enable financial institutions to gauge customers’ financial position better and offer services accordingly.

AI and ML-based security 

These technologies enable monitoring fraud in real-time and offer insights into fraudulent transactions. By processing large quantities of data, ML helps in risk management by optimizing operations and preventing fraud proactively. Likewise, AI algorithms can identify patterns that can indicate fraudulent activities.

While the above trends pave the way for a more beneficial payment experience for everyone, they will also demand some changes on your end. These include the following:

  • A robust technological infrastructure
  • Customer privacy and security
  • Interoperability
  • User awareness and adoption
  • Quick and easy onboarding process

Final Words

It shouldn’t come as a surprise that ACH PayFacs provide some exceptional benefits to SaaS companies and software service providers. End-users can send and receive payments instantly while benefiting from low transaction fees, flexible and recurring billing, and great customer experiences.

For a SaaS company or ISV, partnering with an ACH payment facilitator solution like Stax Connect could be the easiest and quickest way to embark upon the PayFac business model. To learn more, contact us today.

FAQs about ACH Payment Facilitators

Q: What is an ACH payment facilitator?

An ACH (Automated Clearing House) payment facilitator is a service or platform that manages the processing of electronic payments, specifically ACH transactions. ACH transactions are a form of electronic fund transfer commonly used for direct deposit, payroll, and vendor payments.

Q: What does an ACH payment facilitator do?

An ACH payment facilitator typically handles several aspects of payment processing. This includes initiating ACH transactions on behalf of clients, managing the transfer of funds between banks, ensuring compliance with regulatory requirements, and providing security measures to protect the financial data involved in transactions.

Q: Are payment facilitators regulated?

Yes, payment facilitators are regulated. They must comply with regulations set by financial authorities such as the Federal Reserve and the National Automated Clearing House Association (NACHA) in the United States. These regulations include guidelines for transaction processing, data security standards, and customer authentication practices.

Q: What’s the difference between a payment facilitator and payment aggregator?

The difference between a payment facilitator and a payment aggregator lies mainly in their operational model. A payment facilitator directly manages client accounts and facilitates transactions on their behalf. In contrast, a payment aggregator bundles multiple small transactions from various unrelated clients into a single large transaction for processing. This aggregation model is often used for smaller businesses or individual merchants.

Q: What is an example of a payment facilitator? 

An example of a payment facilitator is Stax Connect. Stax Connect offers a platform for businesses to manage their ACH transactions, including facilitating direct payments, providing transaction reporting tools, and ensuring compliance with relevant financial regulations.

 

Understanding Risk Management Strategies as a PayFac

For SaaS companies, becoming a payment facilitator (or PayFac) offers a ton of advantages—including but not limited to—boosting retention and profitability while exercising greater control over the customer experience.

However, several complex types of risks come along with this. Not only must PayFacs safeguard themselves and their clients against potential threats like fraud or cybersecurity breaches but also ensure PCI compliance, customer due diligence, and adherence to card regulations.

As such, PayFacs need to equip themselves with an effective risk management strategy that helps them continuously monitor risks and employ appropriate risk responses if needed. This article will help your business’s stakeholders understand the various risk factors to watch out for as well as the different types of risk management strategies to employ.

Let’s get started.

TL;DR

  • Four main types of risks come with payment facilitation: compliance risks, operational risks, transactional risks, and reputational risks. PayFacs need to equip themselves with an effective risk management strategy that helps them continuously monitor risks and employ appropriate risk responses if needed. 
  • Common risk management strategies for PayFacs include proper merchant vetting and onboarding, transaction monitoring and fraud prevention, chargeback mitigation, KYC/AML compliance, and data breach prevention. 
  • To establish an effective risk management program as a PayFac, you must establish a dedicated risk management team, utilize the right tools and technology, develop proper risk management policies and procedures, conduct regular risk audits, and stay up-to-date with the latest industry regulations. 
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Mitigating Risks as a PayFac: Key Risk Categories

As you may already know, as a payment facilitator, you can enable your software users (or sub-merchants) to accept payments through your SaaS platform—without having to use a third-party payment gateway or provider. 

This allows you to bring the payment experience in-house, keep it on-brand, gain customer trust, and provide a seamless checkout experience to end users.

However, you are likely to come across a wide range of threats and external risks as you go about facilitating payments for your sub-merchants. Broadly, these can be classified into the following categories:

Compliance risks

Potential risks that may arise from non-adherence to any card brand or governmental regulations come under this category. This means that PayFacs need to conduct a thorough risk analysis of their sub-merchants before onboarding them so they are screened against terror financing or money laundering.

Several US legislations (like the Patriot Act, anti money laundering laws, or FinCEN regulations) require PayFacs to know the identities of the business owner(s) they plan to facilitate payments for, during the underwriting stage. They must also ensure that sub-merchants are compliant with the regulations set by card companies, e.g. PCI compliance.

Operational risks

Also known as strategic risks, these are risks that may stem from a PayFac’s unsound business practices or faulty decision-making. The potential impact of failed or inadequate internal systems, processes, procedures, etc. could also be classified as operational risks.

For example, the breakdown of old hardware, human errors, or malware can cause a hindrance to payments. Inexperienced staff in high-pressure roles could also cause serious lapses. Even the organizational shake-up that comes with the decision to become a PayFac may disrupt your core business.

Transactional risks

These are the risks that may arise from the processing of transactions on your platform. The PayFac is liable for all the transactions that happen on its platform. So you must have risk avoidance, risk identification, and risk reduction strategies in place to combat fraudulent transactions. You should also have contingency plans or initiatives in place to mitigate the impact of a risk.

For instance, a customer may order a product and receive it but claim they didn’t. They would then request a chargeback from their bank instead of requesting a refund from the seller—which essentially constitutes friendly fraud. Since PayFacs are responsible for processing and settling funds, they are liable for chargebacks as well. 

Reputational risks

Risks associated with things like data breaches, poor customer service, company controversies, etc. could result in financial losses, litigations, law enforcement action, and damage to reputation. 

Any illicit activity on the part of your sub-merchants can also cause a serious loss of reputation and customer trust. PayFacs must therefore keep track of dubious/high-risk merchants and immediately terminate the contracts of those engaged in any illegal activity.

Risk Management Strategies for PayFacs

Now that we’ve covered the various types of risks you need to watch out for, let’s take a look at some risk management strategies you could employ.

1. Merchant onboarding and vetting procedures

To authenticate prospective sub-merchants, PayFacs must collect all relevant information about their business—in line with all applicable laws and regulations. Once you collect the information, make sure to validate it so that any fraudulent merchant applications may be avoided.

Once the information is collected, PayFacs must render an underwriting decision to approve or decline sub-merchant applications. This requires sound underwriting policies and procedures. After, the PayFac performs due diligence during the merchant underwriting process and ensures that a merchant poses no undue financial risk, causes no harm to the payment system, and operates within an allowed jurisdiction. 

2. Transaction monitoring and fraud prevention techniques

As a PayFac, you must diligently monitor the daily transactions of your sub-merchants and look out for any unusual activity.

  • Velocity checks. Any abrupt or unusual deviation from a sub-merchant’s usual transaction pattern should be a cause for alarm. Monthly sales amount (volume), average transaction amount, sales-to-purchase return ratio, etc. are some of the common metrics you need to track.
  • Fraud detection and prevention. Early detection can help in the rapid mitigation of fraud. PayFacs must, therefore, bring any potential losses under the scanner (from sub-merchants engaged in questionable business activities). Any unusual activity in a user’s normal course of doing business should set off alarm bells immediately. You must then find the root cause and remedy it.

