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Sub-Merchant Management

Status: Complete

Last Updated: 2025-12-28

Overview​

Understanding how sub-merchants operate under a PayFac's master MID is fundamental to PayFac operations. This includes MID structure, identification requirements, chargeback routing, and when sub-merchants should graduate to direct merchant accounts.

MID Structure in PayFac Model​

Traditional vs. PayFac MID Structure​

Key Differences​

AspectTraditional MIDPayFac Master MID
OwnershipMerchant owns MIDPayFac owns MID
Network RelationshipDirectThrough PayFac
SettlementDirect to merchantTo PayFac, then to sub-merchant
LiabilityMerchant liablePayFac liable
ChargebacksDirect to merchantTo PayFac, routed to sub-merchant
ComplianceMerchant responsiblePayFac responsible

Master MID Components​

PayFac's Master MID Contains:

  • Single network registration
  • PayFac as merchant of record
  • All sub-merchant transactions aggregated
  • Single settlement account (funds to PayFac)

Sub-Merchant Identifiers (SMIDs):

  • Unique identifier per sub-merchant
  • Used for internal routing
  • Required for network reporting
  • Enables chargeback routing

Sub-Merchant Identification​

Network Requirements​

Each network requires sub-merchant identification in transactions:

Visa Requirements:

FieldDescriptionLocation
Sub-Merchant IDUnique identifierAuthorization message
Sub-Merchant NameBusiness nameClearing record
Sub-Merchant MCCCategory codeAuthorization & Clearing
Sub-Merchant AddressBusiness locationClearing record

Mastercard Requirements:

Similar structure with Payment Facilitator-specific fields:

  • Payment Facilitator ID
  • Sub-Merchant ID
  • Sub-Merchant Name
  • Sub-Merchant MCC

Descriptor Requirements​

Statement Descriptor Format:

[PayFac Name]*[Sub-Merchant Name]

Examples:

  • PAY*JOESCOFFEE
  • PLATFORM*SMITHCONSULT
  • ACMEPAY*GREENSTORE

Best Practices:

  • Use recognizable names (DBA, not legal name)
  • Keep under 22 characters total
  • Include customer service phone when possible
  • Test with real cardholders before launch

Common Problems:

  • Legal name instead of DBA: "ACME HOLDINGS LLC" vs "Joe's Store"
  • Unrecognizable abbreviations: "ACMPY*GRNST" confusion
  • Missing sub-merchant portion: just "PAY*" with no identifier

Transaction Flow with Sub-Merchant ID​

Chargeback Routing Mechanics​

How Chargebacks Flow​

Chargeback Timeline​

DayActionResponsibility
0Cardholder disputesIssuer
1-3Chargeback createdNetwork
3-5PayFac notifiedSponsor Bank
5-7Sub-merchant notifiedPayFac (SLA: 24-48 hours)
7-21Evidence collectionSub-Merchant
21-30Representment filedPayFac
45-120ResolutionNetwork

Financial Responsibility Chain​

When Sub-Merchant Can Pay:

  1. Sub-merchant provides evidence
  2. PayFac represents on their behalf
  3. If lost, debit sub-merchant settlement
  4. If sub-merchant has insufficient balance, use reserve

When Sub-Merchant Cannot Pay:

  1. Deduct from sub-merchant reserve
  2. If reserve insufficient, PayFac covers
  3. PayFac pursues recovery (collection)
  4. If PayFac fails, sponsor draws portfolio reserve

Reserve Usage for Chargebacks​

Example: $500 chargeback on terminated sub-merchant

Sub-Merchant Reserve Balance: $300
Gap: $200

Step 1: Apply $300 from reserve → $200 remaining
Step 2: PayFac covers $200 from operating capital
Step 3: PayFac attempts collection (rarely successful)
Step 4: If PayFac distressed, sponsor uses portfolio reserve

Sub-Merchant Graduation​

When to Graduate​

Volume Thresholds:

  • Processing >$500k/month consistently (6+ months)
  • Approaching PayFac program limits

Business Maturity:

  • 2+ years processing history
  • Stable, growing business
  • Strong financial position

Performance Criteria:

  • Chargeback ratio below 0.5% consistently
  • No fraud incidents
  • No compliance violations

Benefits of Graduation​

BenefitDescription
Better RatesDirect interchange access, no PayFac markup
Higher LimitsNo PayFac volume caps
Direct RelationshipBank relationship building
CustomizationControl over settings, descriptors
Credit BuildingProcessing history for future financing

Graduation Decision Matrix​

FactorGraduateStay with PayFac
VolumeAbove $500k/monthBelow $100k/month
GrowthStable/GrowingVolatile/Seasonal
CBRBelow 0.5%Above 1.0%
Business AgeOver 2 yearsUnder 1 year
PreferenceWants independenceValues simplicity

Graduation Process​

Step 1: Assessment (Week 1-2)

  • Evaluate sub-merchant readiness
  • Discuss with sponsor bank
  • Get acquirer quotes for direct MID

Step 2: Application (Week 3-4)

  • Sub-merchant applies for direct MID
  • New acquirer underwrites
  • PCI compliance verification

Step 3: Technical Setup (Week 5-6)

  • Gateway integration
  • Terminal programming (if applicable)
  • Descriptor configuration

Step 4: Transition (Week 7-8)

  • Parallel processing (both MIDs active)
  • Traffic migration
  • Monitoring for issues

Step 5: Completion (Week 9+)

  • Full cutover to direct MID
  • PayFac relationship wind-down
  • Final settlement and reserve release

Contractual Considerations​

PayFac Agreement Terms:

  • Early termination fees?
  • Notice period requirements?
  • Reserve release timing?
  • Non-compete clauses?

