Updated: Tuesday, September 2, 2014
Funding options for IADs
T he merchant cash advance alternative funding option for small to midsize businesses (SMBs) has been well documented. But ATM ISOs are SMBs, too, and yet not as much attention has been given to the alternative funding avenues available to them. Super G Funding LLC, which specializes in funding ISOs, devoted a white paper to the challenges and opportunities for ATM ISOs, also termed independent ATM deployers (IADs), in finding capital to grow their businesses.
Like most merchants, IADs are having trouble obtaining traditional bank loans in the present economy, said Super G Funding in Lending Challenges and Solutions for Growing Your IAD in Today's Economy. Fortunately, a number of financing options are available to IADs, including equity investment strategies. IADs can turn to venture capitalists, angel investors, public investors and corporate investment firms to gain capital, said Super G Funding.
However, the downside to going the equity investment route is that investors carry more risk than traditional lenders. "As equity investors rarely have the same rights as debtors, companies are not required to repay the original investments should the business collapse," the paper noted. "Since there is the risk of losing their investment should a business fail, equity investors require higher returns than lenders and usually demand a seat on the board and require approval for any major changes or expenditures – often taking control out of the hands of the IAD's management team."
Alternative to the alternatives
Another funding option for IADs is selling off merchant portfolios, with multiples ranging between 12 to 35 times monthly residuals and larger portfolios commanding the highest multiples. But Super G Funding recommended that IADs sell portfolios only when they leave the business completely.
However, an alternative to the alternatives exists: borrowing against residuals through residual loans, which allows IADs to remain in business and maintain control of the business. "A residual loan resembles a cash advance product but doesn't take a cut of each day's transaction fees," Super G Funding said. "Instead, it takes monthly draw-downs for interest and principal before the borrowing IAD receives the residuals.
The alternative lender explained that, under the terms of a residual loan, the IAD has its processor temporarily assign distribution of residuals to the lender; the lender takes its monthly cut and forwards the remainder to the IAD. In addition, IADs can be easier to get than bank loans, can be funded in five to seven business days and can qualify for loans that are often five times their monthly residual streams.
"Because a residual loan's criteria is based on an IAD's residuals, credit history is not a factor," said Super G Funding Chief Executive Officer Darrin Ginsberg. "Instead, the lender looks at the past 12 months of residuals, what makes up the residual stream, how those residuals are performing and then bases the risk factor on those criteria."
IADs in the same SMB boat
Super G Funding reiterated the analysis of Meredith Whitney, CEO of New York-based Meredith Whitney Advisory Group LLC, who said small business credit has "contracted at one of the fastest paces of any lending category."
Todd McCracken, National Small Business Association President and CEO, chimed in, saying, "Not only have small-business owners been unable to find new credit over the last four years, nearly a third have had their existing credit slashed, and one in 10 had their loans called in early."
But the biggest factor in IADs unable to secure traditional funding is that banks simply do not understand the IAD business model based on residuals. "[B]anks have strict credit criteria based on eligible collateral, and residual streams are not a traditional asset to borrow against," Super G Funding said. "Banks also have to know how ISO and IAD residual streams evolve in order to properly manage that risk – something institutions are unlikely to look into unless they are focused on lending to payment processing-based businesses."
Inc. 500/5000 payments industry fast trackers
Friday, August 29, 2014
S cottsdale, Ariz.-based BlueSquare Resolutions LLC earned top honors among the 34 payment processors named to the 2014 Inc. 500/5000 list of fastest-growing private companies in the United States. Rankings were determined based on percentage of revenue growth from 2010 to 2013. The three-year growth rate for companies on the list this year averaged 516 percent.
BlueSquare secured the Inc. 500 No. 19 position and placed No. 1 in the Financial Services category. The company advanced from the No. 101 position last year by posting three-year sales growth of 11,489 percent and generating $46.4 million in 2013 revenue. "We worked extremely hard on our acquisition strategy and were able to develop new, organic acquiring relationships that yielded great results for us in 2013," said Nick Glincher, President of BlueSquare, who noted that the company expects to see similar growth this year.
Since launching in 2009, BlueSquare has focused on ISOs with small to midsize merchant portfolios that either seek additional liquidity or the back-end support they offer to advance the ISO's own growth initiatives. "I'm happy that we are lucky enough to see transactions and that people in the space trust us enough to refer business to us, whether it be a referral relating to an ISO that wants to get acquired, needs debt or whatever the case may be," he stated.
Additional payment companies included among the Inc. 500 were Fishers, Indiana-based Advocate Merchant Solutions Inc. (151); Encino, Calif.-based GrayPay LLC (157); Boca Raton, Fla.-based TouchSuite (259); Whitefish, Mt.-based Glacier Payments (338); and Virginia Beach, Va.-based ToCharge LLC (388).
This marks the sixth appearance for TouchSuite. "When I started this company, I determined that it required at least one new client a day just to break even," said Sam Zietz, Chief Executive Officer at TouchSuite. "Today TouchSuite manages thousands of client accounts and earns tens of millions of dollars annually – an accomplishment I attribute in no small part to the incredible talent, innovative thinking and entrepreneurial spirit that comes together in this company."
Other Inc. 5000 payment processors honored in order, starting at the top were Repay-Realtime Electronic Payments, Total Apps Inc., Clearent LLC, FlashBanc LLC, MeritCard Solutions LP, Allied Wallet Ltd., Payoneer, PayLease, AffiniPay, Bank Associates Merchant Services (BAMS Holdings Group LLC), Vision Payment Solutions, United Bank Card (Harbortouch), Miva Merchant Inc., Paymetric, CardConnect, Reliance Star Payment Services Inc., Expect Payment Solutions LLC, Payscout Inc., Central Payment, Security Card Services LLC, Gravity Payments, YapStone Inc., Vantage Payments, Point & Pay LLC (a wholly owned subsidiary of North American Bankcard), Infintech LLC, Electronic Cash Systems (a division of U.S. Alliance Group Inc.), Forte Payment Systems and Bluefin Payment Systems.
Additional merchant-supporting companies that fared well this year were Base Commerce LLC (23), an application-programming-interface-driven commerce platform; shopping app developer Shopkick Inc. (191); electronic billing and payments software provider Transactis (420); and multimarketplace management software provider Solid Commerce (475). Also spotted in the Inc. 5000 were Chargebacks911, HubSpot Inc., RetailNext Inc., Executech Lease Group, Bigcommerce Party Ltd., Advanced Fraud Solutions, Autoscribe Corp., Payscape Advisors, G2 Web Services, USAePay and Secured Retail Networks Inc.
Prepaid and loyalty gift card program providers who made the grade were PrePay Nation (97) and Z-Prepay (377), followed by iSend, CashStar Inc., GiftCardRescue.com and GiftCards.com LLC.
Among merchant funding businesses familiar to the payments industry were Retail Capital, FastPay Partners LLC, Reliant Services Group, Fora Financial, OnDeck Capital Inc., Channel Partners LLC, Swift Financial Corp., CAN Capital, and Merchant Cash & Capital, to name several.
Congratulations to everyone in the payments industry whose hard work and dedication earned recognition in the Inc. 500/5000 winners' circle this year. If your company was so honored and is not included herein, please send a note to firstname.lastname@example.org, and we'll see that you're mentioned in an upcoming Readers Speak and added to the article's HTML version.
New York proposes bitcoin licensing program
Tuesday, August 26, 2014
I n mid July 2014, the New York State Department of Financial Services laid out a proposed regulatory framework for the issuance of bitcoin licenses. If the regulations are enacted, New York would become the first state to regulate the bitcoin marketplace in the United States. But some in the bitcoin community argued that the alternative currency and its emerging marketplace are still in the early days of development and could be curtailed by over-burdensome regulation.
The NYDFS said regulating bitcoin is important to ensure consumer protection and guard against illegal activities, such as data theft and exploiting bitcoin as a money laundering tool. NYDFS Superintendent Benjamin M. Lawsky said, "We have sought to strike an appropriate balance that helps protect consumers and root out illegal activity – without stifling beneficial innovation. Setting up common-sense rules of the road is vital to the long-term future of the virtual currency industry, as well as the safety and soundness of customer assets."
The NYDFS' licensing proposal targets primarily bitcoin exchanges. To obtain and maintain BitLicenses, exchanges would have to comply with a long list of requirements. These include:
- Safeguarding consumer assets by having traditional reserve accounts (with funds denominated in U.S. dollars) to back bitcoin exchange activities
- Providing virtual currency receipts to customers
- Establishing and maintaining written policies and procedures to resolve consumer complaints
- Providing risk disclosures to consumers, such as statements that virtual currency transactions are generally irreversible and losses due to fraudulent or accidental transactions may not be recoverable
- Complying with anti-money laundering (AML) mandates such as providing the following from each transaction: the identities and physical addresses of the parties to the transaction, the amount or value of the transaction (purchase, sale or transfer denomination, and the payment method), date the transaction was initiated and completed, and a description of the transaction
- Verifying identities of accountholders
- Reporting fraud and suspected illegal activity to the NYDFS
Other requirements include operating cyber security programs, designating chief information security officers, keeping certain financial records and making quarterly financial reports to the NYDFS.
Necessary, but caution urged
Jeremy Allare, Chief Executive Officer at Boston-based bitcoin startup Circle Inc., said in an Aug. 13 blog post that the NYDFS' BitLicense proposal is the "first material attempt at government rule-making around digital currency, and given the significant role that New York plays in defining rules for the financial industry, this is a historic and crucial milestone for the development of the Bitcoin industry globally. Regulators and lawmakers from around the United States and across the globe will scrutinize and possibly emulate the approach established in New York."
However, Allare noted that New York's proposal is premature and heavy handed and would result in "radically limiting those who can participate in this industry, pushing firms offshore and into sometimes shadier jurisdictions." Allare added that, as currently written, it would be “technically impossible” for Circle to comply with New York's proposed regulations. "Without some material changes, Circle will have no choice but to block New York customers from accessing our services,” he said.
Despite this warning, Allare welcomes bitcoin licensing, but he believes regulation needs to be designed with caution and forethought. "The high-level goal of establishing a license framework for a new class of digital currency-based money transmitters and money services businesses is reasonable," he said. "Having such a framework in place can materially open up commercial opportunities for companies by reducing the perceived risk and the regulatory uncertainty that currently hang over bitcoin companies – enabling firms to find banking partners, insurance partners, auditors, and other business partners."
Allare concluded that the bitcoin marketplace is at a pivotal crossroads in its development. For bitcoin licensing to work, the NYDFS must, among other things, exempt software creators and bitcoin mining operations from the requirements, simplify the business approval and reporting processes, and normalize the AML requirements with federal rules already in place. Allare believes these steps would regulate bitcoin operations without curtailing innovation.
Inevitable, but too limiting
Tom Waters, Director of Sales at Bank Associates Merchant Services, is not surprised by the reaction of the bitcoin community to the BitLicense proposal. "Regulation was inevitable so the timing is perfect," he said. "It is the first step in developing a consistent framework and guideline for those who are cautious to enter the market for fear of accidentally breaking a law."
But Waters echoed Allare's concerns. The proposal "extends too far in limiting commercial participation beyond money transmittal," he said. "The current proposal seeks to enforce the activities of software developers, payment processors, mining pools and other entities that do not act as money transmittal services.
"At the very least, it forces startups and entrepreneurs to move out of the state to continue their work. That would simply just be bad for New York. At worst, it will be blindly mirrored and implemented by other governmental bodies, effectively hobbling the growth of a very high potential innovation."
However, Waters noted that the NYDFS seems to be listening to the bitcoin community, as Lawsky extended the original 45-day comment period (which began on July 23) another 45 days after bitcoin supporters weighed in on the proposal. "It appears that he is willing to remain flexible to find common ground with innovators who seek to continue developing their work in New York," Waters said.
Need more time
Evidently, Lawsky read the late July open letter posted on the social media site Reddit, in which about 400 bitcoin supporters said they needed more time to evaluate and comment on the proposal. "Many of us are individuals or small startups operating on limited budgets without access to extensive legal resources," the letter stated. "This imposes a substantial burden as we seek to understand the proposed rules and their current and future impacts on our businesses, open-source projects, and educational research."
In an Aug. 5 letter, the Bitcoin Foundation stressed that the bitcoin community should have an active voice in shaping the regulations. The letter said NYDFS' rulemaking process should be upgraded to take advantage of 21st century technology to more adequately include public opinion in the process.
Its letter highlighted social media tools like News Genius and GitHub that would provide greater collaboration between the bitcoin community and regulators. “[T]he department should resist the constraints of administrative procedures developed in the era of postage stamps,” the letter stated.
NRF appeals to higher power
Friday, August 22, 2014
I n a remarkably sustained and intrepid campaign, retail associations and retailers led by the National Retail Federation have petitioned the U.S. Supreme Court to rule on the seemingly never-ending debate over debit card fee regulation. The NRF said it is of "staggering importance" to U.S. retailers and consumers that the nation's highest court weigh in on the implementation of the Durbin Amendment to the Dodd-Frank Act of 2010, which the NRF through its lobbying efforts helped pass into law.
Ever since the Federal Reserve was mandated by the Durbin Amendment to implement debit card interchange fee reforms and capped the fee at 21 cents per transaction, the NRF and other retail trade groups have argued that the cap was set too high, although the cap effectively reduced the amount of debit interchange that retailers had to pay by over half. The NRF wants the cap to be reduced to 12 cents per transaction.
The NRF, in conjunction with the National Association of Convenience Stores, the Food Marketing Institute, the National Restaurant Association, NRF member Boscov's Department Store, and NACS member Miller Oil Co., petitioned the Supreme Court on Aug. 18, 2014, to consider the case. These retailer advocates were behind the original lawsuit claiming that the Federal Reserve misinterpreted the Durbin Amendment's requirement that regulations be "reasonable and proportional" to the actual costs of processing electronic transactions.
The NRF said the Fed initially proposed a cap of no higher than 12 cents per transaction before settling on 21 cents "after heavy lobbying from the financial services industry."
"When a federal agency blatantly disregards the clear intent of legislation passed by Congress and signed into law by the president, that's a dispute that cannot be ignored," said NRF Senior Vice President and General Counsel Mallory Duncan.
NACS President and Chief Executive Officer Henry Armour chimed in, saying, "Debit swipe fee reform was needed to address the price-fixing of debit swipe fees that the giant card companies engaged in for the nation's largest banks. Unfortunately, the Fed overrode the language of the law and blunted the positive impact of reform. We need the Supreme Court to decide this case so that American merchants and their customers stop paying billions of dollars more than they should per year to the big banks."
Effects of debit fee cap
Recent research suggests that the current debit card interchange fee cap has had a major impact on financial services. In Debit Profits under Pressure: Alternative Revenue Models Needed, Mercator Advisory Group said that the Durbin Amendment has severely reduced the profitability of debit cards. In this post-Durbin world, debit card issuers have been forced to find ways to make up for lower revenue from debit card fees, according to Mercator.
"To counter this decline, debit card issuers have sought ways to reduce costs and improve efficiencies relating to the DDA account and debit cards," Mercator said. "Many issuers are still struggling to find alternative revenue-generating strategies, since raising card fees or account fees have not been very successful."
Additionally, Aite Group LLC investigated the costs to retailers of different tender types, such as cash, credit cards and debit cards, and found that debit acceptance is the cheapest tender type across the board. In a July 2014 report, Tender Truths: The Real Cost of POS Transactions in the U.S., Aite said debit has become "the least expensive form of payment [for retailers], mostly as a direct result of the Durbin Amendment."
One argument debit fee reform proponents make is that retailers would pass on debit card fee savings to consumers via reduced prices. But in July 2014, payments industry advocacy organization the Electronic Payments Coalition said that those fee savings were, in fact, not being passed on by gas retailers.
"This summer, Americans are facing average retail gasoline prices of around $3.61 per gallon," the EPC said. "Unfortunately, despite the strain that these high prices place on consumers, there is still no evidence that gas retailers are passing on any of the roughly $1 billion annual subsidy they receive from the Durbin Amendment on to consumers in the form of lower prices."
EPC Executive Director Jeff Tassey added that payment networks "voluntarily capped the fees that they charge gas retailers on fuel transactions in the hope that doing so would lower gas prices for consumers. Unfortunately, gas retailers took all the money and ran – sticking their customers with the bill."
Since the debit interchange cap went into effect in October 2011, retailers, their associations, and even the Durbin Amendment's sponsor, Sen. Richard Durbin, D-Ill., have criticized the fee cap as too high. A group of retailers led by the NRF and other trade groups subsequently filed suit to get the fee cap overturned.
In late July 2013, a U.S. District Court for the District of Columbia ruled in favor of the lawsuit. "It appears that the Board [of Governors of the Federal Reserve] completely misunderstood the Durbin Amendment's statutory directive and interpreted the law in ways that were clearly foreclosed by Congress," wrote Judge Richard J. Leon, adding that the Fed had to reevaluate its implementation of debit card regulations.
However, the Fed appealed that decision. In March 2014, a three-judge panel at the U.S. Court of Appeals for the District of Columbia Circuit threw out Leon's ruling, concluding that the Fed reasonably interpreted the demands of the Durbin Amendment. Of that March 2014 ruling, Duncan said, "The Fed ignored congressional intent and worked to shield debit card companies and big banks. A self-described victory for the banks usually results in higher costs for consumers."
On to the settlement
The NRF is also working to get overturned the controversial and long disputed $7.25 billion settlement of the class-action lawsuit brought by retailers against Visa Inc. and MasterCard Worldwide over interchange fees. The settlement was approved in December 2013 by a New York district court judge. But the NRF was disappointed by the settlement terms.
In June 2014, the association, along with RILA, filed an appeal of the decision in the 2nd U.S. Circuit Court of Appeals in New York. Duncan called the settlement a "backroom deal" among the card brands and a few large retailers that would "do nothing to bring the fees under control."
"Approval of a mandatory settlement of such breathtaking scope in the face of widespread and substantive objection is unprecedented and warrants reversal," the plaintiffs said in their appeal.
Report says DOJ knew Operation Choke Point negatively affected legitimate businesses
Tuesday, August 19, 2014
T he Federal Deposit Insurance Corp. eliminated from its documentation lists of what has been termed "high-risk" merchant types. The move is seen as a response to the controversy over the U.S. federal government's Operation Choke Point program that allegedly targeted businesses unfairly by denying them the ability to process transactions electronically.
On July 28, 2014, the FDIC said it was clarifying its role in supervising relationships between merchants and their payment processors. (This FDIC action was mentioned briefly in a sidebar to our lead article, "Operation Choke Point draws fire from Congress, industry," published Aug. 11, 2014, issue 14:08:01, which was going to press when this news broke. This follow-up story provides further details.)
"FDIC guidance and an informational article contained lists of examples of merchant categories that had been associated by the payments industry with higher-risk activity when the guidance and article were released," the agency said. "The lists of examples of merchant categories have led to misunderstandings regarding the FDIC's supervisory approach to TPPPs [third-party payment processors], creating the misperception that the listed examples of merchant categories were prohibited or discouraged."
The FDIC stated that the list contained various types of telemarketing or e-commerce categories, with businesses in those categories associated with higher-risk activity. The agency defined higher-risk activity as that which could be subject to "complex or varying legal and regulatory environments, such as those that may be legal only in certain states; those that may be prohibited for certain consumers, such as minors; those that may be subject to varying state and federal licensing and reporting regimes; and those that may result in higher levels of complaints, returns, or chargebacks."