3. Reserve accounts and chargeback mitigation strategies

PayFacs can use reserve merchant accounts to reduce risk exposure. In this case, you would be setting aside a portion of your sub-merchants’ funds to protect yourself against any risk. Reserve accounts can be used when sub-merchants offer delayed delivery of products or services, for example, businesses offering annual membership, events, or travel-related businesses.

However, note that reserve accounts are the property of sponsored merchants. They can only be drawn upon under applicable clauses in your payment services agreement.

Having chargeback mitigation strategies in place can help you reduce the losses from chargebacks and illegitimate disputes. Ideally, the goal behind such strategies should be to keep a low chargeback ratio. This can be ensured using a fraud detection system with a filter, maintaining transaction records, and implementing chargeback alerts. 

4. Know your customer (KYC) and anti-money laundering (AML) compliance measures

Having a robust AML system in place mitigates the risks of criminals using your payment system for laundered money. However, to implement an effective AML system, it is important to have effective KYC controls in place. This involves having the basic information of your sub-merchants in your records. This includes their name, date of birth, address, identity documents, etc.

AML and KYC are mandated by the FATF as part of its comprehensive framework of measures to protect financial systems from vulnerabilities.

5. Data security and breach-prevention practices

All payment systems run on information. PayFacs are storing, organizing, and transferring sensitive information all the time. Any breach of this information can cause colossal losses to merchants, customers, and marketplaces.

Most PayFacs have technology in place to prevent these breaches. However, you must ensure that all systems comply with security standards such as PCI DSS. Regular cybersecurity audits, training your employees in security best practices, and sensitizing them against irresponsible behavior could significantly help safeguard against breaches.

Implementing Effective Risk Management Programs

As a PayFac, you must acknowledge that you can never have zero percent risk. However, risks can be managed well by employing some effective risk management programs. These would typically involve the following:

  • Establish a dedicated risk-management team: Risk management is a full-time job. So hire experts, train human resources within the organization, and fix their responsibilities per a comprehensive risk management plan. The Electronics Transactions Association (ETA) recommends having industry experts and legal counsel to ensure compliance with various standards, laws, and procedures.
  • Utilize risk management technology and tools: Just having a well-trained risk management team is not enough. As a PayFac, you have to invest in cutting-edge risk management technology to stay a step ahead of fraudsters. For instance, proper tools are required to spot and decline fraudulent applications during underwriting. These include negative databases, device fingerprinting, third-party validation, and geolocation checks.
  • Develop and implement clear risk management policies and procedures: PayFacs must have sound risk management policies and procedures. These must be in line with the regulations in vogue and ensure all aspects are covered. A sound and unambiguous risk management policy provides an effective starting point for all the subsequent actions at the managerial and operational levels.
  • Conduct regular risk assessments and audits: The risk management process is extremely dynamic with new risks and challenges emerging all the time. This means PayFacs always need to be vigilant. This calls for regular risk assessments and audits—preferably by an external agency—to close all the possible gaps in the security setup. Audits must again be in line with your policies, industry regulations, and legislation.
  • Stay informed about evolving payment industry regulations: If threats are evolving, so must the mechanisms to tackle them. PayFacs need to be aware of changing regulations to align their business practices accordingly.

Final Words

Risks are a persistent factor for PayFacs and can be a cause for serious losses for the entire payment ecosystem. But with the right kind of policies, teams, and technologies, PayFacs can achieve significant risk mitigation for themselves, their sub-merchants, and of course end users.

However, the easiest way to go about becoming a PayFac while making sure effective risk management strategies are in place is to partner with an expert like Stax. Stax Connect can help you build a complete payments ecosystem quickly from scratch while helping you successfully manage risk efficiently and inexpensively. Contact our team today to learn how.

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FAQs About Risk Management

Q: What is risk management?

Risk management in the context of Payment Facilitators (PayFacs) involves identifying, assessing, and controlling threats to an organization’s capital and earnings. These threats, or risks, could stem from a variety of sources, including financial uncertainties, legal liabilities, technology issues, strategic management errors, accidents, and natural disasters. A crucial aspect of risk management for PayFacs includes safeguarding against risks like fraud, cybersecurity breaches, and ensuring compliance with regulations such as PCI standards and anti-money laundering laws.

Q: Why implement risk management?

Implementing risk management is crucial for PayFacs to protect themselves and their clients from potential threats, ensuring a secure and trustworthy payment processing environment. Effective risk management helps in maintaining compliance with various legal and regulatory standards, preserving the integrity of the payment system, preventing financial losses, and safeguarding the reputation of the PayFac.

Q: What are the top risk management strategies?

Top risk management strategies for PayFacs include:

  • Merchant Onboarding and Vetting Procedures
  • Transaction Monitoring and Fraud Prevention Techniques
  • Reserve Accounts and Chargeback Mitigation Strategies
  • KYC and AML Compliance Measures
  • Data Security and Breach-Prevention Practices 

Q: What are examples of risk mitigation?

Examples of risk mitigation include setting up systems for real-time transaction monitoring to detect and prevent fraudulent activities. A PayFac can also establish strict protocols for merchant onboarding to ensure compliance with anti-money laundering regulations. 

Another example? Implementing advanced cybersecurity measures to prevent data breaches and protect sensitive information. 

 

How to Streamline Your SaaS Clients’ Merchant Underwriting Process—and Improve Adoption Rates

Offering payment processing services is a move that makes sense for a lot of SaaS companies, particularly if your software helps your customers run their business.

For example, if you have a project management app, then you can add payment features that allow people to use your software to take payments from their clients. Similarly, if you provide appointment scheduling solutions, then it’s worth offering payment tools so your users can leverage your solution to take upfront payments and deposits.

Adding payments to your suite of features and offerings enables you to provide more value to your users. They can take advantage of more features, which then encourages them to keep using your software.

Not to mention, payments serve as an additional (and highly lucrative) revenue stream for SaaS companies, so your business will also enjoy a healthier bottom line.

How exactly can you get your users started with payments? The first step is to find a partner that can provide the right payment technologies and services to your customers. From there, your users must go through an application and underwriting process that determines their eligibility to accept payments.

TL;DR

  • Merchant underwriting is the risk level assessment process an acquiring bank carries out on every new merchant before they grant them a merchant account.
  • The bank assumes the risk on behalf of the business and needs to make sure that they screen new businesses before handing out merchant accounts. This is where merchant underwriting comes in—merchant account underwriters check if new merchants meet the guidelines set by the bank and card brands.
  • A business can choose to open a merchant account on their own but the process can be laborious and time-consuming. SaaS companies can avoid having to integrate their software with that of gateways and banks, undergo thorough merchant underwriting, and submit mountains of documents by working with a trusted PayFac like Stax to make their software more comprehensive for their clients.

What Is Merchant Underwriting?

In simple terms, merchant underwriting is the risk level assessment process an acquiring bank carries out on every new merchant before they grant them a merchant account. Before we learn more about merchant underwriting, let’s understand what a merchant account means and why having one is important for any business. 

