A merchant account is a type of business bank account that is used to process electronic and payment card transactions. Merchant accounts are provided by acquiring banks, often through payment processors or independent sales organizations (ISOs).
Because merchant accounts are required to process credit and debit card transactions, it’s important to understand how they work, what they cost, and how to protect your merchant account from closure.
How Merchant Accounts Work
A merchant account is a bank account that functions as an intermediary between your business bank account and a cardholder’s issuing bank.
When a customer completes a transaction, the payment gateway or point of sale (POS) system, issuer, acquirer, and card brand work together to ensure funds from the purchase are deposited into your merchant account. In some situations — like when the cardholder uses a credit card — your merchant account acts as sort of a loan or line of credit because the issuer advances funds to you before the cardholder has actually paid the bill.
After a period of time — anywhere from a couple hours to a few weeks — the funds (minus fees) are transferred from your merchant account to your business bank account. Timing is influenced by factors such as when the transaction is processed and/or when the batch is settled.
Merchant Account Providers vs. Payment Facilitators
Merchant account providers are sometimes referred to as “payment service providers,” but the two terms aren’t interchangeable.
Though both types of providers help businesses accept credit cards, process transactions, and receive payments, they differ in how they offer this functionality.
- Merchant account providers are acquirers, ISOs, and processors that issue your business a unique merchant account and MID. This takes place after an underwriting process to determine what risk your business presents to the merchant account provider. Your business is also fully responsible for adhering to the terms of your merchant service agreement.
- Payment facilitators (PayFacs) or payment service providers (PSPs) serve as the merchant of record with acquirers and processors, operating a single merchant account. From there, PayFacs assign businesses as sub-merchants under the PayFac’s master merchant account. PayFacs take on the liabilities of maintaining a merchant account, reducing how long it takes your business to receive approval for processing card transactions.
Should you use a merchant account or a payment facilitator?
Which is better for payment processing: a merchant account provider or a payment facilitator?
The biggest downside of working with a merchant account provider directly is the approval process. A lot of merchant account applications are denied.
Another disadvantage is the amount of time it takes to complete the underwriting process and open a merchant account. However, the benefits of working with a merchant account provider usually compensate for the waiting period.
First, merchant account provider rules and regulations are outlined and specifically defined in your merchant service agreement.
Second, opening a direct merchant account means you can form and develop relationships with the acquirer or processor providing it. As a result, they may be more receptive and flexible to the unique needs of your business, opening up the possibility of negotiating the terms of your merchant service agreement.
Ultimately, partnering with a merchant account provider gives your business more control over risk management.
There is no right or wrong decision. Choose the option that’s best for your unique business.
On the flip side, PayFacs generally offer one-size-fits-most plans that, in some cases, allow for limited variation. In exchange, account approval is fast — and may even be instant. PayFacs may also offer some tools acquirers and processors don’t, such as analytics, invoicing, and reporting functionality.
Though PayFacs don’t typically require a minimum monthly transaction limit or volume, they do generally limit maximum transaction size or volume. This makes PayFacs appealing to new or smaller businesses.
However, because PayFacs are liable for ensuring compliance with the rules and regulations of an acquirer or processor, they are more likely to freeze or terminate merchants that represent too high a risk.
Merchant Accounts vs. Payment Facilitators
| Merchant Account | Payment Facilitator | |
|---|---|---|
| Merchant of Record | You | PayFac |
| MID | Unique to your business | Assigned as sub-merchants under the PayFac’s master MID |
| Approval Process | Underwritten | Quick approval — potentially instant |
| Opinion on Risk | Somewhat lenient | Low tolerance for risk; usually quick to terminate processing |
| Terms and Conditions | Negotiable | Non-negotiable |
| Processing Volume Limits | Negotiable minimum and maximum volume limits | Usually has a volume limit |
| Transaction Amount Limit | Negotiable minimum and maximum amount limits | Usually has an amount limit |
| Additional Features | Usually minimal | May include invoicing, analytics, etc. |
Traditional Merchant Accounts vs. High-Risk Merchant Accounts
When you apply for a merchant account, the acquirer or processor performs research to determine what degree of risk your business represents. This process is called underwriting and is extremely subjective, varying from processor to processor as each assigns different weights to various risk factors.
When the underwriting process is finished, the acquirer or processor decides whether to approve or reject your application. If approved, the bank may classify you as a high-risk merchant depending on the potential threat you pose.
NOTE: Because each acquirer or processor maintains its own underwriting criteria and risk tolerance, your business can have both traditional and high-risk merchant accounts.
