With online purchases and electronic payment methods, we are moving closer and closer to a cashless society. While some people do carry cash with them, a large majority has started to rely mostly on credit cards and debit cards for their payments. Business owners understand how crucial it is for them to make this payment method available for their customers. Not only does it increase sales, it also prevents you from losing potential consumers who prefer not to carry cash on them. In order to do this, businesses need to create a merchant account through merchant services providers.

So, what are merchant accounts and how do they work?

What is the Purpose of a Merchant Account?

New business owners might not be familiar with this terminology, which is why we will help you understand the basics about merchant accounts and how to open one.

A merchant account allows you to transfer funds or payments made from your customer’s credit and debit cards when they make a purchase. The funds are deposited into your business banking account automatically after they have been processed, typically within 1 to 2 business days. Therefore, you do not have direct access to this account.

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The institution that sponsors your merchant account also provides you with credit and debit card processing services. Sometimes, a third party can be used for this purpose, depending on where you open your account.

You can opt for merchant accounts which offer extra features, such as check processing services, PCI compliance services, online account reporting features, and more. Optional features usually require you to pay an extra amount for them, while others are already built into your account.

How the Credit or Debit Card Transaction Occurs

A credit card processing service is what allows you to process your debit or credit card transactions. When a customer makes a payment through their card, these processing services check if they have sufficient funds available to make the purchase. They authorize the transaction once the required conditions are met. After the transaction is fully processed, the funds are deposited into your business account.

The credit card association and the merchant account provider charge an interchange fee and a processing fee, respectively. This means that you will not receive the full amount that the customer paid, as there is usually a 3-5% deduction in every transaction.

The processing fee is variable, depending on whether you are on an interchange-plus plan, a tiered plan, or a flat-rate plan. While some merchant services providers are transparent with regards to the processing fee, miscellaneous fees and charges can become difficult to determine at times.

When your business has hundreds of transactions occurring every month, it can be challenging to keep this information organized. Online reporting is a relatively new feature, as many merchant service providers previously used to send a copy of your monthly account statement in the mail. This would list each transaction in detail, along with a complete breakdown of the processing charges that applied to each transaction.

Nowadays, nearly all merchant services providers allow online account access to make it easy for you to manage and keep track of your funds and transactions as they occur. You can even download a digital copy of your monthly merchant account statement.

Setting Up a Merchant Account

Choosing the right merchant service provider is essential. There are many excellent companies out there, but also many that offer terrible contract terms. Being cautious is essential, especially when you have hundreds or thousands of dollars at stake.

The contract terms, pricing schedules, and features offered by merchant service providers can be very different, so be sure to do extensive research into your options. Small business owners, in particular, should be wary about high rates and fees, and burdensome contracts. They can result in you losing your profits and having to pay an expensive penalty to be released from an unsuitable business deal.

Most merchant service providers abide by the industry’s standard three-year contract with an automatic renewal clause. This means that once your initial term of three years ends, your contract will be renewed for another year or two. In this case, if you wish to close your account, you will be liable to pay an early termination fee (ETF) of two hundred to more than six hundred dollars.

Liquidated damages pose another disadvantage, since the service providers might require you to pay up to thousands of dollars to compensate for the anticipated processing charges during your remaining contract term.

Fortunately, criticism from merchants have led to the industry making changes to their policies, with some companies waiving the early termination fee (ETF), or offering you a monthly billing plan. This would erase the system of long-term contracts and penalties for closing your account.

Be Wary of Contract Terms

Like with any business deal you get into, you should thoroughly read the contract terms provided by your merchant services provider. The sales team hired by the merchant services providers is often not adequately trained or knowledgeable about setting up a merchant account. If the company uses commission-based sales agents or if they outsource their sales to independent agents, you could end up stuck in an unfortunate business transaction.

Failure to disclose important contract terms or concealing information regarding processing rates and other aspects is more common than you think. Many merchants have been talked into overpriced long-term contracts and some independent agents can also be guilt of forgery.

While it may be out of your control who the company outsources its sales team to, you can take precautions to protect yourself. Read the entire contract before you sign, especially if the sales agent is eager to have you sign without giving you ample time to go through the fine details. In that case, you can assume that there are unsuitable terms in the contract which they are trying to conceal from you. You will be better off dealing with another merchant services provider.

