The Complete Guide To Surviving Rolling Reserves (Plus, 4 Smart Tips To Manage Your Cash Flow In A Crisis)
So, you’re just about ready to finally start accepting credit cards in your business. You’ve done your homework and shopped around for a good merchant services provider (or, at least, one that will take you on as a merchant). You’ve even followed our advice and read through every word of your contract documents. That’s when you find a little unpleasant surprise. It turns out that your contract includes a feature called a rolling reserve. It’s something that your sales agent either glossed over or didn’t mention to you at all. You have the feeling that this is something that is going to cost you money. A lot of money. Unfortunately, you’re right.
In this article, we’ll explain what a rolling reserve is, as well as several other variations of account reserves. We’ll tell you how a rolling reserve works and show you why you might have one. Finally, we’ll give you some tips for dealing with a rolling reserve and keeping your cash flow going while you’re subject to one.
Table of Contents
What Is A Rolling Reserve?
You probably already understand that whenever a customer pays by credit card, the issuing bank has to lend them sufficient funds to cover the cost of the transaction. The bank then expects the customer to repay this amount within a specified period of time. If the customer chooses to repay this amount over a longer period, interest accrues and the bank profits from the transaction. What you may not be aware of is the fact that your merchant account provider is also issuing you a credit when they disburse funds from your accepted credit card transactions. Why is this so? Well, providers typically deposit funds from your transactions within 1-2 business days. However, the customer can dispute a transaction and file a chargeback for a much longer period of time – typically 120 days.
So, if a customer files a chargeback after you’ve already received your funds, who is responsible for covering it? You are, right? Well, it’s not quite that simple. While merchants often end up ultimately covering the cost of chargebacks, your provider will typically issue an immediate refund to the customer while the chargeback is being investigated. This takes money, of course, and providers usually don’t have a large pile of cash sitting around to cover these types of things.
Because providers can find themselves on the hook for covering the cost of chargebacks, they’ve instituted something called a Reserve Account to protect themselves. The rolling reserve is the most common means of funding this type of account. A Reserve Account is a subaccount of your basic merchant account. With a rolling reserve, the Reserve Account is funded by withholding a portion (typically around 5-10%) of your credit card transaction funds and putting them into the account to cover any chargebacks that might occur. The account “rolls” because eventually, the initial deposits will be released and refunded to you, while funds from new transactions are added to the Reserve Account.
The good news about rolling reserves is that your provider only holds your funds temporarily, although it’s usually for about six to twelve months. The bad news is that Reserve Accounts are non-interest-bearing, so you won’t make any money from them. You will, however, get your money back – although you might have to wait a long time for this to happen. Depending on how your reserve is structured, your provider might eventually refund all of your money and close the reserve account altogether.
You should also know that, unless your provider specifies otherwise in your contract, rolling reserves only apply to Visa and Mastercard credit card transactions. You won’t have funds held from transactions where the customer used a card from American Express, Discover, or some other less-popular brand. Debit card transactions are also exempt from reserve withholding, as funds for these transactions come directly out of the customer’s bank account.
In addition to protecting your provider against chargebacks, reserve accounts protect you as well, making it much less likely that you’ll experience an account hold, freeze, or termination. This is particularly valuable if you’re using a payment services provider (PSP), such as Square (see our review) or PayPal.
Other Types Of Reserve Funds
There are two main variants of reserve accounts, although they’re basically just modifications of rolling reserves. Here’s what you need to know about each of them:
- Capped Reserves: With this type of reserve, the balance of your reserve account is capped at a percentage of a single month’s processing volume for your business. Typically, the cap for this type of reserve is set at between 50% and 100% of your monthly volume. Once you’ve reached the cap for your account, no reserves will be withheld from subsequent transactions for that month. In case you’re wondering, a 100% cap does not mean that your provider keeps all of your money in the reserve. Here’s an example: If you start out processing $5,000 per month, your provider will withhold 100% of your funds until the $5,000 cap is met. After that, no further reserves are withheld, except to cover the cost of actual chargebacks. Unfortunately, the money kept in a capped reserve usually isn’t gradually released over time. You’ll only get that money back when you close your account altogether.
- Up-Front Reserves: Instead of withholding a portion of each transaction, an up-front reserve requires you to fully fund the reserve from another source before you begin processing transactions. You can do this by either providing a letter of credit from your bank or transferring the funds from another account. Some providers will also give you the option of withholding 100% of your initial transactions until the reserve is met. This type of reserve is also sometimes referred to as a minimum reserve.
Can Any Processor Require A Reserve Fund?
One thing you need to understand about reserves is that any merchant services provider can require you to maintain a rolling reserve. This includes both traditional merchant account providers and payment services providers (PSPs). Regardless of the type of provider you’ve signed up with, it’s virtually guaranteed that your contract will include a boilerplate reserve account clause in one form or another. However, you’ll only be required to maintain a balance in your reserve account if it’s specified as a condition of being approved for a merchant account. This is typically spelled out in the Merchant Application portion of your contract.
The truth is that the majority of low-risk businesses do not require a reserve account of any kind. Rolling reserves are typically imposed only on businesses that would otherwise not be approved for an account at all. This includes most high-risk businesses, and also some low-risk businesses in special circumstances. The most common reason for a low-risk business to need a rolling reserve is if the business owner has a low personal credit score. While rolling reserves are typically required when the account is first opened, they can also be imposed later on if the business suffers an unusually high number of chargebacks.
