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 fairly 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 payment 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 payment processors work and how they differ from regular merchant accounts. We’ll also discuss the pros and cons of using a third-party payment 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?
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.
Why Is Third-Party Payment Processing Popular?
In recent years, third-party payment 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 payment 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 payment 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 Processors VS Merchant Accounts
|Third-Party Payment 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 will be 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.
Risk Considerations For Third-Party Payment Processing
Experiencing a sudden account hold, freeze, or termination is a risk for any business that accepts credit cards. However, this risk is higher if you sign up with a third-party payment 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 payment 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 payment 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 it’s difficult to provide a specific amount where it makes sense to upgrade to a full-service merchant account. While we generally recommend full-service merchant accounts to businesses processing over $5,000/month, 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 payment 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!