What Is A Merchant Account? The Complete Small Business Guide
Does your business need to accept credit card payments? Find out what a merchant account is, how you can set one up, and how much you'll pay.
In its simplest form, a merchant account serves as a temporary repository for funds from approved and processed credit and debit card transactions, safeguarding them until they can be transferred to your primary business bank account. It’s an essential requirement for accepting credit card payments in any business.
In this article, we’ll explain what a merchant account is, shedding light on its functionality, associated costs, and the process of setting one up. We’ll also give you some valuable advice on how to choose the best merchant account provider for your particular business.
Table of Contents
- What Is A Merchant Account?
- How Do Merchant Accounts Work For Credit Card Processing?
- How Much Do Merchant Accounts Cost?
- What Do You Need To Open A Merchant Account?
- Does Your Business Need A Merchant Account?
- Alternatives To Merchant Account Processing
- I Want To Open A Merchant Account. What’s Next?
- FAQs: Merchant Accounts
What Is A Merchant Account?
A merchant account is simply a bank account where funds from your processed credit and debit card transactions are deposited until they can be transferred to your regular business bank account. A merchant account is an essential tool for credit card processing online, in-store, and even on the go.
Unlike a traditional bank account, you won’t have direct access to any funds being held in your merchant account. Instead, your merchant account provider will automatically transfer these funds from your merchant account to a designated bank account once the transactions have fully cleared. This process can take up to 3-5 business days, although many providers now offer next-day – or even same-day – funding (often for an additional fee).
How Do Merchant Accounts Work For Credit Card Processing?
When you sign up for a merchant account, you’ll have access to credit card terminals and payment gateways (for online sales) that route your customers’ credit card data to your provider’s processing network for transaction approval and processing. Credit card data is coordinated with the cardholder’s issuing bank to ensure that sufficient credit is available on the account, and a variety of anti-fraud checks are run to guard against illegitimate credit card use.
If there are no red flags, the transaction is approved, and the issuing bank will transfer the funds to your merchant account.
Your payment processor will deduct all applicable fees and charges (interchange fees, card association fees, processor markup, etc.), and then transfer the remaining funds to your business bank account.
In today’s payments environment, most merchant accounts come with a variety of additional features besides just credit card processing. Support for alternative payment methods, including ACH transfers, echecks, QR code payments, etc., are frequently included.
Other services, such as analytics and reporting, gift card programs, loyalty programs, inventory management, employee scheduling, etc., may also be available.
How Much Do Merchant Accounts Cost?
Unfortunately, merchant accounts represent a significant business expense, even with the most affordable provider. Credit card processing fees can account for approximately 1.5% to 3.5% of your sales volume, and monthly fees can run anywhere from $40/month at the lowest, to over $200/month.
Here’s a breakdown of what you should expect to pay to open, maintain, and close your merchant account:
What Do You Need To Open A Merchant Account?
Once you’ve selected a merchant account provider (or several likely candidates), you’ll want to gather the necessary information about your business and obtain the documents you’ll need to get through the application process. While specific requirements vary from one provider to the next, almost all of them require the following items:
- Completed Merchant Application: This form gathers all the essential information about your business that a provider needs to begin the underwriting process. The most important item will be specific information about what types of products and services you’ll be selling. Don’t be vague or dishonest here — incomplete or inaccurate information will usually lead to your account being shut down once you start accepting transactions. The application also requires information about your monthly processing volume, which will be a major factor in determining your processing rates.
- Processing Hardware Requirements: For in-person transactions, you’ll want to have a good idea of what type of credit card reader you’ll need. This can be anything from a simple mobile card reader to a full-blown point-of-sale (POS) system. We recommend purchasing any required hardware directly from your provider to ensure that it comes with the correct software load out of the box.
- Software Requirements: eCommerce merchants will also require access to a payment gateway to process online transactions. Today, this may be packaged as part of an integrated payments platform that works with your physical processing equipment.
- Bank Account & Routing Information: In addition to properly separating your personal and business finances, you’ll need this information to ensure that funds from your merchant account are deposited in your business bank account. If you don’t have one yet, learn what documents you need to open a business checking account.
- Financial Statements: Financial documents such as statements from your bank can prove to an account provider that you’re financially competent and responsible. In addition to bank statements, it’s common for businesses to furnish processing statements to prove to account providers their average amount of transactions processed over a monthly or annual period.
- Business ID: Your business ID, more commonly known as an Employer Identification Number (EIN), is basically the social security number of your business. This is the number you’re required to use when filing your business’s taxes and is often a unique identifier that’s found on your tax and legal forms.
- Business License: Certain businesses may be required to possess one or more business licenses, such as a sales tax registration license or professional/occupational license. Verify with your potential merchant account provider whether specific business license requirements are imposed on merchant account applications.
- Additional Supporting Documents: These may include marketing materials, a business plan, your business’s return and shipping policies, and inventory reports. Merchant account providers require various amounts of supporting documents, so check with your account provider as to their supporting document requirements for applications.
Does Your Business Need A Merchant Account?
If all of this sounds complicated and expensive — which it is — you may be wondering if a merchant account is something you really need or just a luxury.
For most (but not all) merchants, the answer will be yes!
Operating without a merchant account (or an aggregated account offered through a payment service provider) means that you won’t be able to accept any kind of credit or debit cards, and your overall sales volume will suffer as a result.
However, there are some circumstances where you either won’t need a merchant account or simply won’t be able to get one. If you never have a customer ask to pay by credit card (e.g., you’re a freelancer or independent contractor), you might not want to pay for something that you’re never going to use. Likewise, businesses that sell cannabis products can’t get a merchant account at all, as federal regulations currently prohibit using a credit card to pay for these products.
In general, a merchant account will be the best choice for your business if:
- You’re running an established business with a stable sales history
- You want to offer your customers the flexibility of paying with a credit or debit card
- You reliably process (or expect to process) over $5,000/month (below this amount, a payment service provider is a more economical choice)
- You’re willing to research providers, read your contract documents, and negotiate the details of your contract with sales representatives
- You want access to the additional security measures available through a merchant account
- You’re willing to implement the required security measures to keep your account PCI-compliant
Alternatives To Merchant Account Processing
If you’ve concluded that a full-service merchant account is too expensive for your business, or you simply can’t get approved for one, you’ll be happy to know that there are alternative choices available. These choices include signing up with a payment service provider (like Square or PayPal) or getting an ACH-only account. Here’s what you need to know:
I Want To Open A Merchant Account. What’s Next?
If you’ve decided that obtaining a merchant account is the best choice for your business, you’ll want to know more about how to find the right provider and negotiate the best contract terms you can get, all while avoiding the many pitfalls that can make your merchant account far more expensive than it needs to be.
In your journey to setting up your merchant account, keep in mind the following points:
- Do research any company you’re thinking of signing up with
- Do read all contract documents before you agree to sign up
- Do provide all requested documents and information during underwriting
- Do monitor your monthly processing statements for unexpected charges or price increases
- Don’t do business with telemarketers or sales agents who show up uninvited at your business
- Don’t agree to lease your processing hardware
- Don’t provide inaccurate or incomplete information about your business during underwriting
- Don’t accept your provider’s initial price quote without negotiating
You’ll also want to learn more about how credit card processing works before you open your first merchant account. Good luck!