A merchant account is a kind of commercial bank account that is necessary for any business that wants to accept any type of electronic payment such as those made via credit and debit cards. Unless a business sticks to accepting only cash, all payments processed electronically in its brick-and-mortar locations, through online payment portals, via email or messages, and through IVR are settled using this bank account. 

Your SaaS clients will need to have a master merchant account if they want to facilitate ACH, debit cards, eChecks, and credit card payments for their sub-merchants. Merchant accounts are set up with acquiring banks, which can be any large bank that offers a deposit account to a business and provides them with services to be able to accept electronic payments. 

For an acquiring bank, processing any payment is similar to extending a line of credit to the business. This means that the bank assumes risk on behalf of the business and this is why they need to make sure that they screen new businesses before handing out merchant accounts. This is where merchant underwriting comes in—merchant account underwriters check if new merchants meet the guidelines set by the bank and card brands. 

How a PayFac like Stax can help

A business can choose to open a merchant account on their own but the process can be laborious and time-consuming. For first-time business owners and small businesses, the process of getting their businesses approved for merchant accounts can be complicated as it requires knowing various guidelines, collecting the right data, and submitting lots of documentation. 

Working with a payment facilitator can be the answer here. By hiring the services of a payment facilitator or processor, a business does not have to open its own merchant account. Instead, only the PayFac will have a merchant account as it allows its clients to accept payments. 

This system works very well for SaaS providers. Software service providers can partner with a payment processor so that they can offer payment processing options to clients who use their software for other business tasks. SaaS companies can avoid having to integrate their software with that of gateways and banks, undergo thorough merchant underwriting, and submit mountains of documents by working with a trusted PayFac like Stax to make their software more comprehensive for their clients.

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What Merchant Underwriters Need to Know

During the merchant underwriting process, there are five important factors about a business that an underwriter needs to look into. As a software company, you can help your clients understand what merchant underwriters need to know and help them gather all the required information to simplify the underwriting process.

  • Products and services offered
  • Industry risk
  • Transaction size and volume
  • Chargeback volume
  • Billing policies

As a software provider, you can implement some best practices to make these processes as streamlined as possible, so your users can get up and running with payments ASAP.

Let’s explore them below.

Best Practice #1: Understand the Payments Funnel in SaaS

Ricky Quote

To improve the payments experience of your users, you first need to understand the payments funnel within the context of SaaS companies. Richard Dunbar, VP of Professional Services at Stax, says that there are two key components to this: payments attachment (top of the funnel) and payments processing (bottom of the funnel).

The former refers to the phase of the journey when users first enroll in payments, while the latter is when they actually start processing.

According to Richard, many SaaS companies and ISVs focus on the “attachment” part of the journey and expect users to just start processing.

But it doesn’t work that way.

To truly maximize your payments initiatives, you need to think of the payments funnel holistically and understand when and where to:

  • sign up users for payments; and
  • prompt them to use the feature and initiate transactions.

“This is what we call payment adjacency,” explains Richard. “It’s about knowing where in your app it makes sense to have payments-related activity. That could be during sign-up or it could be at the point when they need to send an invoice.”

He continues, “It’s not as simple as putting a signup button and expecting people to click it. You have to put your payment offerings in front of users when and where they have the inclination to do it.”

The right payments-adjacent strategy depends on your software, as there are many ways to put payments in front of your users. For example, if you’re a point of sale or eCommerce platform, then it may be beneficial to have the payments conversation early. For other companies, the right time to introduce payments may be when a user is about to engage in payment-related activities like invoicing.

There are other methods to implement payment adjacency and the best course of action will vary based on your customer journeys and offerings

“We have some ISV partners where their software will ask the user about payments when they’re on the platform’s invoicing feature. Their system will say, ‘Hey, did you know that you can process payments through our software?’”

“Then it’ll give users the opportunity before they send the invoice to quickly sign up for payments so that they can embed the digital payment link straightaway.”

All this to say that offering payments isn’t just about building a feature and waiting for people to discover it. You need to be smart about timing and placements to ensure you’re presenting payments at the most optimal time.

Doing so will make it easier for users to see the value of the feature and they’re more likely to adopt it.

Best Practice #2: Familiarize Yourself with the Payments Underwriting Process and Requirements

Ricky Quote 2

Underwriting is an important part of getting your customers onboard payments. It involves submitting information from your users, analyzing their payments data, and assessing risk. It can be a time-consuming process without the right approach and a solid payments partner. Richard says you can make this step easier by familiarizing yourself with the underwriting process and requirements of your specific processor.

The underwriting process involves five steps as detailed below.

  • Document gathering – The merchant account application requires a business to submit many documents including bank statements and others regarding business type, transaction processing volumes, and financial history. You will probably have the information required by your client at this stage and you can improve customer relations by making it readily available to them. You can also help clients submit documents in the format requested by your PayFac.
  • Application review – Once you pass on documents on behalf of your client to your payment processor, their merchant underwriters will review them. The time taken in this step is usually shorter when you partner with a PayFac like Stax.
  • Follow-up – This is when the underwriters will get back to you if they need more information from your clients.
  • Application approval – The underwriter approves or rejects the merchant account application during this stage. A few reasons for rejection can be high-risk merchants, bad credit scores, and transaction volumes that are outside of the norm in the industry in which the business operates. 

High-risk industries include firearms and gambling and here the underwriter can approve the application by increasing processing fees. A high chargeback rate and high transaction volumes can be suspicious for a small business which can lead to applications being rejected. Underwriters also look for large transactions or inconsistencies in transactions. 

  • Onboarding – If the application is accepted, your PayFac starts onboarding your client. With a good payment processor, you will only have to integrate one simple API for payment processing with your software product that the client is already well-versed in.

“Depending on the processor, the underwriting process and requirements are going to vary. But there are certain things that are consistent, and those are the things that SaaS providers and ISVs need to make sure they’re educated on.”

The Financial Crimes Enforcement Network (FinCEN), a government agency that analyzes financial transactions, requires payment processors to analyze merchant information and do enough due diligence to assess risk.

“You may already know some of those FinCEN requirements, depending on your type of application,” says Richard. “So instead of asking your users to give that info to you again, you can just say, ‘We already know this information, so we’re just going to send it through.’”

That way, you can unburden your users from having to dig around for data. This, in turn, helps them complete the application faster. Another way to look at it is that you are allowing your clients to be completely transparent in their merchant account applications, which is essential if you want their applications to be approved.

Best Practice #3: Leverage Data From Your Platform

You can further streamline the underwriting phase by putting what you already know about your customers to work. One common question that’s asked during the payments application process is how much credit card volume the merchant processes.

Ironically, many business owners don’t know the answer to that question.

“The reason they don’t is that a lot of them are doing this for the first time, so they have no idea. Or, they may work with a processor they’re unhappy with so they never push people to use credit cards, which means their figures are skewed,” remarks Richard.

If you’re offering payments through your software, you will be much better off using the data you already have, rather than asking your customers to provide it.

For instance, if your platform has invoicing capabilities, you can look at your user history to figure out their transaction volumes. From there, you can provide your payments partner with an informed estimate that they can use during the underwriting process and quickly enroll users into using the payments feature. You can also deduce the expected transaction volumes for a business in the future so that your payment processor can put the correct transaction lines in place. 

Information such as chargeback history, credit history, sales volume, transaction size, etc. should be easily available to SaaS providers that offer invoicing services. You can collect accurate data and offer it to your payment processor, which will make the merchant account underwriting process far easier for your clients and reduce the chance of multiple follow-ups and rejections.

