Third Party Payment Processors: The Complete Small Business Guide
How does third party credit card processing work? Start here to learn what third party processors are, the benefits of using one, and the risks for small businesses.
Third-party payment processors are a relatively new way for small and first-time business owners to accept credit and debit cards without the need for a traditional full-service merchant account.
Also known as payment service providers (PSPs), third-party processors make it possible for a business to sign up for an account online and start accepting non-cash payments almost immediately.
In this post, we’ll explain how third-party processors work and how they differ from regular merchant accounts. We’ll also discuss the pros and cons of using a third-party processor instead of a merchant account, which should help you decide which option is a better choice for your business.
Table of Contents
- What Is A Third-Party Payment Processor?
- Why Is Third-Party Payment Processing Popular?
- Third-Party Payment Providers VS Merchant Accounts
- Risk Considerations For Third-Party Payment Processing
- Is A Third-Party Payment Processor Right For My Business?
- Common Questions About Third-Party Payment Processors
What Is A Third-Party Payment Processor?
A third-party payment processor is an alternate way for businesses to accept credit and debit cards without their own merchant accounts. Users are aggregated into a single merchant account, reducing costs and streamlining security requirements. This arrangement bypasses the usual underwriting process, allowing businesses to begin accepting cards very quickly.
For customers, there won’t be any noticeable difference in paying with their credit cards. Merchants, however, can benefit from predictable pricing, lower account maintenance costs, and freedom from oppressive long-term contracts.
How Does Third-Party Processing Work?
For the most part, there is little difference between accepting credit cards through a third-party processor and a traditional merchant account provider. The primary difference between these two entities comes down to how your account is managed.
With a third-party processor, you’ll be aggregated into a single merchant account with hundreds of other users. If you have a full-service merchant account, however, you’ll be issued a unique Merchant Identification Number, which identifies your business to the payment processing networks.
In either case, transactions will be tagged to your account, and funds from payments (minus processing fees) will be reliably deposited into your business bank account.
If you’re a small business owner, this distinction may not seem very important, and you might understandably wonder why anyone would need a full-service merchant account when a cheaper, less complex alternative is available. The truth, of course, is a little more complicated. Using a third-party processor frequently is a better choice for small or newly-established businesses, but when your business grows sufficiently, a merchant account will be not only more secure but also less expensive overall than sticking with a basic third-party processor.
Who Offers Third-Party Payments? A List Of Third-Party Processors
Compared to traditional merchant account providers, there are relatively few third-party payment processors on the market. However, most of them enjoy a high degree of brand recognition among merchants and consumers alike. Here’s a list of some of the most well-known third-party processors:
- Stripe Payments
- Venmo For Business
- Amazon Pay
There are also several other business software providers that offer payment processing using the third-party processing model as an optional feature of their service, including:
- Shopify Payments
- Wave Payments
- FreshBooks Payments
- QuickBooks Payments
Why Is Third-Party Payment Processing Popular?
In recent years, third-party processors have become a very popular choice for small businesses. In fact, they’ve made dramatic inroads into the market share of traditional merchant account providers, many of whom have been unable — or unwilling — to offer a similar service. As we’ll see below, third-party processors offer numerous advantages for a small business owner.
However, the real reasons that merchants choose them come down to the following three factors:
- Simplified approval process
- Transparent pricing
- Lack of long-term commitment
In other words, third-party processors are perceived as being easier to use and less expensive, period. (Check out our complete guide to credit card processing rates and fees for a more detailed discussion of costs.) While this perception frequently holds true in actual practice, it’s not always the case. In deciding between a third-party processor and a true merchant account, it’s important to understand that both options have advantages and disadvantages, and the best choice for your business today might not be your best option a year from now.
Third-Party Payment Providers VS Merchant Accounts
|Third-Party Processors||Merchant Accounts|
|Account Structure||Aggregated with other users, no unique Merchant ID||A unique Merchant ID number for that business|
|Approval Process||Simplified, can be completed online with account approval typically in less than 24 hours||Complex with extensive documentation required; approval can take several days to as long as two weeks|
|Commitment||Month-to-month billing; no long-term contracts||Varies — May offer month-to-month billing or require a long-term contract (typically 3 years)|
|Pricing Transparency||All rates & fees are fully disclosed online prior to an account application||Varies — Rates & fees might be published, but typically requires customized pricing quote & negotiation|
|Processing Rates||Flat-rate pricing is used in almost all cases||Varies — Options may include tiered, interchange-plus, or membership pricing plans|
|Account Fees||None for a basic account (some optional services require a monthly fee)||Varies — Often not disclosed by sales agents, but are listed in contract documents|
|Processing Limits||Cannot exceed monthly processing volume limits or max transaction size||Limits on monthly volume & max transaction size can be negotiated|
|Account Stability||Increased risk of account hold, freeze, or termination||Little risk of holds, freezes, or terminations following account approval|
|Customer Service & Support||It may be limited to online self-help resources||Typically offer telephone & email support (quality of support varies)|
|Overall Affordability||Typically less expensive for merchants processing less than $5K/month||Typically less expensive for merchants processing over $5K/month|
Given the number of variables involved, it’s apparent that neither one of these approaches to credit card processing is going to be the superior choice for all businesses. Instead, you’ll have to evaluate each factor individually to determine which approach will work best for your business. Below, we’ll help you weigh the pros and cons of each model to determine which choice will be best for you.