Transition Support:

  • Data export requirements
  • Historical reporting access
  • Customer communication
  • Tax document handling (1099 changes)

Real-World Example​

Scenario: Growing E-Commerce Business

MetricMonth 1Month 12Month 24
Volume$25k$150k$600k
Transactions5003,00012,000
CBR1.2%0.4%0.2%
StatusOnboardingStableGraduation Candidate

Graduation Timeline:

  • Month 24: Volume exceeds $500k, CBR excellent
  • Month 25: Discuss graduation, get acquirer quotes
  • Month 26: Apply for direct MID
  • Month 27: Technical integration
  • Month 28: Parallel processing
  • Month 29: Full cutover
  • Month 30: Reserve released, relationship transitioned

Outcome: Sub-merchant saves ~0.5% in fees, PayFac maintains goodwill, potential referral relationship continues.

Sub-Merchant Lifecycle Summary​

Self-Assessment Questions​

Question 1​

A cardholder sees "PAY*123456" on their statement and doesn't recognize the charge. They initiate a dispute. How could this have been prevented?

Answer

Problem: Descriptor uses internal ID (123456) instead of recognizable business name.

Prevention:

  1. Proper Descriptor Configuration:

    • Use DBA name, not legal name or internal ID
    • Format: PAY*JOESCOFFEE not PAY*123456
    • Test descriptors with real cardholders

  2. Best Practices:

    • Include customer service phone in descriptor
    • Send email receipts with clear merchant name
    • Match online checkout name to statement descriptor
    • Train sub-merchants on descriptor importance

  3. Ongoing Monitoring:

    • Track "unrecognized charge" chargebacks
    • Audit descriptors quarterly
    • Update descriptors when sub-merchants rebrand

Key Insight: Friendly fraud (disputes on legitimate charges) is often caused by poor descriptors. Prevention is easier than fighting chargebacks.

Question 2​

A sub-merchant owes $50,000 in chargebacks but only has $30,000 in reserves and has stopped processing. Walk through the financial recovery process.

Answer

Step-by-Step Recovery:

Step 1: Reserve Application

  • Apply $30,000 reserve to chargebacks
  • Remaining exposure: $20,000

Step 2: PayFac Coverage

  • PayFac covers $20,000 from operating capital
  • Required to meet chargeback obligations

Step 3: Collection Efforts

  • Send demand letter to sub-merchant
  • Engage collection agency if needed
  • Consider legal action for larger amounts
  • Recovery rate typically: 10-30%

Step 4: Loss Recognition

  • Write off uncollectable amount
  • Document for sponsor reporting
  • Adjust underwriting criteria

Lessons Learned:

  • Reserve was inadequate (10% vs needed 17%+)
  • Should have held reserve longer (180+ days)
  • Enhanced monitoring might have caught issues earlier
  • Consider increasing reserves for similar merchants

If PayFac Cannot Cover:

  • Sponsor draws from PayFac's portfolio reserve
  • May trigger onboarding freeze
  • Material impact on sponsor relationship

Question 3​

Your top sub-merchant processes $1M/month with 0.15% CBR and has been with you for 3 years. They're asking about graduation. What factors should influence your recommendation?

Answer

Recommendation: Support Graduation

Positive Factors:

  • $1M/month = well above graduation threshold
  • 0.15% CBR = excellent performance
  • 3 years = proven track record
  • Likely outgrown PayFac program limits

Business Analysis:

FactorCurrent (PayFac)Direct MID
Effective Rate~3.0%~2.4%
Monthly Savings-~$6,000
Annual Savings-~$72,000

PayFac Considerations:

  • Losing $1M/month affects portfolio metrics
  • Revenue impact: ~$30,000/month in fees
  • Relationship value vs. short-term revenue

Recommended Approach:

  1. Support graduation (goodwill, reputation)
  2. Offer transition assistance
  3. Explore ongoing partnership (referrals, future products)
  4. Negotiate reasonable exit terms

Key Insight: Forcing high-performing merchants to stay creates resentment. Supporting graduation builds long-term relationships and referrals.

References​

  • Visa Payment Facilitator Sub-Merchant Requirements
  • Mastercard Payment Facilitator Standards
  • Card network descriptor requirements
  • Industry best practices for sub-merchant lifecycle management
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