What Is A Merchant Account?

Although it’s getting easier, establishing a merchant account can still be expensive and time-consuming. It can also be costly to maintain over time, but the benefits will significantly outweigh the disadvantages for most businesses. The primary advantages of having a merchant account include the following:

Debit card processing works much the same as credit card processing, but the big difference is that funds come directly from the customer’s bank account rather than a line of credit. The settlement process — the final stage of releasing funds to your merchant account provider and then transferring them to your bank account — can take anywhere from a few hours to several business days, depending on the speed of the debit network and the customer’s bank.

Also, transactions authenticated with the customer’s PIN are processed on a different network than the one used for credit cards. PIN debit transactions are inherently more secure, so the fees to process them are lower than for credit cards.

Many providers offer additional special services to certain business types. For example, a “restaurant merchant account” might include extra features such as table management or employee scheduling. However, the basic functionality of a merchant account is going to be the same regardless of what industry your business is in. All merchant accounts perform the same function: to act as a temporary place to park funds from transactions until they can be distributed to the merchant. Nonetheless, there are two distinguishable types of merchant accounts:

• Full-Service Merchant Accounts: With this type of account, you’ll have your own account that’s separate from other users. Full-service merchant accounts are underwritten before you can be approved for an account, and come with a unique Merchant Identification Number (MID) to identify your business to the payment processing networks.
• Aggregated Accounts: Accounts you obtain through a payment service provider (PSP) like Square or PayPal are aggregated with other users, so you won’t have a Merchant ID number. You can also sign up for an account online, bypassing the usual underwriting process and allowing you to start accepting payments very quickly. The downside to this approach is that your account will be at a much higher risk of a sudden hold, freeze, or termination if a suspicious transaction is detected.

One other distinction to be aware of is between low-risk and high-risk merchant accounts. While most businesses (retail, restaurants, etc.) are deemed to be low-risk, certain types of businesses (adult entertainment, CBD products, vape shops, etc.) are deemed to be in a high-risk industry, and you’ll usually have to find a provider that specializes in serving these businesses. High-risk merchant accounts differ from low-risk accounts in the following ways:

• Almost always a full-service merchant account (PSPs typically don’t accept high-risk businesses)
• Extensive underwriting process required before account approval
• Might be underwritten by an offshore bank or processor
• Typically require a long-term contract
• Usually charges much higher processing rates (2-3 times higher than for a low-risk business)
• Typically charges higher recurring account fees
• May offer additional chargeback protection and fraud prevention features
• Very likely to include a rolling reserve account when first opened

Finding a merchant account provider for your business can be very challenging. With literally hundreds of providers competing for your business, separating the good companies from the bad ones can be difficult. Here are some things to consider when trying to find the best deal:

• Going through your bank: Many merchants assume that opening a merchant account with their existing bank will be the easiest way to get started with credit card processing. While the odds of approval are high, we’ve found that banks have no incentive to offer lower prices or more flexible terms to existing users. Other than expedited funding times, there is usually no advantage to opening a merchant account with your bank.
• Talking to other business owners: It’s always a good idea to see what providers other business owners in your community are using. Personal testimonies from people you know and trust can be a compelling way to choose a provider. However, be aware that every business is different, and a company that’s a great fit for your friend’s business might not work out so well for yours. Also, the unfortunate truth is that the majority of business owners don’t have an in-depth knowledge of the payments industry, and frequently pay too much for merchant services simply because they don’t know that there are more affordable alternatives available to them.
• Researching companies online: Review sites (like this one!) can be invaluable in narrowing down your list of candidates, as they consolidate publicly available information about providers and compare it against industry standards to tell you why a particular provider offers a better deal than others.
• Talking to provider sales representatives: Most traditional providers employ a staff of in-house and independent sales agents to market their accounts — all of whom are under tremendous pressure to sell accounts. This pressure is, in turn, directed at business owners, so you can expect them to reach out to you with unsolicited (and usually unwelcome) attempts to get you to sign up with their company. If you’re contacted by a telemarketer, receive a cold call from a sales agent, or have an agent come into your place of business to try to pitch you a merchant account, be very suspicious. Reputable companies don’t employ these kinds of sales techniques — because they don’t have to.

Merchant account providers traditionally charged application fees and account set-up fees to open a merchant account. These fees, which were supposedly intended to offset the cost of processing your application and underwriting your account, could run well over $100 — even if you were ultimately turned down for an account. Today, market pressures and competition from low-cost payment service providers (PSPs) have forced most reputable processors to eliminate these charges altogether. Note that high-risk merchant accounts may still require these fees due to the much more extensive underwriting process required to get approved for a high-risk account.

While PSPs like Square don’t charge any monthly or annual fees for a basic account, most full-service merchant account providers will charge a monthly account maintenance fee (typically around $10-$30/month) to cover the costs of keeping your account up-to-date. Other fees you might see include the following items:

• Transaction processing fees (variable; typically averaging about 1.3%-3.5% per transaction for low-risk businesses)
• Annual fees
• PCI compliance fees (monthly, annual, or included with account maintenance fees)
• PCI non-compliance fees (typically $15-$30/month; only assessed if the account is non-compliant)
• Payment gateway fees
• Monthly minimum fees
• Software subscription fees
• Chargeback fees (only assessed if you experience a chargeback)

There is usually no cost to close your account unless you’re on a long-term contract. If this applies to you, you might have to pay an early termination fee (ETF) if you close your account before the end of your current contract term. ETFs can run into hundreds of dollars and might include an expensive liquidated damages clause as well. Today, most reputable providers will offer you a month-to-month contract that you can close at any time without having to pay a penalty.

Please refer to our complete guide to credit card processing rates and fees for more detailed information on these and other fees you might see on your processing statement.

Also called third-party payment processors, PSPs are very popular with small businesses. They’re an especially good choice for startups that don’t have an established credit card processing history. These providers usually offer pay-as-you-go billing with no long-term contracts or monthly fees, and predictable flat-rate pricing that’s simple to understand. However, they’re not perfect: they rarely accept high-risk businesses, and accounts are at a higher risk of suddenly being frozen or shut down. Also, the flat-rate pricing structure can actually be more expensive than a merchant account at higher volumes, particularly if you accept a lot of debit card transactions.

This type of processing uses the Automated Clearing House (ACH) network to allow your customers to pay you by transferring funds directly from their bank accounts. ACH processing has enjoyed a resurgence in recent years as a more affordable alternative to credit cards for eCommerce businesses. While most merchant account providers include ACH processing with your account (either as a standard feature or a paid option), it’s also possible to set up an ACH-only account. ACH-only processing is popular with certain high-risk industries, particularly cannabis merchants.

While a merchant account is ultimately maintained by a bank, you won’t have direct access to the funds in it as you would with a business banking account. Instead, your merchant account serves as a temporary holding place for funds from transactions until they can be processed and transferred to your bank account.

eCommerce-only merchants can use a payment service provider (PSP) like Square or PayPal to sell online without a full-service merchant account. However, this can become a more expensive option than a merchant account at higher processing volumes. Also, some very high-risk merchants can establish ACH-only accounts to accept online payments.

If you are operating as a sole proprietor, you can still open a merchant account in your name or your business DBA. This option works well for freelancers and independent contractors. Note that in most cases, an aggregated account through a payment service provider (PSP) will usually be more cost-effective than a full-service merchant account.