Best Practice #4: Customize Your Payments Application

Use the insights and info you glean from the above steps to design an efficient application and payment enrollment procedure for your users.

Once you know what information is necessary and what steps the processor will take to evaluate the merchant, you can customize your application to make it as simple as possible for the user to complete.

Accomplishing this is easy when you have the right payments partner. At Stax Connect, for example, we allow you to enroll merchants in 3 ways:

  • Full API enrollment. The process takes place within your app, giving your users a fully branded experience.
  • Hybrid API enrollment. The payment enrollment procedure begins on your platform, then customers are redirected to a white-labeled landing page where they can complete the application.
  • White-glove enrollment. This option lets you fill out the payments application form for your users.

Regardless of which option you choose, you have the ability to tailor the application process based on the info you need. You’re in control of what questions to include and how the application is formatted.

Best Practice #5: Be Upfront About Approval Estimates

So, your customers filled out the application and submitted it to the payments processor. What’s next?

Well, depending on your payments partner, users could breeze through the process… or it could take a while.

The key is to talk to your payments services provider and ask them about their approval times. For some processors, it could take about a week for a merchant to get approved.

But for best-in-class providers (like Stax Connect), the process takes just a couple of hours.

Whatever the case, be sure to communicate with your users. As Richard puts it, “It’s important to be upfront with the merchant and set clear expectations.”

If someone needs to accept credit cards ASAP and you’re working with a processor that has long lead times, then you need to let the customer know, so they can make an informed decision on whether or not to move forward.

That said, if you know that you’ll be working with people that want to get up and running right away (and these days, who isn’t?), see to it that your payments partner is able to deliver.

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Final Words

Adding payments to your current SaaS offerings can create a win-win situation for you and your customers. Users get more out of your platform and can access more features, while your business sees higher revenues and lower churn.

Stax Connect offers a fully managed payments facilitation ecosystem for SaaS and ISVs. We make it easy to monetize payments thanks to our robust platform and tailored revenue-share models. Stax Connect can integrate with your software quickly so you can start offering payments on your schedule.

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FAQs about SaaS Companies Payment

Q: What is the importance of offering payment processing services for SaaS companies?

SaaS payment processing services provide added value for a SaaS company’s customers by allowing them to use the software for their transactions. It also serves as an additional revenue stream that can benefit the business’s bottom line.

Q: What are the key components of the payments funnel?

The payment funnel comprises two key components: the payment attachment and payment processing. The former refers to users enrolling in payments, while the latter is about actual transaction processing.

Q: What is payment adjacency, and how does it contribute to a better payment experience?

Payment adjacency involves strategically placing payment offerings within the app where they make the most sense and when users are inclined to use them. It enhances user experience by providing the right payment functionalities at the right moment.

Q: Why is understanding the payments underwriting process important for SaaS providers?

The payments underwriting process involves assessing a customer’s risk and eligibility to handle transactions. Understanding this process helps streamline it and makes it less burdensome for users, thus improving customer experience and market adoption.

Q: How can data from your platform contribute to simplifying the underwriting process?

Using existing customer data, such as transaction volumes, can simplify the underwriting process. Instead of asking customers to provide information, the software can provide the necessary data, making the process quicker and easier for the user.

Q: Why should the payment application process be customized?

A customized application process contributes to an efficient user journey. By tailoring the process to the necessary information and procedures from the payment processor, users can complete the application in a straightforward manner.

Q: Why is it necessary to inform users about approval estimates in the payment process?

Communicating the estimated approval time helps set clear expectations for the users. It allows customers to plan and make informed decisions about their payment processing needs.

Q: How does adding payments to SaaS offerings benefit both the company and its customers?

For customers, it means gaining more functionalities from one platform, facilitating their operations. For SaaS companies, it can result in higher revenues and lower customer churn. Payments act as an additional feature that keeps customers engaged and loyal to the platform.

Q: What is the role of a payments partner in the payments underwriting process?

A payments partner can provide the necessary technology and services for the underwriting process, assist in enrolling users, and aid in risk assessment. The right partner can make the process efficient and greatly reduce the time for approval.

Q: What is the role of Stax Connect in the SaaS payments underwriting process?

Stax Connect offers a fully managed payments facilitation ecosystem for SaaS and ISVs. They provide a robust platform and tailored revenue-share models to easily monetize payments. They can integrate with your software quickly to start offering payments according to your schedule.


 

How to Maintain Anti-Money Laundering Compliance as a PayFac

For any merchant selling products or services online, it’s always a good idea to allow customers to make payments on their platform itself—instead of redirecting them to a third-party website or gateway. Not only is this inconvenient for customers but also risky.

For obvious reasons, the issue is even more pronounced for businesses in the financial services industry such as insurance companies or money services businesses. With the global economy moving online, corruption, fraud, trafficking, and other illicit activities continue to rise. According to a UN report, money laundering activities of about $1.6 trillion took place in 2020, accounting for about 2.7% of global GDP.

The US, therefore, requires financial institutions as well as financial services firms to have anti-money laundering (or AML) compliance programs in place. In this article, we’ll discuss everything you need to know about ensuring AML compliance as a payment facilitator (or PayFac).

Let’s get started.

TL;DR

  • An anti-money laundering (AML) program is a set of laws and procedures that seek to uncover attempts to disguise illicit money as legitimate. The Bank Secrecy Act (BSA) establishes AML program requirements for financial institutions in the US while the USA Patriot Act lays down which entities are required to comply.
  • An effective AML compliance program must include Know Your Customer (KYC) protocols, transaction monitoring and reporting, risk assessment and categorization, and training and awareness for staff.
  • Best practices for ensuring AML compliance as a PayFac include continuously updating your AML policies, utilizing advanced technologies for monitoring, periodic internal reviews and audits, and engaging with AML experts and consultants. However, be mindful of challenges like rapid technological advancements, evolving money laundering techniques, diverse clientele, varying risk profiles, cross-border transactions, and varied regulations.
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Understanding AML Basics

With money laundering, perpetrators try to hide criminal activities ranging from small-time bribery or tax evasion to drug trafficking or organized crime. Often, it’s also used for the financing of terrorism making the world highly unsafe.

Launderers usually funnel illicit money using an associate’s cash-generating business or inflating their invoices. Using a technique called “layering,” funds are transferred while completely concealing their source. Likewise, with smurfing or structuring, large amounts are transferred in small chunks to avoid raising alarms in AML scrutiny.

An anti-money laundering (AML) program is a set of laws and procedures that seek to uncover attempts to disguise illicit money as legitimate. 

As such, the Bank Secrecy Act (BSA) establishes certain AML program requirements for financial institutions in the US. It mandates ongoing monitoring of suspicious activity, recordkeeping, and submitting suspicious activity reports (SARs) to the government. The USA Patriot Act lays down which entities are required to do so.

An effective AML compliance program must include the following:

  • Internal procedures to ensure compliance as well as ongoing staff training
  • Appointing a BSA/AML compliance officer to manage and monitor day-to-day compliance
  • Independent testing (by third parties)
  • Taking a risk-based approach to customer identification
  • Employing risk-based procedures for ensuring beneficial ownership compliance—per the Financial Crimes Enforcement Network (FinCEN)’s rules—and conducting customer due diligence (CDD)

The need for strong anti-money laundering programs was felt as the global economy opened up and paved the way for unbridled financial transactions. With AML legislation, financial institutions are required to follow strict protocols for money laundering risk management. Non-compliance can have major implications.

