What Is A Merchant Account?
If you’re a business owner, you’re probably already aware of just how important it is to be able to accept credit and debit cards as payment methods from your customers. Although we’re still quite a way off from becoming a truly cashless society, today almost all American consumers have either a debit card, a credit card, or both, and rely on them to make most of their day-to-day purchases. Card acceptance translates directly into increased sales and prevents the possible loss of a sale from consumers who now usually carry little or no cash and leave their checkbooks at home.
Unfortunately, being able to accept credit cards isn’t something that you can just do on your own. You’ll need to establish a relationship with a merchant services provider and obtain what’s called a merchant account.
If you’re new to running a business, you might be wondering what a merchant account is and how it works. The primary thing to know about a merchant account is that it is simply an account into which you transfer funds from your customers’ credit and debit card purchases after they’ve been processed. You might be surprised to know that you won’t actually have direct access to your merchant account. Instead, funds deposited into it are automatically transferred to your business banking account, usually within 1-2 business days.
When you sign up for a merchant account, you’re obviously getting more than just an account that you can’t directly use. You’ll also receive credit and debit card processing services, which may be provided by a third party or by the same company that is sponsoring your merchant account. Most merchant accounts also come with a variety of extra features. While some of these features are built into your account, others are optional (meaning you’ll usually have to pay extra for them). Additional features of merchant accounts can include check processing services, online account reporting features, services to keep your account PCI compliant, and many others.
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What Does A Credit Card Processor Do?
Regardless of how you have your account set up, it will always include a processing service to process your debit and credit card transactions. These processing services will confirm the availability of sufficient funds when your customer uses a card to pay for purchases, and, if all necessary conditions are met, will authorize the transaction. Once the transaction has been fully processed, you’ll get your funds. Of course, you won’t receive 100% of what your customer paid you. You’ll pay both an interchange fee (that goes to the credit card association) and a processing fee that goes to your merchant account provider. The portion of the processing charge that goes to your merchant account provider may be clearly transparent if you’re on an interchange-plus pricing plan, or it may be very difficult to determine if you’re on either a tiered or flat-rate plan. There are a host of miscellaneous fees and charges that you might have to pay on some transactions. While processing fees are highly variable, you can expect to pay around 3-5% total in processing fees for each transaction. For a deep dive into processing rates and fees, see our post The Complete Guide to Credit Card Processing Rates & Fees.
If your business processes dozens or even hundreds of transactions every month, you may wonder how you’re even going to begin to keep track of the information generated by all this activity. Fortunately, most merchant services providers today offer some form of online account access, allowing you to keep track of your transactions (and your expenses) in real-time. It wasn’t all that long ago that online reporting didn’t exist, but today it’s an essential feature of your merchant account. You’ll also receive a monthly account statement that lists each transaction and breaks down the processing charges associated with it. While merchant services providers traditionally mailed a paper copy of your monthly account statement, most providers today allow you to download a digital copy.
For help in deciphering your account statement, check out our post How to Analyze Your Credit Card Processing Statement.
How To Get A Merchant Account
Setting up a merchant account isn’t terribly complicated by itself, but it’s all too easy to make a mistake that can cost you hundreds – or even thousands – of dollars down the road. It’s essential that you do some deep research into any merchant services provider you’re considering, as they all have different features, pricing schedules, and contract terms. Like any other industry, merchant services providers range from the outstanding to the truly awful. Unfortunately, most providers are pretty terrible, at least when it comes to serving the needs of small business owners. High rates and fees can eat into your profits, and onerous contract terms can leave you stuck in a bad business relationship where the only way out is to pay an expensive penalty to break your contract.
Unfortunately, the industry standard – and the only thing most providers will offer you – is a three-year contract with an automatic renewal clause that renews for one or two-year periods after the end of the initial term. Closing your account early will leave you liable for an early termination fee (ETF), which can run anywhere from $200 to over $600. Some providers will even hit you with liquidated damages, which will result in a penalty based on the anticipated processing charges over the entire remaining period of your contract. In some scenarios, liquidated damages can run into thousands of dollars. The good news is that the industry is slowly responding to criticism from merchants about their contracts. Some providers will now waive the ETF if you ask, and others (including all of our favorite companies) will offer you month-to-month billing. No long-term contracts and no penalties for closing your account – it doesn’t get any better than that.
One of the most potentially difficult aspects of setting up a merchant account is dealing with a provider’s sales team. Many companies outsource this function to independent sales agents. Unfortunately, they don’t always provide them with high-quality training and adequate oversight. Combine this with the fact that many sales agents are paid on a commission-only basis, and you’ve got a recipe for disaster. We’ve seen literally hundreds of complaints from merchants who’ve had independent agents fail to disclose important contract terms and even outright lie to them about processing rates, contract terms, and other aspects of their merchant account. Some have even been accused of forging merchants’ signatures on contract documents to lock them into overpriced long-term contracts.
