Credit cards don't process themselves. This is where merchant accounts come in. A merchant account is essentially the middleman that lets businesses accept credit and debit cards in person and online.
Usually provided by banks and other financial institutions, a merchant account processes electronic payments by transferring funds between customers' and merchants' banks. During a sale, the merchant account works behind the scenes to withdraw funds from the customer's bank and deposit them directly into the merchant's checking account. The process works the opposite way during a refund.
Here is a simple explanation of how a merchant account works, what to look for in a merchant account and how small businesses can get one. For a more in-depth look at merchant accounts, check out our Credit Card Processing Buyer's Guide, which will also help you figure out whether your business needs a merchant account and how to find the right one for your business.
How a merchant account works
When a credit card transaction is processed, information must be sent to a payment gateway to see if the cardholder has sufficient funds. For traditional transactions, this is generally part of the point of sale (POS) machine, which reads the cardholder's data and checks with the credit card company to ensure the transaction can go through. This is known as a "swiped" or "card present" type of merchant account, which can include retail, restaurant or lodging merchants.
But in a "keyed" or "not present" transaction, this is done online by a payment gateway, which connects to the credit card company. These kinds of merchants can include mail order companies, telephone order companies or e-commerce/Internet merchants. When merchant accounts are set up, the same company, called the payment processor, can often set up the payment gateway in the same process.
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Within the e-commerce category, there are a number of different kinds of merchant accounts:
- Direct — applied for directly at a merchant bank.
- Local — an account in one's home country.
- Offshore — an account outside of the country of the merchant, known as an international merchant account.
- High-risk — for online businesses with a high percentage of chargebacks and returns.
- Third party — connected via an additional secure payment gateway to a direct credit card payment processor, contributing to the work of the processor and sharing its expenses. Ideal for beginner e-commerce companies.
Generally, merchant transactions are not posted to the account at the time of purchase/refund. These transactions are usually posted in a batch during the merchant's settlement process. Depending on the business, the settlement process can either be automated to occur at a specific time of day, or manually initiated. This is dependent upon the specific payment gateway.
How to get a merchant account
To get a merchant account, a business must apply and be approved. Credit card companies guarantee that a cardholder is entitled to receive a promised good or service; if such good or service is not delivered, then the cardholder is entitled to their money back. As one of the most basic consumer-protection principles, this also mitigates the risk that the credit card processor faces. The payment processor has the potential to lose money every time it processes a credit card transaction for your business. Thus, all businesses who want a merchant account must apply, and sometimes there is a fee associated with this.
It's important for businesses to stay grounded in reality when applying for these merchant accounts. When applying, the prospective processor should be able to provide clear answers on the type of documentation required and how long the approval process might take. If the processor makes unrealistic blanket promises or statements, it would be a good idea to be skeptical and take a closer look at the company.
When applying for a merchant account, it's important to have financial documents in order to leverage the best terms of approval possible. Having a strong processing history is another valuable tool that you could use to leverage your application. An old-fashioned cover letter will help explain exactly what your business does and why it deserves a merchant account.
Find a merchant account
From credit card processors to POS system providers, small businesses have many merchant account options to choose from. To help small businesses find the right merchant account, Business News Daily has done extensive research and analysis to find the best credit card processors and the best POS systems, where you'll also find a roundup of reputable credit card processors and POS system vendors.
Updated on June 16, 2015. Additional reporting by Elaine J. Hom.