Key AML Requirements for PayFacs

Now that we’ve covered the basics of AML compliance and its role in the financial system, let’s dive deeper into how PayFacs can help.

1. Know Your Customer (KYC) protocols

Compliance starts with establishing and verifying the identities of a business’s customers. A SaaS company looking to facilitate payments for its sub-merchants needs to have a Know Your Customer (KYC) or customer identification program (CIP) in place. You need to know the nature of their businesses or activities and ensure their money comes from legitimate sources only.

You’ll also need to screen sub-merchants based on crime suspicion, economic sanctions, and the US Treasury’s Office of Foreign Asset Control’s (OFAC’s) or the Financial Action Task Force’s (FATF’s) sanctions lists, etc. With proper KYC protocols in place, you can effectively unearth the deposition of illicit funds, layering, and acquisition of assets like real estate.

2. Transaction monitoring and reporting

Onboarding sub-merchants following thorough KYC isn’t enough. PayFacs must also monitor their transactions continuously for any suspicious behavior and report them to the authorities immediately. 

For instance, a merchant with steady transaction volumes suddenly sees a spike of, say, 200% in two days, which then goes down again. This could be a possible case of illicit funds being pumped into the business for laundering.

3. Risk assessment and categorization

The first step towards mitigating risk is to assess it. To that end, PayFacs must detect, manage, and categorize risky accounts. They can then be dealt with with appropriate levels of scrutiny and caution.

To make your risk assessment and categorization effective, you must conduct exhaustive AML screening. For this, you might require data from government sources, international regulators, and law enforcement agencies. Categorization also enables you to dedicate the right amount of human and technological resources to riskier accounts.

4. Training and awareness of staff

Your employees also need to be aware of your company’s policies, protocols, and procedures and have a thorough understanding of the legal landscape surrounding AML. They need to be given regular training to deal with novel techniques used by money launderers. 

But training can’t be a one-off practice. Since the AML landscape changes rapidly, training needs to be conducted regularly to keep your staff always a step ahead of fraudsters.

Best Practices for Maintaining an AML Compliance Program

As mentioned earlier, a lot of action goes on behind the scenes to ensure the effectiveness of an AML program. Here’s what you need to ensure as a PayFac.

1. Continuous updates to AML policies

Once drafted and implemented, AML policies can’t be expected to serve you forever. As the nature of money laundering risks, fraud, and techniques evolve, so should your AML policies to tackle them effectively. Reviewing and continuously updating your AML policies is therefore necessary.

2. Utilizing advanced techniques for monitoring

Automation and predictive analysis technologies can help manage risk much better than manual processes. The latter can be a serious waste of time and resources, and leave plenty of loopholes in the compliance process.

Repetitive tasks are best handled by automation to free up human resources for critical decision-making only. Although compliance does require complex technologies and ideas, good solutions are flexible and can be effectively adapted into existing workflows.

3. Periodic internal reviews and audits

Regular internal reviews and audits are necessary to plug all the loopholes. As technology advances and launderers evolve, the review net must become tighter as well. The best option would be to hire an independent or third-party expert for compliance reviews and audits. This will provide an effective and unbiased view of your policies and contribute more significantly towards improvement.

4. Engaging with AML experts and consultants

AML is an ever-evolving field. To stay updated with all the latest developments in the field, engaging with AML experts and consultants can be extremely helpful. The exchange of learning and best practices can take place at regular conferences, keynote sessions, and industry summits. 

PayFacs may also invite experts to work with their team on various critical steps of the AML compliance process such as drafting policies. This can also result in a great deal of rich learning for the in-house team.

Challenges Faced by PayFacs in AML Compliance

All said and done, there will always be several challenges in AML compliance. Here are the things to keep in mind.

1. Rapid technological advancements

Technology is always going to be a huge part of a PayFac’s AML efforts. But the problem is that launderers are always changing and evolving their technology chameleon-style. This can pose a serious challenge as you must dynamically dedicate resources and personnel to catch up.

2. Evolving money laundering techniques

With increasing innovation and skills, PayFacs may find it quite challenging to keep up with evolving techniques in money laundering. Continuous research and gaining deep insights into the ever-evolving techniques alone can help unearth suspicious transactions.

3. Diverse clientele and varying risk profiles

PayFacs onboard and deal with a diverse merchant base. This means different payment patterns and a diverse range of laundering techniques in play. Keeping all of these in check and detecting suspicious activities can be quite challenging.

4. Cross-border transactions and varied regulations

As a PayFac, you may need to process transactions for merchants across national borders. This means you’ll operate over a diverse AML regulatory and legislative landscape across the globe. Adapting to different AML regulations and laws can be quite complicated, confusing, and conflict-ridden.

Final Words

As a PayFac, you may have to deal in transactions worth billions every day. In other words, glaring opportunities for money launderers to sneak in and exploit. This can be a source of serious threats like global organized crime, terrorist financing, drug and weapons trafficking, and other financial crimes. To create a safer, crime-free world, PayFacs, therefore, have a responsibility to ensure strict AML compliance.

The good news is, with a solution like Stax Connect, you can not only start facilitating payments and also onboard sub-merchants quickly while managing risk. Each merchant is verified and validated using KYC, AML, OFAC, and credit checks so you may rest easy as we do the heavy lifting for you. To learn more, contact our team today.

FAQs about Anti-Money Laundering Compliance

Q: What is anti-money laundering compliance?

Anti-money laundering (AML) compliance refers to the set of laws, regulations, and procedures designed to prevent criminals from disguising illegally obtained funds as legitimate income. Compliance requires financial institutions, including Payment Facilitators (PayFacs), to monitor their financial transactions for suspicious activity, perform customer due diligence, and report to authorities as needed.

Q: Why is AML compliance critical for PayFacs?

PayFacs are a prime target for criminals who are trying to launder money. Because PayFacs process payments for a variety of merchants, they can be used to disguise the source of illegal funds. 

Additionally, PayFacs often have access to large amounts of cash, which can be used to finance criminal activities. 

By implementing effective AML controls, PayFacs can help to prevent criminals from using their platforms to launder money. This can help to protect the PayFacs themselves, their merchants, and their customers from financial loss and other negative consequences.

Q: How often should PayFacs review and update their AML policies? 

PayFacs should review and update their AML policies on a regular basis to ensure that they are aligned with the latest laws and regulations. Additionally, PayFacs should review their AML policies whenever they make significant changes to their business operations, such as expanding into new markets or offering new products or services.

Q: How can technology aid in better AML compliance?

Technology can enhance AML compliance through automated monitoring systems, artificial intelligence, and machine learning algorithms that detect unusual patterns and high-risk transactions. These tools can process large volumes of data efficiently, ensuring more accurate and timely reporting of suspicious activities.

Q: How can you establish anti-money laundering compliance program

To establish an AML compliance program, a PayFac should: 

  • Develop internal policies, procedures, and controls to meet AML regulatory standards. 
  • Assign a compliance officer responsible for implementing and monitoring the program. 
  • Conduct ongoing employee training to recognize and handle suspicious activities. 
  • Perform independent audits to review and improve the program. 
  • Ensure proper customer due diligence, including identity verification and risk assessment.

