Time Has Come For Honesty In Negotiating The Split

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Give up the smoke and mirrors. The time has come for ISOs and agents to bring honesty and transparency to their negotiations on the residual split, industry sources say.

Both ISOs and agents may benefit from open communication because their goals do not conflict, and both need to preserve the profit motive, observers agree.

The disparities begin when prospective agents estimate how many new accounts they would bring in to an ISO with whom they would like to work, says Steve Norell, director of sales for US Merchant Services, a Port St. Lucie, Fla.-based ISO.

New agents with low volume might receive as little as 35% of the profits on the merchants they sign up, while experienced agents might earn as much as 85% because they sign more merchants and thus generate more revenue.

“Automatically, you should cut it in half” when agents estimate how much business they will bring in to the ISO, says Norell. “That’s the way it’s been since Day One.”

Agents also can fudge on how much effort they will put in to servicing the accounts, another important factor in determining the split. Duties could include doing paperwork and terminal downloads and following up with customer service, sources say.

But agents should not feel alone in bandying about empty promises and questionable figures; ISOs also manipulate the numbers, according to Drew Freeman, president of Merchant Data Systems, a Miami Beach, Fla.-based ISO.

Problems occur when ISOs mark up their costs instead of providing their true expenses on Schedule A of their contract with sales agents, Freeman says. Consequently, ISOs’ real costs remain a mystery to agents, he maintains.

Norell agrees. He says, for example, that an ISO’s statement costs may come to $1.50, but he charges the agent $5. That gives the ISO $3.50 it does not have to split, he says. If the agent charges the merchant $10, that means the ISO and an agent with a 50-50 split each earn $2.50.

But by doing the math, suddenly, the so-called 50-50 split on the $10 fee results in the ISO making $6 and the agent $2.50, Norell points out.

Freeman recalls having an agent with a supposed 80% revenue share based on marked-up costs. “I renegotiated his deal as a 50-50 rev share on true cost,” he says. “He picked up an additional $30,000 a year.”

That example shows why a split cited out of context means almost nothing, Freeman notes. “It is just moving numbers around,” he says.

“The real issue to me is not the split; it’s what you’re getting a split of,” says Stephen A. Aschettino, president of Aschettino Law PC, a New York-based law firm.

ISOs can further finesse the split by charging agents fees or by charging merchants fees but leaving those out of the revenue to be split, Aschettino says.

Many merchant fees could escape the attention of unwary agents. ISOs charge merchants fees for statements, charge-backs, customer service, processing, network sponsorships, ACH rejections, payment-slip retrievals, statements, cancellations, setups, activations, site inspections and help-desk services, Aschettino says, adding that ISOs “get fairly creative” when levying fees.

In the last couple of years ISOs and processors have begun charging fees for failing to comply with PCI data security standards, he notes. Those fees typically range from $15 to $30 a month or can be quoted as annual fees of as much as $300.

When the new compliance fees arrived in the market, ISOs and agents immediately asked how big a take they could expect, recounts Adam Atlas, a Montreal-based attorney with Adam Atlas Attorney at Law.

In many cases their cut of the compliance fees came to zero, putting agents in the position of receiving no compensation for the tough job of convincing their merchants to swallow yet another new fee, says Atlas.

“They’re having to work to make a sale on which they have no upside,” he says.

Another new fee appears likely to pop up soon and, once again, agents may find themselves with another sales job to perform, no share in the proceeds and no say in setting the amount of the fee, Atlas says.

The Internal Revenue Service will compel acquirers to submit annual reports beginning with the current tax year on each of their merchant’s credit and debit card revenue. The reports go to the merchant and to the IRS, he notes. “We have to expect merchants are going to be charged for this,” Atlas predicts.

Although arriving at the figures needed for the reports will not require any data not already on hand, the fees charged to merchants for providing it could come to $10 a month or $2 a year – no one knows yet, Atlas says.

Yet the compliance fees and IRS reporting fees will not benefit agents initially because they were not mentioned in most of the contracts now in force, he continues. The contracts were signed before the fees were ever assessed.

Contracts vary from one to five years but typically last three years, says Holli Hart Targan, a partner in the Southfield, Mich.-based law firm of Jaffe, Raitt, Heuer & Weiss PC.

She recommends ISOs and agents seek help from lawyers familiar with the acquiring industry anytime they draw up or sign contracts and when negotiating the residual split.

