For software vendors and others considering becoming payment facilitators, risk is understandably – and appropriately – a top concern.

So, for our ongoing series about the factors that go into deciding whether to become a PF, we ask experts a fundamental pair of questions: where does the risk come from, and how bad is it?

Types of risk faced by payment facilitators

As the CEO of Rich Consulting, Deana Rich helps clients evaluate their risk exposure and develop risk management and underwriting programs to combat it. She talks about two primary types of exposure with her clients, she said.

The first type of exposure is the credit risk: Is the submerchant operationally viable? Rich gave the example of a submerchant selling custom furniture who takes payment up front. If that submerchant goes out of business before delivering the furniture, the customer will initiate a chargeback. The chargeback goes to the payment facilitator if the submerchant no longer exists.

This type of exposure can and should be evaluated during the underwriting process with a look at financial statements, Rich said.

The second type is fraud risk: the question of whether a merchant is who they say they are, and whether they are selling what they say they are selling. While fraud risk is less straightforward to quantify, payment facilitators can think about it in terms of probability, she said.

How bad is it?

Rich cited the example of a PF that doesn’t specialize in any one market and is taking applications online. That PF has a higher probability of encountering identify theft and other non-financial risks during underwriting than a PF serving a particular vertical, she said.

“That might be a higher risk for them than it would be for a PF selling software to doctors’ offices that costs $50,000 to install. If submerchants have to write that check before they can begin processing, there’s not a high risk of identity theft,” Rich said.

Dan Spalinger agreed that the level of risk depends very much on the payment facilitator and the types of submerchants they are taking on. Spalinger is a senior consultant for Double Diamond Group and Rich Consulting, and previously led Vantiv’s PF underwriting and oversight department.

“For PFs and software vendors looking to support low-risk industries, such as government entities or schools, for example, their risk isn’t necessarily going to be with the financial status of the underlying entities. You wouldn’t be concerned about governments or schools just going away,” Spalinger said.

While risk may vary according to each PF’s business model, Melissa Sutherland advises all PFs to have a healthy respect for the volume – as well as the savvy – of bad actors looking to infiltrate the payments system. Sutherland is director of merchant solutions for LegitScript, a solutions provider that helps payments providers and other businesses mitigate risk, in part by vetting merchants and monitoring for transaction laundering.

Sophisticated criminal networks are looking for the easiest path to penetrate the ecosystem, which can mean targeting the least-prepared companies, she said.

“The volume of questionable actors in this space is underreported and underappreciated from a money movement perspective. The spectrum of people that want to do harm is considerable,” Sutherland said.

Despite her firsthand knowledge of the criminal activity, she is not warning payment facilitators away from the space. Instead, she says that participating in the system must be done wisely.

“Do it with a solid understanding of your constituents’ needs and the problems that you solve for them, partner with compliance companies who act as thought leaders, and surge forward,” she said.

“Don’t underestimate the volume of risk that’s out there. Prepare for it, plan for it, expect it, and deflect it, because you can. There are tools and people and ways to deflect it,” Sutherland said.

Know yourself, and know your customers

While Rich agrees that payment facilitators need to understand that fraud is a factor and they will likely experience some loss, taking on payments may not always be as risky as they think, she said.

“The risk really has to be evaluated based on the type of vertical you’re going to accept,” she said. “You can say no to certain types of verticals, thereby reducing your risk. Sometimes people think the risk is much bigger than it is because they don’t understand the controls.”

Putting those controls into place will be critical, the experts all agreed. They include proper due diligence through KYC procedures on the front end, and transaction monitoring to stay on top of the submerchant activity.

“Know who you’re doing business with,” Rich said. “Make sure you know who they are, what they sell and how they’re selling it. Then, once they’re on board, make sure you monitor them to verify that they’re doing what they said they were going to do.”

Spalinger agreed. “It’s having the controls and monitoring in place so that if something does go wrong and your front-end processes fail, your back-end transactional risk monitoring processes are sufficient that whatever losses you incur are limited by those checks,” he said.

The first step for any company getting into payment facilitation is to understand their core competencies and what they want to be to their constituents in the marketplace, Sutherland said. Not all PFs have to offer everything to everyone.

“Once they have that clearly defined, I think the path to be or not to be a payment facilitator becomes a lot less treacherous,” she said.

For companies that decide stepping into the payment facilitation role makes good business sense for them and adds value for their customers, the road to a safe, compliant environment is still very much an individualized process, which needs to be handled with help from those with experience managing risk in the PF space, our experts agreed.

“It’s a matter of understanding what you can do and what you can’t do and plugging and playing the capabilities of other partners in the industry if you can’t bring everything in-house yourself,” Spalinger said.

No matter their approach to the problem, companies who take on the payment facilitator role need to do so with eyes open and risk mitigating infrastructure in place, Sutherland said.

“The core mission always has to be: serve the constituents with great products in a compliant environment,” she said.

Payment facilitators always need to consult with their acquirers and attorneys or other advisers for detailed advice particular to their situations.