Traditional Merchant Accounts
A low-risk, or traditional, merchant is one that’s not expected to exceed the acquirer or processor’s acceptable risk tolerance. Because perceived risk is subjective, there’s no concrete definition for what constitutes a low-risk merchant.
In general, you are likely to receive approval for a traditional merchant account if your industry, products or services, sales methods, location, and customers present little risk to the acquirer or processor.
High-Risk Merchant Accounts
High-risk merchants are those that may expose an acquirer or processor to financial loss, legal liability, or regulatory scrutiny. Your business may be classified as a high-risk merchant based on a mix of factors that include your:
- History — the length of time you’ve been in business, how long you’ve processed payments, sales volume, ticket amount, credit score, and percent of chargebacks, fraud, and returns
- Preparation — the processes, systems, and tools in place to mitigate potential risk
- Reputation — the industry you operate in and the products or services you sell
High-risk merchants must typically pay higher or additional fees than those with traditional merchant accounts. This helps offset the increased risk the merchant poses to the acquirer or processor. Additionally, many types of high-risk merchants are required to register with card brands to meet their regulations.
A WORD OF WARNING: Your initial classification may change over time as your level of risk fluctuates. Engaging in increasingly risky activity — or failing to properly mitigate risk — can result in reclassification as a high-risk merchant. Similarly, high-risk merchants can request reclassification after implementing processes and tools that limit and reduce risk.
Merchant Account Costs & Fees
Opening and maintaining a merchant account requires you to pay a variety of costs and fees. Some merchant account fees are paid during the initial account setup. Other costs and fees are paid on an ongoing basis for the administration of your merchant account and the services provided.
Merchant account fees are often outlined in your merchant service agreement and may include:
- Application fee — assessed when submitting a merchant account application
- Setup fee — a one-time fee paid upfront for establishing your merchant account
- Monthly or annual fee — paid on an ongoing basis for the services provided by the acquirer or processor
- Monthly minimum fee — the required minimum amount of processing fees you must pay in a given month
- Interchange fee — a flat fee plus a percentage of each total transaction amount paid to the cardholder’s issuing bank
- Early termination fee — assessed for ending your contract early or breaking the terms of your merchant service agreement
- Statement fee — the cost of mailing statements to you
- Batch fee — a flat fee assessed when sending a batch of a day’s online transactions to your merchant account
- Chargeback fee — a penalty assessed any time you receive a chargeback
NOTE: Merchant account fees vary from processor to processor. Some acquirers and processors may assess more fees, and others may assess fewer. Additionally, some fees — such as an application or setup fee — may be waived. Review your merchant service agreement to identify which costs and fees you’re obligated to pay and on what basis they’re due.
If you have a high-risk merchant account, your business may be expected to pay higher fees and rates. In addition, you may be required to pay a capture fee, which is an additional fee assessed if you exceed the maximum transaction limit within a given month.
Merchant Account Reserves
Some acquirers or processors may require you to maintain a merchant account reserve. A reserve account sets aside funds in case you are unable to fulfill your financial obligations — such as issuing refunds or covering chargebacks.
Reserves are usually only required for high-risk merchants, but traditional merchant accounts may be susceptible to revenue holds too.
A WORD OF ADVICE: Before signing a merchant service agreement, look over the terms of your contract. The acquirer or processor may be open to negotiating certain limits or fees. For example, you may use sales data and projections to argue for lower fees.
Even after your merchant account is approved, maintain a good relationship with the acquirer or processor. Over time, as your business grows and evolves, you may want to submit a request to reevaluate your account. If you can prove that you’re effectively managing risk, you could ask for more favorable terms and conditions, such as a reduction of funds withheld for your reserve account.
How to Get a Merchant Account
If your business needs a merchant account, the process is fairly straightforward — though it can take time. It also requires some preparation and research beforehand to prove that your business qualifies for a merchant account.
Get a business license.
Depending on your industry and local laws, you may already have a business license. If not, many acquirers and processors require merchants to obtain a business license before applying for a merchant account.
An active business license may help you during the underwriting process, too, by demonstrating ongoing compliance with your local laws and regulations.
Set up a business bank account.
Acquirers and processors may require you to establish and maintain a business bank account, even if your business isn’t otherwise required to.
Your business bank account is the final destination for any funds, minus fees, that clear your merchant account. It can also serve as the source for merchant account debits and fees, such as processing fees and chargeback fees.
Determine your business needs.
Different types of businesses and business structures require separate merchant accounts. How your business sells its products or services determines which type and how many merchant accounts are needed, as well as the terms of each merchant service agreement.
For example, processing both electronic payments through an ecommerce store and in-person purchases at a physical location may require separate merchant accounts. Similarly, you may require separate merchant accounts for processing foreign payments or high-risk transactions.