Advantages Of Using A Third-Party Processor
Here’s a look at the benefits of using a third-party processor for your business:
- Quick Setup: Third-party processors allow you to sign up for an account online, and you’ll usually be approved very quickly.
- Low (Or No) Initial Setup Costs: EMV-compatible card readers will cost you some money, but usually much less than what you’d pay for a traditional countertop credit card terminal or a POS system.
- No Monthly Fees: Third-party processors usually don’t charge any monthly fees to maintain your account and you won’t have a monthly minimum to worry about.
- Predictable Flat-Rate Pricing: Third-party processors make it easy to know in advance what your processing costs will be with flat-rate pricing plans. You shouldn’t have any unpleasant surprises waiting for you on your monthly processing statement.
- No Long-Term Contracts: Third-party processors only charge you for actually using your account, and you won’t be locked into a lengthy contract. You also won’t have to worry about getting hit with a merchant account early termination fee if you close your account.
- Technology-Driven Platforms: Third-party processors tend to be run by people with technology backgrounds, while traditional merchant account providers are usually run by people with finance backgrounds who aren’t really experts in modern computer technology.
Disadvantages Of Using A Third-Party Processor
Third-party processors also come with some significant limitations that make them an inadequate choice for many businesses. Here are some of the most notable disadvantages:
- Account Stability Issues: Not going through the complete underwriting process before you start processing transactions means that your account isn’t as secure as an individual merchant account.
- No Specified Processing Limits: With a full-service merchant account provider, you’ll be required to stay within maximum monthly processing limits and maximum transaction sizes. Third-party processors, unfortunately, tend not to specify what these limits are in advance.
- Limited Acceptance For Specialized Cards: Third-party processors generally don’t allow you to accept specialized cards such as SNAP/EBT cards or government-issued credit cards. Debit cards are generally accepted, but you’ll pay much higher processing rates than you would under an interchange-plus pricing plan offered by a traditional merchant account provider.
- Limited Hardware/Software Options: With a third-party processor, you’ll usually be limited to using just the hardware and software products that your processor offers – and these are often pretty generic.
- Expensive Flat-Rate Pricing: For a very small business owner, you’ll usually save money with a third-party processor because you won’t have to pay all the extra monthly and annual fees that come with a full-service merchant account. However, flat-rate pricing is significantly more expensive than interchange-plus pricing on a per-transaction basis.
- Limited Customer Service Options: Many third-party processors are notorious for offering limited options for customer support. Merchant account providers, however, usually offer 24/7 telephone support. Unfortunately, the quality of that support can vary widely from one provider to another.
Risk Considerations For Third-Party Payment Processing
Experiencing a sudden account hold, freeze, or termination (and learning how to avoid them) is a risk for any business that accepts credit cards. However, this risk is higher if you sign up with a third-party processor. The reason this is so is that third-party processors typically allow you to sign up for an account and start processing transactions without first going through the extensive underwriting process required to establish a full-service merchant account.
How can you avoid this situation? The truth is that there’s no 100%-effective solution that will eliminate the risk of a hold, freeze, or termination. However, the following best practices will minimize the chances that you’ll ever have to deal with this situation:
- Be completely honest about the nature of your business and what products/services you’re selling
- Follow all recommended PCI compliance guidelines to minimize the chance of a fraudulent transaction getting through
- Follow all recommended actions to lower your risk of chargebacks or friendly fraud
- Have a backup means of accepting payments in place in case you lose access to your account (Venmo and Zelle are great options)
While it’s important to take the risk of a hold, freeze, or termination seriously, the truth is that most low-risk businesses rarely encounter these problems. With a little preparation and a willingness to play by the rules, you should be able to safely use your third-party processing account for many years without ever having a problem.
Is A Third-Party Payment Processor Right For My Business?
The choice between a third-party processor and a traditional merchant account will ultimately depend on the nature and size of your business. Unfortunately, there isn’t a single provider on the market that offers a true “one size fits all” service that’s suitable for every business.
In making your decision between these two approaches to credit card processing, ask yourself the following questions:
- Is my business going to run year-round, or is it seasonal?
- How large do I anticipate my monthly processing volume will be?
- Will I need specialized features, such as a POS system or an integrated payments platform?
- Is my business in a high-risk category?
Ultimately, your overall processing costs will determine whether you should sign up with a third-party processor or go all-in with your own merchant account. As a very general rule, we usually recommend third-party processors to small businesses and merchants who are just starting out. In contrast, larger, more established businesses will usually save money with a traditional merchant account.
Monthly processing volume is usually the most important factor in making this determination. Unfortunately, there are so many variables involved that we can’t provide a specific amount where it makes sense to upgrade to a full-service merchant account. We’ve seen figures from vendors ranging from as low as $1,500 per month to as high as $10,000 per month.
To make this process as simple and accurate as possible, we recommend our Merchant Account Cost Analysis Workbook, which includes spreadsheets to help you automatically compare rate quotes.
Lastly, choosing between a third-party processor and a merchant account isn’t entirely a matter of dollars and cents. Sometimes, it’s worth paying a little extra for things like better customer support or more fully featured software. While costs are always going to be important, we recommend that you consider the overall value you receive in choosing a provider. Good luck!