Getting Started

Once you have found a merchant services provider that you trust and have understood their terms and policies, you can start setting up your merchant account. They will ask you to provide the following information:

  • Your Employer Identification Number (EIN)
  • Your business name and what type of business it is
  • Your contact information
  • Your bank statements (if you have an existing business)
  • Your projected monthly processing volume
  • Your tax information
  • Your routing and account numbers for the bank account where the funds will be deposited
  • Your detailed credit history

A credit check is not always required, but since a merchant account acts as a line of credit, they might ask you for your credit history as a reassurance. It allows a glimpse into your money management and helps prevent fraud, since your business will be liable for any refunds or chargebacks.

Companies with an efficient application process can make the process easier. If you have the necessary documentation, you can get your merchant account approved within a few business days. High-risk businesses might take a little longer to get their account approved.

What is the Difference Between Merchant Accounts and Payment Service Providers (PSPs)?

Traditional merchant services providers can make the process of opening up merchant accounts expensive and complicated. To overcome the potential problems and consequences that come with merchant accounts, the industry has come up with an alternative service: payment service providers (PSPs). Like merchant account providers, they give you’re the ability to accept debit and credit card payments, but do not require you to set up a merchant account.

Many companies fall into the category of payment service providers (PSPs). Some the best known are

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Square, Paypal, and Stripe. Square has a mobile processing system which makes it ideal for retail merchants, while PayPal and Stripe are the leading PSPs in the eCommerce industry. For merchants with volume of 10,000 or more per month we recommend Dharma which has consistently been the best merchant account for years.

How Do Payment Service Providers (PSPs) Work?

Unlike merchant service providers, PSPs do not give you a full-service merchant account with an individual ID number. They work by combining their users into a single, large account. This means that you will be exempt from the monthly fees, annual fees, and the costs associated with maintaining a traditional merchant account.

Another advantage is that payment service providers use a flat-rate pricing for their processing rates. Although these rates are higher than those found with merchant accounts, the payment process is simplified and you save more money by not having to pay extra fees.

Since PSPs offer pay-as-you-go pricing and strict month-to-month billing, small business owners benefit a great deal. There us no long-term contract or termination fee if you wish to close your account.

Are There Disadvantages to Payment Service Providers (PSPs)?

With all the benefits that come with using a payment service provider instead of a merchant service provider, you might wonder why anyone would opt for merchant accounts.

The greatest disadvantage with PSPs is that they lack stability. Your PSP account can be shut at any time and reason, without notice. For example, a large-ticket transaction can freeze or shut down your account. This may hinder your ability to accept debit and credit card payments on a daily basis. Moreover, PSPs tend to have poor customer support services, with only a self-help section on their websites.

Merchant accounts offer reliability, especially if your business relies of the everyday transactions of credit or debit cards. For large businesses, the merchant account fees are not too significant to affect their profits or growth, granted you work with a reputable service provider.

PSPs are more beneficial for low-volume businesses or merchants who process below five thousand dollars a month. While they are instantly approved, and do not have early termination fees, PSPs are not very reliable as account terminations and funding holds are difficult to predict.

Although the set up takes a few days, and they can have account fees, merchant services providers are the better option for mid or high-volume businesses. Account terminations and funding holds are not common, and they provide high-quality support with a dedicated account manager to assist you. Some merchant services providers offer an interchange-plus pricing and month-to-month billing, such as Dharma Merchant Services, Payline Data or CDGcommerce.

Conclusion

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You can overcome the challenges of opening a merchant account if you do your research and carefully analyze all your options when it comes to merchant service providers. Getting quotes from a few companies is a great way to get started so that you can see which quality of service versus costs combination matches your business requirements.

For new and small-scale businesses, payment service providers (PSPs) are a safer and simpler option as it requires less of a commitment. You can change your service provider after a month if you don’t like their service.

However, keep in mind that as your business grows, you will need a more stable option. PSPs pricing will tend to get higher, eventually costing you more than a merchant service provider would. Setting up a merchant account at a lower cost is possible even for a small business, if you select the right merchant services providers.