Requirements for Getting a Merchant Account
Posted on 30 October 2003 09:50 AM
There are many requirements and restrictions associated with both getting and keeping a merchant account. This section will help you to better understand what these requirements and restrictions are and why they exist. This section covers the following topics:
Your merchant account is a financial agreement between you and the bank that issued the merchant account. Just as a bank will impose rules on a checking account or savings account, rules are imposed on merchant accounts. Almost always, these rules are in place to achieve one objective - to avoid risk. There are three types of risks associated with merchant accounts:
Credit risk: Credit risk is the risk the bank takes with respect to the amounts you, as a merchant, may owe the bank. Many people are surprised to learn that this is not the most important factor when it comes to accepting (or rejecting) a merchant account application, especially for new, startup businesses with small monthly charge volumes (less than about $5,000 per month). This is because fraud and contingent liability risks are much more important factors when underwriting a merchant account application. Merchant accounts are routinely issued to individuals who have no credit or poor credit histories. It is also not unusual for a bank to decline the leasing application for equipment (based on insufficient or poor credit), but grant the applicant the merchant account.
Your credit rating becomes more important the longer you are in business and especially as your monthly charge volume grows. Few business owners can succeed and remain in business beyond just a few years unless they build a good credit rating.
Fraud risk: Fraud risk is the risk of inadvertently processing credit card transactions that have not been authorized by the credit card holder. Credit card fraud typically occurs as the result of stolen cards or card numbers. While all merchants are susceptible to credit card fraud being perpetrated via their web sites, new merchants are at great risk since they are not as familiar with the methods of detecting and preventing suspicious credit card transactions. In addition, some types of businesses and certain products are subject to higher fraud risk.
Contingent liability risk: This is the greatest risk associated with the merchant account. It not only includes the risks associated with fraud but also all of the unforeseeable risks associated with different types of businesses and marketing methods.
To better understand contingent liability, consider the following real world example. A couple of years ago, a new startup company was offering lifetime Internet dial-up accounts for a one-time, flat fee. Many subscribers took advantage of this offer by using their credit card to pay the fee. Recently, this company declared that it was discontinuing its business because this marketing model simply was not viable. Since the company could not fulfill its promise of a lifetime account, subscribers demanded, and were entitled to, a refund of their fee payment.
The above is an example of contingent liability. In this case, the liability was the growing amount of all potential refunds. Payment of these refunds was contingent on the ISP remaining in business and offering the service for the lifetime of the customer. Lifetime services or products represent the worst-case scenario when it comes to contingent liability. The liability just grows and grows with each new sale and to truly understand the financial risks requires the application of actuarial tables similar to those used by the insurance industry to forecast costs associated with life insurance policies. If you offer a lifetime service or product for a single, flat fee, don't expect to get a merchant account.
Contingent liability will be a factor any time that a payment is made for something that is contingent on the merchant providing a service or product at some future date, as opposed to immediately delivering the product or service. In general, a merchant account will not be approved for any product or service that is delivered more than 90 days after payment.
Another form of contingent liability is associated with intangible services. An example of a high-risk, intangible service would be the sale of an online, pay-per-view video delivered over the Internet. In general, the more fleeting the service along with the higher cost of this one-time service, the greater the risk. The risks associated with this type of service are due to the fact that it is extremely difficult or impossible for the merchant to provide proof of delivery.
You will find it difficult, if not impossible, to obtain a merchant account for any of the following products, services, or businesses:
The following products, services, or businesses will usually require the payment of higher than normal setup and/or transaction fees:
High-risk businesses may be required to pay higher setup and/or transaction fees. In addition, a reserve may be required. The actual total amount of the reserve and how the reserve is established will vary from bank to bank and from business to business depending on the extent of risk exposure. Although merchants sometimes view reserve requirements as a negative requirement, they can act as a safety net for businesses that are exposed to higher risk of chargebacks.
Reserves are usually specified as a percentage of the monthly charge volume and are created by withholding a percentage of each transaction. As an example, consider a monthly charge volume of $10,000 with a 50% reserve requirement and a 5% withholding amount. In this example, the total required reserve would be $5,000 (10,000 x 0.5). This reserve would be built by withholding 5% of each transaction or sale, or about $500 per month. So, the reserve would take about 10 months to be built.
Reserve amounts belong to the merchant. They are held in escrow by the bank in the event they are needed to offset unexpected chargebacks.
The United States is currently the world leader when it comes to e-commerce technology. In addition, the US has always enjoyed lower costs for both computer hardware and software. It is not unusual for a software application sold in the US to cost up to twice as much in other countries. Because of these two factors, the general consensus among industry consultants is that if you are going to do e-commerce, do it in the US. Although the virtual nature of the Internet may make it viable for a large company to establish a presence in the US, most small and medium sized businesses may find this difficult or cost-prohibitive. Compounding the problem is the fact that most US banks will not establish a merchant account to businesses outside of the US.
The following are minimum requirements for establishing a merchant account with all US merchant banks:
The above requirements apply to all businesses applying for a merchant account. Obviously, these requirements are easily met for persons living in the US. However, these are also the requirements for most merchant account providers that offer "International" merchant accounts to businesses located outside of the US. Most providers will assist you (for a fee) in establishing these requirements.
The following are additional requirements imposed by most (but not all) banks if your principal company is located outside of the US: