his article explores challenges, considerations, and practical as well as legal issues entrepreneurs in the bankcard industry face in setting up an ISO or merchant level salesperson (MLS) business.

Entity formation

First, you need to decide what type of limited liability entity is most appropriate for your needs. These entities come in various forms including limited liability companies (LLCs), S-corporations and C-corporations. They are designed to protect you from your company's liabilities and lawsuits.

Although every ISO and MLS is different, an LLC is generally preferable to a corporation because:

• LLCs involve less corporate maintenance.
• LLC operating agreements allow for more flexibility in management.
• LLCs have the option to receive flow-through tax status similar to ordinary partnerships or sole proprietorships.

Some jurisdictions impose gross-receipt taxes on LLCs. If your business is in such a jurisdiction, you will likely be able to avoid higher taxes by forming an S-corporation.

By the time your business begins formal operations, it should be established as a corporation or LLC. This will maintain your limited-liability shield. Otherwise, all advantages of operating as a corporation or LLC can potentially be lost.

All contracts should be entered in your company's legal name and signed by officers on the company's behalf. In addition, all marketing materials, stationery and letterhead should reflect your company's name.

Relationship building

Once you have set up your corporation or LLC, decide with whom you want to do business. Fledgling ISOs and MLSs will need to partner with either a bank or larger ISO. Since banks typically do business only with long-established, larger ISOs, players that are new to the payments industry will typically need to link up with a larger ISO or processor.

The Green Sheet is a valuable resource for locating established ISOs seeking partnerships with budding ISOs and MLSs. When forming a relationship with a larger ISO or processor, keep the following in mind: the processor's reputation for integrity, marketing support and leads, training, and overall compatibility with your organization.

Another important issue (which is often a red herring) is an ISO's payout percentage. Some ISOs offer lower payout percentages but provide excellent leads, training and free equipment that make working with them worthwhile. Of course, if you generate your own leads and do not need training, it makes sense to go with an ISO that offers larger payout percentages or buy rates.

Also consider an ISO's underwriting standards (some ISOs have looser underwriting criteria or can take merchants with higher processing volumes), industry focus and merchant services.

The degree of portability the ISO allows and whether you will be able to assign future revenue streams are also important concerns. Full portfolio portability is difficult for a small to medium-sized ISO or MLS to obtain. It's essential, however, that you have full portability of your payouts.

The next issue to consider is risk. How much are you willing to undertake? Unless you have a full, accomplished and reliable risk department in place, you should probably focus on sales, and let the larger ISO deal with merchant losses.

You will also have to decide whether it's appropriate to register your ISO with Visa U.S.A. and MasterCard Worldwide. While ISOs must be registered to have a direct relationship with a bank, registration is not necessarily a prerequisite to doing business with a larger ISO or processor.

The card Associations require registration if you want to:

• market products and services in your own name as opposed to the name of a larger ISO
• employ independent contractors to market on your behalf.

To register your prospective ISO, you must submit applications to Visa, MasterCard and the member bank with which you wish to do business. All three sets of applications will explore similar information relating to your prospective ISO's financial history, including profit and loss statements, available funds, assets, and credit worthiness. The application process takes at least several months. In addition, Visa and MasterCard each charge a $5,000 initial registration fee and $2,500 yearly thereafter to maintain the registration.

The registration process is complicated, protracted and expensive. A number of consultants specialize in assisting credit card entrepreneurs through its intricacies. But given the time and expense involved, registering your ISO is ordinarily not necessary if you do not need to sell in your own name or use subcontractors.

Legal maneuvering

Operating an ISO or MLS gives rise to a host of legal issues and potential liability. ISOs and MLSs need to comply with Visa and MasterCard rules and requirements, steer clear of trouble with the Justice Department and other government agencies, and undertake certain mitigation measures to forestall avoidable lawsuits.

Card Association rules regulate all ISO marketing materials. They also impact collection of discount rates as well as the manner and form of merchant agreement execution. The rules further require that ISOs and MLSs maintain records and provide both merchants and cardholders with access to certain information upon request.

Failure to observe the card Associations' compliance obligations may result in stringent fines and other penalties.

Other ongoing legal issues you will face involve your own and your merchants' marketing practices. Inquiries from government agencies often involve allegations relating to the following:

• Merchants' advertising or billing practices
• Merchants' income reporting practices or proceeds allegedly generated by illegal schemes
• Merchants' sale of illegal products or services (such as restricted narcotics or online gaming)
• ISOs' failure to comply with privacy laws enacted to protect cardholders' personal information.
• Violations of Can Spam Act and National Do Not Call Registry provisions.

Some common legal issues ISOs and MLSs face arise from misrepresentations by agents on merchant applications. Fraudulent underwriting can expose you to civil and criminal liability for bank fraud: One sale is never worth the consequences.

Before you invest your time and money to set up an ISO or MLS business, consider these issues to protect yourself and your company. The payment processing industry can be lucrative and rewarding, but you should also be aware of its challenges and risks.

The information contained in this article is for informational purposes only. Please consult an attorney before relying upon it for your specific legal needs. Theodore F. Monroe is an Attorney whose practice focuses on the electronic payment and direct marketing industries. For more information about this article or any other matter, please e-mail Monroe at monroe@tfmlaw.com or call him at 310-694-8161.