Determining your business needs helps you identify the best merchant account providers for your business.
Gather necessary documentation.
Acquirers and processors require background information about your business when evaluating your merchant account application. Before you apply for a merchant account, complete and gather:
- General information about your business, such as its legal name, “doing business as” (DBA) name, address, and owner contact information
- Number of years you’ve been in business
- Tax information, including your tax ID number
- Banking information, including the account and routing numbers
- Financial statements
- Information and projections about your sales volume, including the percentage of sales coming from ecommerce
- Evidence of Payment Card Industry (PCI) compliance
It’s also beneficial to provide any documentation that outlines your risk management and mitigation processes.
Search for merchant account providers.
Some acquirers and processors may specialize in a certain type of transaction or a specific industry. Before applying for a merchant account, search for merchant account providers that seem like the right fit for your business.
This is also the time to determine if you need a dedicated merchant account. Depending on your transaction volume and the size of your business, you may be better served by working with a PayFac.
Apply for a merchant account.
After deciding on a merchant account provider that fits your needs, submit an application. Make sure you provide all requested information and documentation. You may also be required to pay an application fee at this time.
If possible, include a cover letter or other document that outlines what your business does and what processes you have in place for mitigating risk. This can help the acquirer or processor better understand your business and make a more informed decision about the actual risk you present.
Wait for a response.
The underwriting process takes anywhere from a few hours to a few days to complete, though some PayFacs may respond shortly after receiving your application.
During this period, you may be asked to provide additional information to help the acquirer or processor accurately assess your risk. You may also be required to implement risk management techniques before your application is approved.
Review the merchant service agreement.
Once you’re approved for a merchant account, you must review and sign the merchant service agreement. This is your opportunity to negotiate for more favorable terms and lower fees. You should also ask the merchant account provider to explain any topics you don’t understand — such as costs, fees, payment structures, chargeback thresholds, etc. — before signing the agreement.
If the merchant service agreement is acceptable, sign any required documentation to finalize the contract. At this time, you may be required to pay a setup fee before your merchant account is activated.
How to Protect Your Account From Closure
A merchant account is a privilege, not a right. Failing to comply with the terms of your merchant service agreement can result in revocation of your merchant account — and the inability to continue processing credit and debit card transactions.
Why are merchant accounts terminated?
Acquirers and processors are held liable in the event your business is unable or unwilling to meet the financial obligations outlined in your merchant service agreement. If your business begins to present an excessive risk that the acquirer or processor no longer considers acceptable, they may terminate your merchant account.
A merchant account may be terminated for:
- A security breach in which a customer’s data is compromised
- An event in which a customer’s account information is stolen from your business and used to make fraudulent purchases at other locations
- Engaging in money laundering or transaction laundering
- Breaching the chargeback threshold
- Excessive counterfeit or fraudulent transactions
- A fraud conviction of any of your business’s principal owners or partners
- Suspicious activity
- Bankruptcy, insolvency, or liquidation
- Violating a card brand’s standards
- Participating in fraudulent collusive activity with other merchants
- Noncompliance with PCI Data Security Standards
- Processing illegal transactions, whether knowingly or unintentionally
- Identity theft
Merchants that have had their merchant accounts terminated may be added to the MATCH list.
The MATCH list is a database identifying merchants who have had their merchant accounts terminated for a qualifying reason. Acquirers or processors use MATCH to assess the risk a business presents, so inclusion in the database may impact your ability to qualify for a new merchant account in the future.
How to avoid merchant account termination
Because chargebacks are one of the most common reasons for a merchant account to be terminated, implementing strategies and tools to avoid chargebacks should be a priority for your business.
To protect your merchant account from excessive chargebacks, ensure you:
- Follow your merchant account requirements, card brand regulations, and local laws
- Provide only high-quality goods and services
- Prevent malicious fraud
- Fulfill orders with speed and accuracy
- Use clear billing descriptors
- Write and share clear, customer-friendly policies
- Provide outstanding customer service
- Use identity verification tools such as AVS, CVV, and 3D Secure 2.0.
Most importantly, there are chargeback prevention solutions specifically designed to keep chargeback activity to a minimum.
Midigator’s intelligent chargeback technology offers all these solutions from a single portal, providing an easy and efficient way to keep risk in check.
With a complete management strategy, you can prevent the most chargebacks possible — which helps protect your merchant accounts. And as an added bonus, Midigator also fights chargebacks to recover lost revenue, ensuring your bottom line is kept safe too.
If you’d like to take the proactive steps necessary to obtain and keep a merchant account, contact Midigator today. We’ll set you up for success!