While it’s difficult to avoid dealing with independent agents altogether, you can protect yourself by carefully reading your entire contract before you agree to sign anything. If your agent tries to get you to sign up without giving you the chance to do this, it’s a clear indication that there are details in the contract he or she doesn’t want you to know about. Back out of the deal immediately and find a different provider.
Setting up a merchant account once you’ve chosen a high-quality provider is usually pretty straightforward. You’ll need to provide information such as your business name, contact information, and tax information. You’ll also have to provide your routing and account numbers for the bank account into which you plan to accept your deposits. However, few business owners expect to submit to a credit check when applying for a new merchant account. After all, you are accepting money, not borrowing it. But a merchant account is, in some ways, a line of credit. The credit card processor is counting on you to be liable for all chargebacks and refunds on your account, and your detailed credit history can provide a glimpse into your ability to handle money and prevent fraud. For more specific details on the process of establishing a merchant account, see our post Setting Up a Merchant Account: The Quick Guide.
Merchant Accounts & Payment Services Providers (PSPs)
By now, you’ve probably concluded that merchant accounts are both complicated and expensive. Isn’t there an easier way? Well, there is. With all the potential problems and pitfalls that merchant accounts are prone to, the industry has been ripe for disruption. In recent years, several companies have introduced services that give you the ability to accept debit and credit cards, but without the need for a full-service merchant account. We use the term payment service providers (PSPs) to distinguish them from traditional merchant account providers.
Even if you haven’t heard the term payment service provider before, the chances are good that you’ve heard of at least a few of the companies that fall into this category. For retail merchants, Square (see our review) is far and away the most well-known PSP. In fact, they pretty much invented the category when they introduced their mobile processing system back in 2009. On the eCommerce side, PayPal is probably the most popular PSP, followed closely by Stripe.
Payment service providers work by aggregating their users into something akin to a single, large merchant account. If you sign up for their service, you won’t have a true, full-service merchant account with a unique merchant ID number. This arrangement brings costs down significantly, eliminating the kinds of monthly and annual fees that traditional merchant accounts usually impose. Processing rates are also greatly simplified through the use of flat-rate pricing. While these rates are inevitably higher than you might receive with a full-service merchant account, you’ll still save money overall as a small business owner since you won’t be paying any additional fees. PSPs offer true pay-as-you-go pricing, making them ideal for very small and seasonal businesses. You also won’t have a long-term contract or an early termination fee to worry about. Billing is strictly month-to-month, and you can close your account at any time without penalty.
This all sounds great, right? You’re probably wondering why anyone would want a traditional merchant account when PSPs have such obvious advantages. Well, there are some significant trade-offs involved that you need to be aware of before you sign up. The biggest trade-off is account stability, or rather, the lack thereof. PSP accounts can (and often are) shut down without notice to the user for any number of reasons. Often, a single, large-ticket transaction is enough to get your account frozen or shut down completely. If you are really dependent on being able to accept debit and credit cards every day, you might be better off with a full-service merchant account. PSPs also are notorious for providing little or no customer support other than a self-help knowledgebase on their website.
Finally, as your business grows, merchant account fees become less of a factor, while lower processing rates become much more important. We generally recommend PSPs for merchants processing less than $5,000 per month. Above that amount, you’ll actually save money with a full-service merchant account – at least if it’s from a reputable provider.
The table below summarizes the differences between full-service merchant accounts and PSPs:
Merchant account Payment Service Provider
Merchant accounts can seem pretty daunting at first, but they don’t have to be. If you’re getting ready to open a merchant account for the first time, we recommend that you read the articles we’ve linked to above and do plenty of research about any company you’re considering using to provide your account. Get quotes from at least two or three of the leading merchant account providers and compare them to see which one offers the best combination of high-quality services and low costs.
If you’re opening a business for the first time, a payment service provider (PSP) can be an excellent alternative to a full-service merchant account. Just be aware that as your business grows, the higher flat-rate pricing offered by PSPs will actually be more expensive than an interchange-plus pricing plan you could get with a full-service merchant account. You’ll probably also prefer the stability of a merchant account before long. Luckily, merchant accounts don’t have to be too expensive, even for a small business. Providers such as CDGcommerce (see our review) and Payline Data (see our review) can get you a full-service merchant account with interchange-plus pricing and month-to-month billing for as little as $10.00 a month. For a side-by-side comparison of our top-rated providers, check out our Merchant Account Comparison Chart.
A last look at our top picks…