The Green Sheet Online Edition
August 8, 2007 • 07:08:01
Learning the ISO lingo
Like many business sectors, the payments industry has coined its own vocabulary. But while doctors can turn to the Physicians' Desk Reference, and entire law libraries define legalese, our sphere has no comparable compendia.
Terms like "vested residuals," "revenue share" and "free terminal placement" mean different things to different people. This can create truly baffling conversations. Moreover, some of our murkiest verbiage describes ISO programs that merchant level salespeople (MLSs) depend on for their livelihoods. And when misunderstandings involve earnings, the consequences can be severe.
In 2004, the Electronic Transactions Association published the Encyclopedia of Terminology for the Acquiring Industry by Donna L. Embry, Senior Vice President of Payment Alliance International.
The work defines over 3,000 terms unique to the acquiring industry. However, it doesn't cover many terms related to MLS compensation.
You say share, I say split
"Many industry terms -- for example, 'revenue share' and 'true interchange split' -- relate to one thing: agent compensation based upon a percentage of 'profits' after the deduction of certain buy rates," said bankcard industry Attorney Paul A. Rianda.
"Unless the buy rates from ISO to ISO are the same, you can have the same profit percentage paid to the agent and he/she will be paid a differing amount of residuals because of the different buy rates," he said.
Jerry Julien, Equity Commerce's Executive Vice President Business Development, advised MLSs to thoroughly inspect the fine print in agent agreements.
"My personal radar goes off very quickly when an agent doesn't ask me a single question related to my pricing schedule or sections of my agent contract," he said. Pesky concepts clarified
To facilitate understanding, The Green Sheet asked several industry veterans to help define the terminology associated with MLS compensation. Following are their thoughts on some potentially problematic expressions you, as ISOs and MLSs, are likely to encounter:
- Activation bonus
An activation bonus is typically paid to an agent after a merchant whom the agent signed is installed.
"This was not as prevalent in the early ISO days, as counting apps was more important," Embry said. "This model is becoming more important, as having a merchant activate is more critical to meeting the revenue projections." - Agent risk reserve
Banks hold risk reserves to offset against future merchant losses.
"A risk reserve is a certain upfront dollar amount in addition to a fixed number of basis points multiplied against the portfolio's net interchange volume," said Jared Isaacman, Chief Executive Officer of United Bank Card Inc. He noted that it is rare for ISOs or MLSs who do not hold or manage risk on merchant portfolios to pay risk reserves.
"They could, however, pay a risk fee, which is not a reserve and covers any losses the bank may take on the portfolio," he added. "A true risk reserve is not a fee, but a pool of money established on the ISO/processor's behalf to cover future losses."
Sam Caine, President of Card Payment Services Inc., said agent risk reserves are usually funded out of residual payments.
"For example, an ISO may require a three-basis-point risk reserve," he said. "Therefore, each month the ISO will deduct three basis points of the agent's volume from their residual payment to hold in reserve."
He added that it is vital for an MLS to know all the conditions pertaining to a reserve, including how it will be used to fund losses, whether losses are capped and whether the agent's entire residual stream is at risk.
"Typically, agents should not agree to a relationship that requires the agent to have any liability for losses," he said. - BIN sponsor fee
A BIN (bank identification number) sponsorship fee is charged by a sponsor bank for setting up a true BIN relationship.
Isaacman said a BIN relationship exists when an ISO has its own distinct BIN with Visa U.S.A. or MasterCard Worldwide. "It is the ultimate control and ownership a super ISO can have over the merchant program without actually being a bank themselves," he said.
Isaacman added that since the bank is passing through all the income to the super ISO (all the interchange), the only revenue the bank makes (and its only justification for the program) is a BIN sponsorship fee.
The fee is often a fixed number of basis points or cents multiplied against portfolio volumes, he said. And in today's environment, "several super ISOs pass on that BIN sponsorship cost or eat it as a cost of doing business." - Buyout multiples
A buyout multiple is used to calculate how much an ISO is willing to pay an agent to purchase the agent's residual stream.
"If an ISO offers an agent a buyout multiple of 24 times, the agent would receive 24 times their average monthly residual as a one-time, lump sum payment and no longer have any rights to future payments for the purchased merchants," Sam Caine said.
According to Julien, buyout multiples have many interpretations and can greatly affect agents because portfolio acquisitions are on the rise.
He suggested agents ask themselves, "Does this multiple apply if I offer (or my ISO offers) to purchase my residual from me at any given time? What happens in the event my ISO is acquired? Is my multiple immediately applied, and am I given the option of cashing out at that multiple? If not, does my residual stream continue on?"
He also said agents should make sure their buyout rights "are clearly covered and protected as much as possible in writing" in their contracts. - Conversion bonus
A conversion bonus is usually paid to an MLS when a merchant is switched from one processor to another or a terminal is reprogrammed.
Jerry Cain, Chief Executive Officer of iMax Bancard, said this is a bonus "paid to agents to convert existing business that is already processing and, in most cases, [has its] own equipment. The formula is normally 1% to 3% of monthly volume, backed up by three to six monthly summary statements." - Free terminal placement
Just about any terminal manufacturer will confirm that terminals are never really free; someone always bears the cost. But various programs absorb costs differently.
"There is no free lunch," said Steve Christianson of AAmonte Bankcard. "The merchant gets the equipment, and the cost is made up from higher downgrade fees, for example. Or if the rep sells the equipment that costs him nothing, he takes a smaller split, or he does not get residuals at all."
If you're working with a free terminal program, it is vital to know exactly how costs will be recovered. - Interchange plus pricing
This typically refers to a merchant pricing structure that directly passes to the merchant the true cost of interchange and assessments along with a markup.