Why Most High-Risk Processors Require A Reserve Account
If you’re in a high-risk industry, you already know that high-risk merchant accounts are significantly more expensive than vanilla, low-risk accounts. Both your recurring fees and your processing rates will be notably higher than what a comparable low-risk business would have to pay. If this wasn’t bad enough, your chances of being saddled with a rolling reserve are also much higher. Let’s be clear: Not all high-risk merchant accounts will require a rolling reserve. However, the following general categories of high-risk industries will almost always need to maintain a reserve:
- Businesses primarily selling unregulated or poorly regulated products or services (e.g., nutritional supplements, CBD products, etc.)
- Industries that have a significantly elevated risk of chargebacks (e.g., credit repair businesses, adult entertainment, etc.)
If this applies to you, you can expect to have to open and fund a reserve account as a condition of being approved for a merchant account. Depending on your processor, this might be an ongoing requirement that stays in force for the entire time your account is open, or it might go away over time as your business grows (and doesn’t suffer too many chargebacks).
Another case that might require a rolling reserve is if you, the business owner, have bad personal credit. This factor can affect both your chances of needing a reserve account and whether you’ll get approved for a merchant account at all. Check out our post on bad credit merchant accounts for some tips on how to handle this situation. Remember that a low credit rating can be raised over time, eventually allowing you to drop the reserve account.
How Much Is a Typical Reserve Amount?
The terms of your reserve account are going to vary quite a bit from one provider to another. They’re also going to depend on factors that are unique to your business, such as your average monthly credit card processing volume, how long you’ve been in business, and many others. Nonetheless, reserve accounts typically withhold around 5-10% of your credit card transactions. The required balance in a reserve account may be variable or a fixed amount, but it should not exceed 100% of your monthly processing volume.
These terms are expensive enough, but bear in mind that they come in addition to the other expenses associated with maintaining a merchant account. This includes not only processing charges for each transaction, but also recurring fees such as your monthly account fee, gateway fees, point-of-sale (POS) service fees, etc.
Because the money that’s going into a rolling reserve isn’t going toward your bottom line, you’ll want to consider the impact a reserve will have on your cash flow very carefully before signing up with a provider that requires one. If too much of your hard-earned money is going to fund the reserve, you could end up losing money overall. In a worst-case scenario, you could end up going out of business altogether.
What To Do If Your Merchant Account Is Holding Funds In A Reserve
If you’ve shopped around for a merchant services provider and they’ve all told you that you’re going to be subject to a reserve, you’ll need a plan of action for dealing with the inevitable consequences. Here’s a basic checklist of things to do before you sign up for a merchant account that includes a reserve:
- Talk To Your Provider: Before you sign up for an account, you’ll want to be completely clear on the terms of the reserve. While you can find this information in your contract documents, it’s also a good idea to discuss the issue with your sales representative to clarify any questions you may have. How long will the reserve be required? When will funds be released from the reserve? What types of transactions are affected? You’ll want clear answers to these and other questions before you take the plunge.
- Analyze Your Cash Flow: Here’s a hint: You should already be doing this, reserve or no reserve. What are your anticipated sales? What are your known operating expenses (rent, utilities, payroll, merchant account expenses, etc.)? Will you still be able to make enough money after deducting funds for the reserve to cover your expenses and turn a profit? Our post on analyzing and calculating business cash flow can help you figure this out.
- Account For A Projected Shortfall: If you’ve crunched the numbers and conclude that you’re probably going to lose money overall with a reserve, it might be time to consider borrowing some money to keep you afloat while the reserve is in effect. While numerous financial products are available to small business owners, a working capital loan might be the best option in this situation.
- Assess The Long-Term Effects Of A Reserve: This is particularly important if your reserve is going to be a permanent feature of your merchant account. If maintaining the reserve is going to hinder your ability to operate your business over the long term, you need to look for ways to reduce your expenses and improve your cash flow.
Don’t Let A Rolling Reserve Trap You In A Cycle Of Financial Insecurity
At this point, we feel that it’s important to re-emphasize the fact that most small businesses will not need to establish a reserve in order to get a merchant account. Unless you have bad personal credit or you’re in a high-risk industry, you will probably be approved for a merchant account without having to maintain a reserve of any kind.
However, if you’re in a situation where you might be subject to a reserve account, you’ll want to review this article very carefully and consider the potential ramifications that a reserve can have on your business. Not understanding how a rolling reserve works or comprehending how it will affect your cash flow can easily put you out of business if you don’t take steps to mitigate the impact it will have on your bottom line.
Unfortunately, the imposition of a rolling reserve is an underwriting decision, so you won’t be able to negotiate your way out of it by haggling with your sales representative. You might be able to adjust the terms of the reserve, but in most cases, the better strategy will be to lessen the financial blow using some of the methods that we’ve outlined above.
The terms and conditions of your reserve account – if you have one – will vary widely from one provider to another. This is another good reason to shop around and obtain quotes from multiple providers before signing up for a merchant account, particularly if you’re in a high-risk category. High-risk merchant accounts usually require long-term contracts and come with higher account fees and more expensive processing rates than comparable low-risk accounts. So, it’s critically important that you find a reputable provider that will help get you the best possible deal on processing services. Check out our post on the best high-risk merchant account providers for an overview of some of our top recommendations. Good luck!