Why PayFac model increases the company’s valuation in the eyes of investors
In many of our previous articles we addressed the benefits of PayFac model. In a comprehensive white paper on the subject we explained PayFac meaning and how to become a payment facilitator. Payment facilitator model is easier to implement if you are a SaaS platform or a franchisor. If full-fledged PayFac requirements are too much for you, you can start with a white label payment facilitator model.
As we’ve shown in other articles, the model is beneficial for PayFac companies themselves, acquirers, and merchants. In this article we are going to address another advantage of the PayFac model. We are going to show, how it helps a company increase its valuation.
Why Valuation Matters
Most SaaS and software platforms belong to the so-called “growth” companies. It means, that their value is based on the growth of their annual turnover and revenues. As they grow, these companies participate in investment and fundraising rounds. As a company is attracting new investments, each subsequent investment round is based on its increased valuation. So, increase of the company’s valuation becomes one of its overall strategic goals.
A company’s valuation is calculated as its annual revenue multiplied by a coefficient. This coefficient, known as multiplier, is established based on circumstances, but, generally, its value follows whatever is accepted within the industry.
It is the gross revenue, that is, generally, analyzed when it comes to evaluation of a company. Net profit and its respective growth are also significant valuation factors. However, for tech companies, gross revenue growth is still the key valuation criterion. After all, significant share of such a company’s profits is immediately re-invested into further growth (marketing, sales, development, advertising). So, net profit is what is left after these (and other) expenses, and represents a somewhat less illustrative growth indicator.
How PayFac Model Affects Valuation: 3 Scenarios
When it comes to payment processing, depending on the arrangement that a software platform has with the payment processor, such factors as gross revenue and net profit get affected. As a consequence, the company’s valuation gets affected as well.
Let us consider three typical arrangements that a software platform can have with the payment processor or gateway. Thus, we will illustrate how each of these arrangements affects gross and net profits of a company.
Scenario 1: classical third-party provider
Under the most traditional scenario, the software platform partners with some third-party gateway or payment service provider. The provider performs all payment management functions, including those related to transaction processing and merchant underwriting. In this case the platform often gets nothing for payment management, while its core product/service remains its primary revenue source. The company is not participating in transaction processing. So, transaction volumes and processing fees affect neither gross revenue nor net profit.
Scenario 2: revenue-sharing agreement with the provider
This scenario is similar to the previous one. However, the platform has some revenue-sharing arrangement with the PSP (payment processor, gateway). It gets a certain commission from the provider for participation in payment processing. As a result, the platform’s gross revenue increases by the amount of the collected commission. Subsequently, net profit might increase as well, depending on the platform’s internal decisions.
Under this scenario, most of the fees collected from merchants do not count as the platform’s annual turnover. It is the payment provider (not the platform) that collects them and includes them into its reported revenue.
Example
The PSP collects 2.9% of fees. Within this amount, 0.3% goes to the platform as a commission. As a result, the platform’s gross revenue increases by 0.3% of total processed transaction volume. On large consolidated processing volumes, even this relatively small share yields significant amounts. At the same time, its net revenue growth depends on how/whether it decides to spend this money. However, we should remember, that it is the gross revenue that the investors might be considering while calculating the valuation.
Scenario 3: PayFac model
The third scenario involves a financially similar arrangement. However, under this scenario, instead of a revenue-sharing agreement, the platform signs a payment facilitator agreement.
To become a PayFac, the platform needs to pay considerable annual registration fees and deal with a lot of paperwork. However, once registered as a PayFac, it can directly collect the fees on its own behalf (not the provider’s).
The platform assumes full responsibility for merchant underwriting, transaction processing, and disbursement of funds. This allows the platform to rightfully collect the full amount of processing fees and recognize it as its own gross revenue. So, its valuation grows proportionately (as shown in the following example).
Example
Now it is the platform that collects 2.9% of processing fees. Then it still pays 2.6% as costs to the provider, banks, and networks (similarly to the previous case scenario). So, the bottom line is the same as under scenario 2. However, now the platform’s gross revenue increases by 2.9% of total processed transaction volume. Although its net profit only increases by 0.3% of this amount at best, it is, again, the gross revenue that matters. For instance, for processing $10 million worth of transactions, the platform collects $290K worth of fees. During the valuation process this gross revenue growth (2.9% of processed transaction volume) will be multiplied by a coefficient. So now the company’s valuation will significantly increase.
Conclusions
Your decision as to PayFac model implementation will depend on your currently available resources and motivation. Getting registered as a payment facilitator calls for significant upfront costs. However, as we can see, PayFac model becomes a convenient and effective instrument, increasing your company’s valuation.
As you become a payment facilitator, you assume respective responsibilities. They include merchant underwriting, background verification (KYC), ongoing monitoring, funding, account settlement, payment reconciliation, reporting, and chargeback management. So, before making a decision, you need to understand, who will take care of these functions (and how).
Keep in mind that there are platforms offering white-label solutions for PayFacs. They supply not only the technology, but also related services, that you would otherwise have to implement in-house. Examples of such platforms include UniPay Gateway and Zift.io.