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What is a Merchant Account? A Guide For Small Businesses

Your small business can boost sales, increase cash flow, and attract more customers just by accepting credit or debit card payments. To do that, though, you’ll need a merchant account.

What is a merchant account?

A merchant account is required to transfer funds from your customers’ credit and debit card purchases to your business bank account. The merchant account and the customer’s issuing credit card bank work together to make sure your business gets paid.

A merchant account is a secure place for the money to sit temporarily while the bank checks to ensure the customer has enough funds to pay for the merchandise. It acts as an escrow, holding the funds until they are approved for transfer to your business account.

A merchant account is very different from a traditional bank account. While a conventional bank account allows you to make deposits and withdrawals freely, the merchant account functions strictly as a holding area with the acquiring member bank. This means that you can’t make a deposit or a withdrawal into a merchant account—they’re only used to advance funds from credit card transactions.

How do merchant accounts work?

Let’s look at an everyday credit card transaction to see where the merchant account comes into play. In this example, Sue is using her Visa to purchase clothing from your store.

  1. Sue runs her Visa card through the payment processing machine at your store’s checkout counter.

  2. Sue’s card and transaction details go from the credit card processor to your business merchant account, which is held at an acquiring bank.

  3. The acquiring bank sends the information to the card issuer. In our scenario, since Sue is using her Visa card, Visa is receiving this information.

  4. Visa forwards the transaction details to the issuing bank to make sure Sue has sufficient funds to pay you for the clothing. If her account isn’t in good standing, the transaction is denied.

  5. Visa sends notice of the approved transaction back to the payment processor, which then contacts your business’ merchant account with the transaction approval. Sue’s credit card payment is successful.

  6. After 1-2 business days, your business merchant account transfers the funds from Sue’s purchase (minus any associated fees) to your business bank account.

A merchant account plays a key role in the process of accepting credit card payments. It means businesses like yours don’t have to wait for Sue to pay her Visa bill before you can receive the proceeds from her credit card transaction at your store.

202108 Merchant Infographic-revised

Why your business needs a merchant account

While we aren’t yet a completely cashless society, many of us use credit and debit cards for just about all of our everyday purchases. Credit card companies encourage this trend by rewarding cardholders with cashback bonuses, rebates, and other freebies.

Many customers also tend to spend more when they have the option to charge their purchases. Spontaneous, expensive purchases are often paid for with credit cards since most people don’t carry large amounts of cash.

What does this all mean for your business? Many (if not most) shoppers will want to charge their purchases, but if this option isn’t available, they’ll seek out your competitors who do accept credit transactions.

The merchant account is the bridge in the credit card processing network that connects the customer, business owner, processor, and banks. Without it, your business can’t process credit card payments.

What to consider when setting up a merchant account

There are many small business banks that offer merchant accounts. But before running to the first bank in your area, consider the following to ensure you sign an agreement with one that is a good fit for your business.

  • Decide which credit cards to accept. MasterCard and Visa are usually the first cards that come to mind, but consider expanding your options. Accepting other cards, like American Express and Discover, will attract those cardholders to your business.

  • Research the fees associated with merchant accounts. The fees for a merchant account will vary from bank to bank. These generally include application fees, startup fees, monthly fees, per-transaction fees, processing fees, and credit card terminal system fees, as well as any additional fees.

    Typical startup fees run $50-$200, with transaction fees ranging from $0.05-$0.50 for each purchase. The merchant account fees applied to your books come from the provider’s online sales reports. However, when Bench handles your books, we ensure they are accurately reconciled for you.

  • Consider the payment method that’s best for your business. Choices include a countertop terminal, mobile swiper, online payment through your ecommerce website, or a point of sale system. If you’ll accept online payments, consider whether you’ll need a payment gateway as well.

  • Assess the risk for your type of business*. High-risk businesses such as those that deal in herbal supplements, weapons, and pawn shops may be turned down by merchant service providers. However, some providers do deal with these businesses, though possibly at a higher cost.

Merchant account requirements

Merchant account providers take on a level of risk for returned card payments and other losses when signing on new businesses. To mitigate these risks, business owners must have the proper documentation to prove their business is legitimate and solvent. These include the following:

  • Business bank account: Proof of an existing business account showing the account number and routing information is required.

  • Personal and/or business financial statements: Merchant account providers want to view your financial statements to ensure stability and assess fraud risk. They’ll usually ask to see two years’ worth of statements. In a newly established business without a commercial credit history, personal banking records, tax returns, and a credit check may be requested instead.

  • Business license: Either a federal or state license is required for regulated businesses. This is usually provided at the time of application.

  • Application form: The application collects both personal and business information, including addresses, Social Security number, and tax ID, if applicable.

  • Business policies and marketing materials: The merchant account provider reviews the business’ shipping and return policies to ensure they comply with industry regulations. Merchant account providers will also want to check the descriptions of products and services offered by your business.

  • PCI compliance: The Payment Card Industry (PCI) has data security standards (DSS) that payment processors and business owners must follow. Merchant account providers require strong security measures to protect the cardholder’s data.

Payment service providers are another option

A payment service provider is an alternative to using a bank’s merchant account services. If you are making sales through an ecommerce site, you’ll most likely use this method to process card transactions.

With a payment service provider, customers can make one-click payments using their mobile devices. Statistics show that this method appeals the most to Generation Z shoppers who prefer this quick and easy payment approach. The service also offers risk-free guarantees for secure payment protection against theft and fraud.

While there are many to choose from, Paypal, Stripe, and Square are the most widely used payment service providers. The following are benefits of using this form of credit processing.

  • Strength in numbers: The payment service provider offers a different approach to credit card transactions. Rather than requiring each business to have its own merchant account, a payment service provider pools their clients together into one large merchant account, reducing overhead costs.

  • Decreased potential losses: With their large merchant base, payment service providers can afford to take on more risk since they stand a better chance of recouping chargeback losses.

    Note: a “chargeback” is a payment that is returned to a debit or credit card when a customer successfully disputes a charge on their statement. Acquiring banks usually charge a fee to the merchant when a chargeback occurs.

  • Accept multiple payment types: This type of connection also allows online businesses to accept multiple payment methods, including cryptocurrency. Customers are not limited to paying with one or two credit cards.

  • Single point of contact: Service providers handle the entire payment transaction from authorization to settlement, ensuring the smooth transfer of funds from the customer’s account to your business account.

  • Efficient setup: The service provider company typically offers a complete turnkey solution with ready-to-go platforms, including free card readers.

  • Fast approval: There’s no long vetting process, and you can usually sign up and be approved on the same day.

  • Reduced fees: While a merchant account has multiple fees, the service provider typically only charges a per-transaction flat fee, generally between $0.10 and $0.25.

The disadvantage to using these companies? With their higher business volume, customer support can be less personalized and harder to reach. Many payment service providers don’t offer phone support, which means delays when you need help with account holds and terminations.

What’s the best payment solution for your business?

How do you decide which is the best solution for your business—a merchant account or a payment service provider? Well, that depends on your business type and the number of transactions you plan to process.

Merchant accounts are used primarily by brick-and-mortar businesses. If you prefer to accept credit cards directly and have a high volume of sales, a merchant account is likely your best bet.

The dedicated merchant account also gives you greater control over your funds. Through them, you can debit the account for chargebacks, correct transaction errors, and take action if there is fraudulent activity.

Payment service provider accounts are geared towards ecommerce businesses, especially ones that expect to do more business with customers on mobile devices. Their lower transaction fees make them a compelling choice for businesses that do a lower volume of sales.

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This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.

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