“It’s the whole basis for your business,” Targan says. “It’s such a critical, foundational document affecting the relationship going forward.”

She advises ISOs and agents to enter their partnership sharing expectations and guarding against unpleasant surprises. “That’s done by looking at the contract, she says.

Rude awakenings can startle newer agents who learn after the fact that the contract prohibits them from taking their merchants along with them when they leave the ISO or that they can lose residuals if they fail to meet performance requirements enumerated in the contract’s clawback clause, Targan says.

“I cringe when someone comes to me after they’ve already signed the contract,” she continues. “Usually they don’t even read it. It’s always to their disadvantage.”

Entering the business blindly seems the norm for new agents, says US Merchant Services’ Norell. Only 5% to 10% of agents hire lawyers to help with the contract, he estimates.

The legal bill might come to a minimum of $750 for having a lawyer review the contract and point out potential problems, Targan says. Longer contracts take more time to assess and thus raise the price of legal services, she says.

More extensive legal services, such as contract negotiating, can run in the thousands of dollars, Targan says, with both sides making proposals and counter-proposals that increase the number of hours lawyers devote to the task.

Hiring a lawyer unfamiliar with the industry can cost more than choosing one who specializes in the acquiring business, says Aschettino, the attorney who practices in New York.

“Huge legal bills” result because lawyers from outside do not understand the contract and thus “redline it like crazy,” marking it up with suggested changes that make no sense, Aschettino says. Those changes waste time and money because they violate industry standards and will never win acceptance, he notes.

At the same time, however, the residual split and every other provision of the contract is up for negotiation, says Targan.

New agents, excited about entering the industry, often sign whatever an ISO puts in front of them, says Targan. “They may think this is a sophisticated company, and they’re not going to change anything,” she says. “That’s always a bad assumption.”

A senior sales person at the ISO usually negotiates the revenue split with agents, says Aschettino. The lawyers often come in after the negotiations to make sure the contract meets legal requirements, he says.

Besides the factors already mentioned, negotiations on the residual split may hinge on upfront bonuses. ISOs can offer agents such bonuses as a fee for signing up merchants and then balance that immediate payment by reducing or eliminating residuals.

Manipulating upfront bonuses can become another source of contention in negotiations and after the contract is signed, says Norell. ISOs sometimes lure agents into working for them by offering hefty bonuses but fail to mention those big payoffs apply only to deals with merchants generating a huge number of transactions, he says.

Signing bonuses also benefit ISOs when agents leave the industry after a short-lived attempt at learning the business, Norell says. Often, disillusioned agents quit after two to six months in the business, he says. If they received upfront bonuses on the handful of accounts they signed up, ISOs may not have to split the residuals.

However, fairly priced signing bonuses can benefit new agents who simply do not have the capital to fund themselves while building their residuals, says Merchant Data Systems’ Freeman. “Everybody knows how long it takes to break even on a merchant account,” he says.

For ISOs, offering signing bonuses may create a burden, Freeman says. “You’re putting out an upfront payment before you get the revenue in the door, he observes. “It makes it that much longer to profitability.”

Ultimately, agents should outgrow signing bonuses and instead seek the long-term residuals the acquiring business can offer, Freeman says. “I’d rather have a recurring residual stream for life than to have some upfront bonuses or give the merchant a free piece of equipment,” he says.

Norell provides an example. A hypothetical agent signs a merchant that yields $100 a month in revenue, he says. The agent gets a $300 signing bonus and a 50-50 split that comes to $50 a month. In 36 months he has made $2,100. With no signing bonus and an 80-30 split, the agent makes $2,280 in 36 months.

Residuals not only tend to work better for agents but also for ISOs, sources say. They represent part of the perfect split, observers agree. That ideal split, they say, should be 50-50 for revenue, after sharing expenses 50-50.

“That’s a true partnership,” Freeman says of a 50-50 split after true expenses, even though he admits the difficulties of figuring some expenses and market pressure to grant more revenue than that to agents.

“I’d rather establish a relationship based on trust, transparency, a good product suite and fair pricing,” Freeman says of the best alternative to today’s back-and-forth negotiations.

“If ISOs were smarter, they would say, ‘I will show you what my exact costs are – we can split everything 50-50 over that,’” agrees Norell.

Then, when agents increase business, ISOs can negotiate better rates with processors, and everyone benefits, Norell continues. “That goes much further than all this smoke and mirrors stuff,” he says. ■

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