Know Your Customer (KYC): What It Is and How to Comply

204.5 billion. That’s the amount of non-cash payments made in the U.S. in 2021, according to the Federal Reserve. That’s a lot of money being exchanged—and also provides a huge amount of possibility for financial crime.

Financial crime can take on several faces, including (cyber) fraud, cryptocurrency scams, and money laundering—and companies offering financial services can lose out on serious bucks. In the U.S., white-collar crime can cost annual losses as high as $300 billion. Meanwhile, in the European Union, it’s estimated to cost between €715 billion to €1.87 trillion a year. Of course, financial criminal activity doesn’t have to just lead to monetary loss—it could also lead to a data breach of customer information. Either way, the stakes can be high and the consequences far-reaching.

If you’re starting a vertical SaaS company, Know Your Customer (KYC) should be high on your list of priorities to check off before launching. Even if you’re not in the financial industry, you’ll need a payment processor or payment service provider (PSP) to start generating revenue, which means you’ll need to either have a proper risk management framework in place—or work with a PSP that has one. If you’re starting the underwriting process and have no idea how to make sense of the complex world of KYC and all the terminology involved, you’re in the right place. From EDD and eKYC to AML to CDD, we’re going to cover everything you need to know about KYC in this article.

TL;DR

  • Know Your Customer, or KYC, is the process of ensuring that companies can verify their (current or potential) customers’ identities and their financial profiles. 
  • KYC’s three main components are the customer identification program (CIP), which was imposed by the USA Patriot Act in 2011; customer due diligence (CDD); and regular monitoring of the customer’s account and activities, which is also called enhanced due diligence (EDD).
  • To choose the right KYC provider, some of the factors you should look at are if the provider offers automated KYC processes, integration with existing systems, future-proof scalability, and full compliance with regulatory requirements.
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What Exactly is KYC?

Know Your Customer, or KYC, is the process of ensuring that companies can verify their (current or potential) customers’ identities and their financial profiles. In the U.S., there are three main components of KYC: the customer identification program (CIP), which was imposed by the USA Patriot Act in 2011; customer due diligence (CDD); and regular monitoring of the customer’s account and activities, which is also called enhanced due diligence (EDD).

It’s important to note that even though CDD and KYC are similar processes that involve verifying customers’ identity, they aren’t the same. While internationally CDD can be seen as a key component of KYC compliance, within the U.S., it’s the opposite: customer due diligence is an ongoing process that is a part of the KYC requirements, which in turn is part of the broader anti-money laundering (AML) regulations set in place for financial institutions.

Why KYC Matters for SaaS Companies

There are a wide range of reasons why companies need to comply with the KYC process—primarily regulatory and ethical.

Within the U.S., the U.S. Financial Crimes Enforcement Network (FinCEN), stipulates that customers and financial institutions ensure KYC compliance to limit illegal activities like money laundering, which is why KYC is seen as a component of AML. 

Failure to comply with AML and KYC frameworks can lead to an array of legal and financial consequences, as compliance with AML requirements has been a part of legislation since as far back as 1970. 

Companies have had to pay serious fines over the years: Commerzbank London had to pay £37.8 million ($47.3 million), while Goldman Sachs faced a fine of $2.9 billion for its role in financial crime. Between 2008 to 2018, $26 billion was handed out in fines, with 91% coming from the U.S.

That said, besides the legal and financial repercussions, there are ethical reasons to have a strong AML and KYC policy in place. With the increased risk of fraud, consumers want to know that they’re partnering with a company that is doing its utmost best to keep their money safe. 

If it’s not clear that your SaaS company is taking KYC seriously—or worse, it comes out due to a scandal—you risk serious reputational damage, which could lead to customer churn. With a rigorous KYC process in place, it’s possible for financial service providers to offer companies the peace of mind that they can be aware of their client’s identity, risk tolerance, and financial standing—minimizing the risk of financial crime while keeping customer data safe.

What The KYC Process Looks Like

While there’s no such thing as a fully standardized KYC process for most businesses, all compliant financial institutions in the U.S. must ensure their customers go through the CIP, CDD, and EDD as part of the merchant onboarding process. Let’s dive a little deeper into each of these components.

Introduce the customer identification program (CIP)

Basically, the CIP requires that companies get four pieces of identifying information about their client for identity verification. This includes their name, date of birth, address, and identification number (such as a social security number). This legal requirement was codified into U.S. law through the Patriot Act, and requires financial institutions to “form a reasonable belief that it knows the true identity of each customer.” This can involve comparing the information provided to databases, and ensuring the customer isn’t a politically exposed person (PEP), on any sanctions list, or suspected to be involved in terrorism financing. The data must be securely kept for at least five years after the account is closed should it be needed down the road.

Customer due diligence

Customer due diligence is the process of collecting a customer’s data to verify their identity and determine the customer’s risk profile, establishing if there should be a business relationship. The level of CDD and risk-based approach varies on the consumer risk and types of transactions that will be carried out.

For example, if you’re a SaaS company that deals  with high-dollar transactions, or works  in the gambling vertical, your risk assessment outcome will likely be high, and regulatory requirements would mean a more intense CDD process. This doesn’t mean you wouldn’t be onboarded as a client, but rather that you’d have more stringent KYC regulations to deal with. You’d also likely have to undergo enhanced due diligence (EDD), which is used for customers with a higher risk of identity theft, money laundering, or other illegal activities.

Various factors play a role in risk ratings, like transaction patterns, geographic location, customer reputation, fund source, or PEP status. While there isn’t a standardized risk rating system, the CDD framework should be able to determine whether a potential client is high-risk or not.

Regular monitoring and periodic reviews

While CIP and CDD can help to protect financial institutions’ reputations when an account is opened, ongoing monitoring is required to ensure that any suspicious financial transactions are detected and flagged as soon as possible so appropriate action can be taken.

Choosing the Right KYC Solution Provider

“A good beginning is half the task” has never been truer than when looking for a reliable KYC provider as a SaaS company taking on payments. Here are a few things you should be on the lookout for when shopping around.

eKYC support: A fully manual KYC procedure is almost never feasible given the global scale on which transactions take place. Not only is it significantly more time-consuming and costly, there’s also a higher risk of error and a data breach. While technology is constantly evolving, some of the more common automated KYC approaches in (digital) onboarding involve using AI algorithms, third-party API integrations, and OCR. By partnering with a provider that uses automated KYC paired with human precision, you can ensure you get the best of both worlds.

Integration with existing systems: Look for a solutions provider that will adapt to your way of working, not the other way around: just because KYC and AML is a regulatory requirement doesn’t mean it should feel like pulling teeth. The digitization of KYC can streamline the process, with many payment processors or financial institutions using API-based applications for identity verification. Industry champions will be able to strike the right balance between providing a seamless onboarding experience without sacrificing security.

Scalability and compliance: Your future payment processor shouldn’t be a temporary solution; they should be able to support you whether you’re processing a thousand or a hundred thousand payments. Make sure you can determine if they can grow alongside you, and double-check to see if they regularly review their KYC, CDD, and EDD policies. For example, ask what local registries they have access to and types of documents they can see, what databases they’re connected to, what KYC information and biometrics they track, and what long-term steps they’re taking to combat the general uptick in fraud. Plus, make sure to research them to see if they’ve ever been mentioned in the news for noncompliance with AML regulations.

While this isn’t an exhaustive list—customer service, flexibility, and data storage are other factors to consider to help you get started with your KYC process.

Wrapping up

If you’re searching for a powerful payment service provider that puts compliance front and center, look no further than Stax Connect. From online credit card payments to in-person contactless transactions and everything in between, our all-in-one payments processing platform offers a range of powerful payment solutions to sustainably scale your SaaS business, while ensuring Level 2 PCI Compliance for all your merchant onboarding needs.

Contact us for a free demo today.


FAQs about KYC

Q: What is Know Your Customer (KYC)?

Know Your Customer, or KYC, is a mandatory process to verify the identities and financial profiles of current or potential customers. It involves three main components: the customer identification program (CIP), customer due diligence (CDD), and regular monitoring of the customer’s account and activities, also known as enhanced due diligence (EDD).

Q: Why is KYC important for SaaS companies?

KYC is crucial for SaaS companies, primarily for regulatory and ethical reasons. Compliance with KYC helps limit illegal activities like money laundering. Failure to comply with KYC and anti-money laundering (AML) frameworks can lead to legal and financial repercussions. Ethically, a strong AML and KYC policy assures customers that their money is safe, thus enhancing the company’s reputation.

Q: What are the main components of KYC?

The three main components of KYC are the customer identification program (CIP), customer due diligence (CDD), and enhanced due diligence (EDD). CIP involves obtaining four pieces of identifying information about the client for identity verification. CDD is the process of collecting a customer’s data to verify their identity and determine their risk profile. EDD involves regular monitoring of the customer’s account and activities to detect any suspicious financial transactions.

Q: What factors should one consider when choosing a KYC solution provider?

When choosing a KYC solution provider, consider if they offer automated KYC processes, integration with existing systems, future-proof scalability, and full compliance with regulatory requirements. The provider should be able to adapt to your business operations and grow alongside you.

Q: What is the significance of eKYC?

eKYC, or electronic Know Your Customer, is an automated approach to the KYC process. It simplifies and speeds up the identification and verification process, reduces the risk of errors and data breaches, and helps companies comply with regulatory requirements efficiently. It typically involves AI algorithms, third-party API integrations, and OCR.

Q: What is the relationship between KYC and AML?

KYC is part of the broader anti-money laundering (AML) regulations set in place for financial institutions. While KYC focuses on verifying customer’s identity and assessing their financial profiles, AML involves measures to prevent illegal activities, such as money laundering and terrorist financing. Compliance with both KYC and AML is legally required and crucial for maintaining a company’s reputation and legal standing.

Q: How does KYC help prevent financial crime?

KYC helps prevent financial crime by ensuring that companies can confirm their customers’ identities and understand their financial profiles. It allows companies to detect and monitor any suspicious financial activities, thereby minimizing the risk of financial crime and keeping customer data safe.

Q: What is the role of regular monitoring and periodic reviews in KYC?

Regular monitoring and periodic reviews are part of the enhanced due diligence (EDD) process in KYC. They are necessary to ensure that any suspicious financial transactions are detected and flagged as soon as possible. This ongoing monitoring helps protect the financial institutions’ reputations and enables timely action against potential financial crimes.

Q: What are the consequences of non-compliance with KYC regulations?

Non-compliance with KYC regulations can result in legal and financial consequences, including hefty fines. It can also lead to reputational damage, which could cause customer churn and affect the company’s standing in the market.

Q: What is Stax Connect in the context of KYC?

Stax Connect is a payments processing platform that ensures Level 2 PCI Compliance for merchant onboarding needs. It provides a range of powerful payment solutions to sustainably scale your SaaS business while ensuring compliance with KYC regulations.


 

What Is Data Tokenization and How Does It Work?

As the world increasingly moves online, it is essential to safeguard the information being stored and transferred over networks. Today, data is as important as currency and should be safeguarded as such. In 2022, there were 1802 instances of data compromise in America which affected 422 million people.

Loss, corruption, improper use, and unwanted access to a company’s data assets can lead to immense negative publicity, which in turn can cause irreparable reputation damage, fines, sanctions, and loss of profits. Moreover, companies need to follow data privacy and compliance requirements to stay in business. 

There are various methods of enforcing data security, such as data masking, encryption, authentication, and data tokenization. In this article, we’ll take a closer look at what data tokenization means, how it works, and the role it plays in payment processing.

Let’s get started.

TL;DR

  • Data tokenization is a substitution technique in which private or sensitive data elements are replaced with randomly generated alphanumeric strings. These strings or tokens have no value and can’t be exploited. The original value or dataset cannot be reverse-engineered from a token value.
  • Payment tokenization is a subset of data tokenization where tokens replace confidential payment data such as customer credit card information. With payment tokenization, the actual credit card data isn’t stored thereby making digital payment transactions more secure.  Besides the enhanced data security, other benefits include reduced risk of breaches, easier regulatory compliance, and compatibility with legacy systems.
  • As businesses increasingly go online, software vendors looking to offer integrated payment processing must consider incorporating payment tokenization as one of their data security features. The good news is that with a solution like Stax Connect, this need not be difficult or complicated.

Learn More

Understanding Data Tokenization

Put simply, data security is a set of policies, processes, and guidelines to protect information in the digital space. This helps to protect any sensitive company and customer digital data from theft, corruption, and unauthorized access.  

The three main principles of data security are Integrity, Confidentiality, and Availability.

  • Data that is accurate and immune to unwarranted changes is said to have Integrity.
  • Confidentiality means that data should be accessible only to authorized users.
  • Availability entails that data should be accessible, in a prompt and secure manner, to those who need it. 

Data tokenization is a substitution technique to protect sensitive data in which valuable data components are substituted with meaningless sets of data generated by an algorithm.

Essentially, private or sensitive data elements are replaced with randomly generated alphanumeric strings. These data strings have no value and hence cannot be exploited. They are known as tokens. The original value or dataset cannot be reverse-engineered from a token value.

Tokenization, as a concept, has always existed—ever since the earliest monetary systems emerged. For example, in prehistoric times, valuable goods such as grain and livestock were often represented as clay tokens. The modern-day casino chips can be thought of as a great example of tokenization.

These are instances of tangible tokenization, but the intent is the same as in digital tokenization. A token acts as a stand-in for a far more valuable object. 

Tokenization vs encryption

Data encryption is another popular data security technique where data is transformed into an illegible format. Encryption is widely used, especially by messaging apps for data obfuscation, where decryption keys restore the original messages once received by the correct recipient.  

Data tokenization and encryption are both popular cryptographic and obfuscation techniques being used in the digital payments space. The main difference is that the encryption process is designed to be reversed once the original data reaches its intended destination. With the decryption key, the encrypted data is restored to its original form, and the strength of data security depends on the complexity of the encryption algorithm. 

However, this also means that data encryption is breakable—hackers can illegally obtain the encryption key or have enough computational power to break complex encryption algorithms.

In contrast, tokenization does not depend on keys or encryption algorithms, as random data is mapped to and replaces sensitive data. The resulting token is essentially a proxy and has no real value. Plus, the token mappings are stored in a secure location and are never transferred over IT networks, unlike decryption keys.

It is also to be noted that encryption can change the type and length of the data that is being secured, which is not the case with tokenization. Businesses need an internet connection to implement data tokenization as it only works over the web. On the other hand, encryption can be applied on local systems with encryption tools and network connectivity is not a prerequisite. 

How Does Data Tokenization Work?

Let’s use payment tokenization—a subset of data tokenization—to better understand how the tokenization process works.