Additionally, the FDIC claimed the lists were "incidental to the primary purpose of the guidance, which was to describe the risks associated with financial institutions’ relationships with TPPPs, and to provide guidance to insured institutions on appropriate risk management for relationships with TPPPs." The FDIC's lists of "high-risk" merchant categories reportedly included firearms and ammunition, adult entertainment, check cashing, and payday lending businesses.
A 'no choking' matter
Operation Choke Point was launched by the U.S. Department of Justice in the spring of 2013. The program seeks to "choke off" high-risk businesses' access to electronic payments by mandating that payment processors terminate that access; by year's end the DOJ reportedly issued over 50 subpoenas to banks and payment processors to force them to terminate processing relationships with certain businesses.
In May 2014, the House Committee on Oversight and Government Reform headed by Rep. Darrell Issa, R-Calif., released a report entitled The Department of Justice's "Operation Choke Point": Illegally Choking Off Legitimate Businesses? that characterizes the program as a strong-arm tactic against financial service providers – comply or be investigated themselves.
"The initiative is predicated on the claim that providing normal banking services to certain merchants creates a 'reputational risk' sufficient to trigger a federal investigation," the report said. "Acting in coordination with Operation Choke Point, bank regulators labeled a wide range of lawful merchants as 'high-risk' – including coin dealers, firearms and ammunition sales, and short-term lending. Operation Choke Point effectively transformed this guidance into an implicit threat of a federal investigation."
The report also charges that the DOJ is aware that its program is negatively impacting legitimate, legally operating businesses. "Internal memoranda on Operation Choke Point acknowledge the program’s impact on legitimate merchants," the report said. "Senior officials informed Attorney General Eric Holder that as a consequence of Operation Choke Point, banks are exiting entire lines of business deemed 'high risk' by the government."
According to the report, the DOJ does not have the legal authority to force processors to comply with Operation Choke Point dictates. By law, the subpoena power is for use in pursuing "civil penalties against entities that commit fraud against banks, not private companies doing legal business," the report said. In fact, the report alleges that the DOJ has "radically and unjustifiably expanded" its authority to target high-risk businesses via processors.
Operation Choke Point apparently used the FDIC's high-risk merchant lists as a way to force processors to comply or face federal probes."Suddenly, doing business with a 'high-risk' merchant is sufficient to trigger a subpoena by the Department of Justice," the report said. "Banks are put in an unenviable position: discontinue longstanding, profitable relationships with fully licensed and legal businesses, or face a potentially ruinous lawsuit by the Department of Justice."
The Electronic Transactions Association sponsored a July 2014 report by the NERA Economic Consulting firm that advocates for industry self regulation as the most effective and efficient means of weeding out fraudulent merchants. In Economic Effects of Imposing Third-Party Liability on Payment Processors, Jeffrey A. Eisenach Ph.D. argued that the financial services industry already has a strong economic incentive to ensure against fraudulent activity.
Eisenach stated that the cost of chargebacks have caused processors to "internalize" fraud risk management. "Thus, processors already have strong incentives to monitor merchant conduct and to reflect the costs of high levels of consumer dissatisfaction back onto the responsible merchants through higher reserve accounts or the threat of termination," he wrote.
Eisenach believes that the DOJ is undermining its own efforts by imposing third-party liability, also called "vicarious liablity," on payment processors. He said the "imposition of vicarious liability on payment processors through Operation Choke Point is generating significant economic costs while generating little or no apparent benefits."
Eisenach added that federal regulators and processors are ultimately in alignment about the need to eliminate "bad actors" from the economy. But he believes industry self-regulation is a more effective means to that end, as it doesn't throw the proverbial baby out with the bath water.
"Industry self-regulation avoids the additional costs of third-party liability to processors and therefore does not distort the market or reduce competition by driving out important lawful merchants," Eisenach said.
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