"It would be stated to the merchant as 'interchange, assessments and 25 basis points,' for example," Sam Caine said. "Agents should make sure they know of any other hidden charges that an ISO might add," he said. "In addition, they need to make sure they have an easy to understand interchange disclosure for the merchant so the merchant knows what they'll actually pay."
Isaacman said usually only very large merchants, such as national chain accounts, are priced this way; it's the most competitive form of pricing. "Lately we have seen smaller merchants offered this type of pricing as well," he said. "For an ISO or MLS, interchange pricing means you have the actual interchange costs as part of your pricing package." - Lifetime residual, minimum residual payment
Lifetime residuals are paid to an agent for the life of the merchant account, as long as the agent does not break the governing contract. Minimum residual payments can be more restrictive.
Isaacman said lifetime residual and minimum residual payment are advertising terms that reflect "an MLS/ISO's vested interest in their residual portfolio from a bank, processor or super ISO."
"Other processors who typically offer more upfront incentives, free terminals and so forth have a 'minimum' residual," he noted. "An example would be that once an ISO's/MLS's residuals equal $200 per month, they are now vested for life."
Isaacman said the difference between lifetime residuals or a minimum residual payment is "just a dollar amount threshold. Ultimately, any good ISO/MLS program offers a vested residual package."
Allen Kopelman of Nationwide Payment Systems said, "In your MLS or ISO contract, there might be a clause stating that if your accounts don't make $150 or $250 a month, then the money either rolls over to accumulate, or you just don't get paid at all.
"That's not good. Cross it out and put $0. Lifetime residuals should be in your contract, and that means that as long as you don't break the contract, the ISO will continue to pay you for as long as the merchants are active -- meaning processing." - Mid-qualified/nonqualified downgrades
These are high-margin fees charged to merchants for processing certain types of credit card transactions.
"For example, corporate cards, business cards, reward cards, purchasing cards are all assessed higher fees than traditional credit cards or offline debit cards," Isaacman said.
He added that fees are assessd in "one of two billing buckets, mid-qualified surcharges and nonqualified surcharges." And in today's environment, these are "two of the highest areas of profit margin" for processors. "When midquals or nonquals are thrown around with respect to an ISO/MLS program, it typically means that the ISO or MLS earns revenue from the mid-qual and nonqual surcharges, as well as has control over how the fees are billed," he said. Percent above buy rate
This permits agents to mark up a buy rate and defines how much the markup can be. "The rep typically gets a buy rate and is allowed to mark it up to the merchant," Embry said. "This differential is typically the residual or revenue that is split or paid in full. Sometimes the markup is capped to only allow a certain percentage. This keeps the rep from gouging or overpricing the merchant."
Kopelman said this type of compensation is not a good choice for MLSs. "If your buy rate is 1.65% and you charge 1.79%, you make 100% over the 1.65% on all the merchant's volume," he said. "But you left money on the table because the ISO is going to keep all the other money made on downgrades (the mid- and nonqualified fees) and the extra spread on check cards." - Revenue split/revenue share
In general, revenue split and revenue share mean the agent will earn income on every available stream of revenue. But it is essential to know which revenue streams are included; applicable restrictions; and the split, or share, for each individual stream.
Steve Schwimmer, President of the National Association of Payment Professionals (NAOPP), said revenue split is often misunderstood. "You have to consider not only the percentage, but for how long and what the revenue buckets are: 40% of 40% is better than 80% of 10%," he said.
"It [revenue split] sounds straightforward," said Dee Karawadra, CEO of Impact PaySystem. "But with some ISOs it may not mean what you expect. ... There are some ISOs that talk about split, but they don't pay on certain categories."
Karawadra noted that ISOs might pad their so-called costs before the split. "They may even add costs to categories that really don't have costs," he said. "I've seen contracts that specify that there is a cost on a monthly minimum. Say the minimum is $25. According to that contract, there is a cost of $12. So $12 is subtracted before the split. There's no cost associated with a monthly minimum. That's just padding. I don't think it is right, but it isn't uncommon." - Signing bonus
Signing bonuses are usually paid when an application is submitted and approved. But they can be paid when a merchant is installed or even at some other specified milestone. "A signing bonus is typically an incentive for a new MLS to start sending in deals," Isaacman said. "It is often paid after the 10th, 20th, 30th deal and so on. For example: Send in 10 deals and earn a $1,000 signing bonus." - True interchange split
True interchange split is a split of a merchant account's profit. Schwimmer said this concept is usually wellunderstood. But Embry said the term is "confusing. You can't split revenue on true interchange, as it is only shared between issuers and acquirers." Karawadra added that agents should watch out for markups, such as a markup at "20 or 30 basis points in 'mid' and 'non' categories." - True interchange pass-through
With this business model, interchange is passed through directly to merchants, who are then charged additional processing fees.
Embry noted that merchants now have the published interchange rates and can break out their costs more effectively. "Interchange is the same for all merchants," she said.
"The additional fees are processing, operational and costs of sales. Creative pricing has become the new norm." - Vested residuals
This term applies when the sponsoring entity collects money from the merchant and then pays a residual to the agent.
"Some contracts require a period of time for the merchant to be installed before a residual is paid," Embry said. "Some contracts will not pay a residual … once the agent ends the relationship. Some contracts will pay the residual for the life of the merchant regardless of where the agent works."
Rianda said the term could pertain to how long the residuals are paid or have to do with the percentage of residuals to which the agent is entitled as time progresses. And the difference between the two can be striking. Schwimmer agreed. "You need to ask, what percentage is vested, for how long and how portable is it?" he said.
Also, ask an attorney with payments industry experience to review a contract before you sign it to be sure its wording is not open to conflicting interpretations.
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