When a merchant accepts a card payment from a customer, their personally identifiable information (PII) such as primary account number (PAN) is sent to the payment processing software that the merchant is using. If the payment processor uses tokenization, cardholder data is replaced with tokens. 

Payment processors use complex algorithms to generate random tokens that are substituted for the original sensitive data as the payment is being processed. This means that even in the business’s internal systems, the real data is never stored. Instead, alphanumeric strings representing the original data—that are inherently meaningless—are stored in the system. The payment service provider would have their own secure storage where the PII is stored. 

In other words, tokenization decouples sensitive information from the payment transaction thereby reducing the possibility of a data breach. PANs, customer information, credit card numbers, etc. are stored in a secure location by the payment processor.

When the payment needs to be verified and completed, the business sends the tokens to the payment processor who then maps the tokens to the original data in their secure data storage system (de-tokenization) and completes the transaction. The actual card information can be read only by the payment service provider or tokenization service and is kept away from intermediaries. 

A token generated by a merchant can be used only by that merchant. This actually makes recurring payments simpler. Subscription-based businesses can use the same token to complete payments on a regular basis without having to collect any sensitive card information. 

Benefits of Data Tokenization

Data tokenization offers a number of benefits including:

  • Enhanced data security and reduced risk – In data tokenization, the personally identifiable information is stored in a secure database that is usually in a remote location. Moreover, only authorized personnel can access the original data. Hence, it inherently fulfills two main components of data security—Integrity and Confidentiality. Even if malicious organizations are able to obtain transaction information or break into a company’s systems, the substitution of sensitive card information with tokens means that they will only be in possession of nonsensitive tokens that have no value and cannot be mathematically reversed to reveal any useful information.
  • Minimized data breach impact – Payment processors offering tokenization can protect their clients from data breaches as client systems don’t need to capture, store, or transmit any sensitive cardholder information. In a sense, clients are also protected from reputation loss and financial repercussions related to data breaches. 
  • Regulatory compliance and ease in meeting standards like PCI DSS – Payment Card Industry Data Security Standard (PCI DSS) compliance requirements are easier to fulfill and maintain as processing and storage of sensitive information is at a minimum with data tokenization. Compliance with such security standards is important for businesses to operate legally and win customer trust. Tokenized information does not need to be protected as per PCI standards. 
  • Compatibility with legacy systems – Unlike encryption, tokenization solutions are compatible with outdated and legacy systems. This can save a lot of money as systems need not be updated every time data tokenization services have to be set up or when supporting software and vendors need to be plugged in. 

The Role of Data Tokenization in Payment Processing

Although digital tokenization emerged as early as the 1970s, it has become extremely popular of late in the payment industry to protect cardholder data. As discussed above, payment tokenization is a subset of data tokenization where tokens replace confidential payment data such as customer credit card information. With payment tokenization, the actual credit card data isn’t stored thereby making digital payment transactions more secure.  

TrustCommerce is attributed to having first developed data tokenization to protect card data in 2001. As such, payment companies often prefer tokenization to encryption as the former is more cost-effective and secure.

As businesses increasingly go online, software vendors looking to offer integrated payment processing must consider incorporating payment tokenization as one of their data security features. The good news is that with a solution like Stax Connect, this need not be difficult or complicated.

Stax Connect has the capabilities to help you build a complete payments ecosystem from scratch in just a month’s time. You get to benefit from our long-standing relationship with the world’s leading sponsor bank and our built-in enrollment engine that takes care of all your risk and compliance requirements.

You can start facilitating payments for your sub-merchants in as little as 20 minutes of getting started. Accept a variety of payment methods while resting assured that all payment info is safely stored and secured via tokenization. To learn more, contact the Stax Connect team for a consultation or request a demo today.

Challenges and Limitations

Despite its many benefits, tokenization comes with a few challenges:

  • Managing the token database – Unstructured and structured data can be encrypted but only structured fields can be tokenized. This is why the tokenization process works so well on data fields like PAN and credit card numbers. With encryption, a small encryption key can be used to encode and decode large volumes of data. A tokenization system does not allow this as unique tokens are generated for each data field and tokens are unique to a merchant. This means that a large number of tokens need to be stored and protected, limiting the scalability of tokens as the amount of data grows. 
  • Ensuring timely and accurate token retrieval – Storing all this sensitive data in a single, centralized token database or vault can lead to bottlenecks when it comes to data or token retrieval. This negatively affects the data availability component of data security. 
  • Potential performance impact on systems – Although many payment processing applications offer tokenization solutions, a tokenization system does increase the complexity of the IT infrastructure of a merchant. Coupling this with bottlenecks that can occur during retrieval and tokenization can impact the performance of a merchant’s computer infrastructure. 

Choosing Between Tokenization and Encryption

Data tokenization does not require complex mathematical processes or algorithms to generate keys or transform data. Hence, tokenization can be technically easier to implement as long as a secure token vault can be established and maintained.

Also, just as tokenization is more compatible with legacy systems, it also works very well with new technologies such as contactless payments and mobile wallets. The fintech industry is seeing rapid innovation and tokenization may be more suitable with future emerging technologies as it is more adaptable. 

If possible, it is best to use both tokenization and encryption in tandem to maximize data privacy and security. Encryption works best for data being transferred and tokenization works best for data storage cases.

For example, social security numbers are being replaced with tokens in a business’ data warehouses. If your business requires storage of original sensitive data for long periods of time, it is best to go with tokenization. It is also a better option if data analytics is important to your business as analytics tools can process tokenized data.

Final Words

Tokenization is an excellent option to secure payment data as it works well to mask structured data such as PANs, credit card data, and card numbers. Tokens ensure that original data isn’t stored or transferred by a business, which not only improves data protection but also makes it easier to comply with security standards. This makes it obvious that companies providing payment solutions should incorporate data tokenization in their broader data security strategy. To find out whether Stax Connect may be the right partner for you, contact us today.

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FAQs about Data Tokenization

What is data tokenization?

Data tokenization is the process of substituting a sensitive data element with a non-sensitive equivalent, referred to as a “token,” which has no extrinsic or exploitable meaning or value. The token acts as a reference or pointer to the original data but cannot be used to deduce the actual sensitive data.

How is data tokenization different from encryption?

Encryption is a process of scrambling data so that it cannot be read without the correct decryption key. Tokenization, on the other hand, replaces sensitive data with non-sensitive tokens. This means that even if the tokens are intercepted, they cannot be used to access the original data without the tokenization system. 

Another key difference between encryption and tokenization is that encryption can alter the format and length of the data, while tokenization does not. This makes tokenization more compatible with legacy systems and applications.

What is the role of data tokenization in payment processing?

Data tokenization is widely used in payment processing to protect sensitive payment data, such as credit card numbers and bank account numbers. When a customer makes a payment, their payment data is tokenized and stored in the merchant’s tokenization vault. The merchant then sends the token to the payment processor to process the payment.

What are the benefits of data tokenization?

Data tokenization offers a number of benefits, including improved data security, reduced risk for breaches, and increased compliance, particularly with  data security regulations, such as the Payment Card Industry Data Security Standard (PCI DSS).

What are the limitations of data tokenization?

Data tokenization is not a perfect solution for data security. For one, data tokenization can be expensive to implement and maintain. In addition, once a data tokenization system is implemented, it can be difficult and expensive to switch to a different system.