Credit cards don’t process themselves; that’s where merchant accounts come in. Merchant accounts are a critical part of modern business, where accepting debit and credit card payments is a basic necessity. This guide explains how merchant accounts work, how to set one up, and what you need to know about them as a small business owner.
For a more in-depth look at merchant accounts, check out our article on how to accept credit cards, which will help you figure out whether your business needs a merchant account and how to find the right one.
A merchant account is a business bank account required for businesses to accept debit and credit card transactions, as well as other forms of electronic payments. A merchant account acts as a bridge between a customer’s credit account and a business checking account. During a transaction, funds will be immediately available in a business’s merchant account, from which they can be deposited into a business checking account.
Once a payment processor has set up a merchant account for your business, you can begin conducting credit card and debit card transactions with your customers. Since it’s a business bank account you’ll need a business license to set one up. To begin processing debit and credit card payments, you will usually need some hardware, which would be available for purchase through your credit card processing partner. In some cases, the payment processor might even give you a free credit card reader to help you get started.
Editor’s note: Are you trying to choose a credit card processor? If you’re looking for the one that’s right for you, fill out the questionnaire below to receive more information from our vendor partners.
Acquiring a merchant account is relatively easy. Here are the steps to follow to create an account:
The first step in obtaining a merchant account is to do a little research. There’s variation in fees and capabilities, and you’ll want to know which companies offer the best solution for your business. For example, some processors are oriented toward your industry, while others specialize in a particular transaction type – such as online purchases or retail sales.
If you have friends in a similar field, ask them for recommendations. You can also look online and compare processors. Your bank may offer merchant accounts, which is something to consider. Your bank may be more likely to approve your business for a merchant account, especially if your company is new.
In addition to any posted fees, compare the hardware costs, customer support and contract length. The standard merchant account contract is three years, including penalties for early cancellation.
When you apply, your prospective processor should provide clear answers on the type of documentation it requires and how long the approval process might take. If the processor makes unrealistic blanket promises or statements, it’s a good idea to take a closer look at the company.
You will need to provide your business information, including your organization’s name and DBA, contact information, length of time in business, your tax ID number, financial statements, business bank account and routing numbers, and sometimes a credit card to pay for the application fee.
If you’ve used a credit card processing tool or service before, be sure to provide information about that company – including how long you worked together. It may be easier to get approved by a new company if you demonstrate a successful past relationship.
Once you submit all the requested information, the processor will likely check your personal and business credit history. Depending on the provider, you may need to pay an application fee.
Add an old-fashioned cover letter to your application to explain precisely what your business does and why it deserves a merchant account.
The merchant account provider will evaluate your application and decide if you’re a good risk. When approving an application, the vendor will take these factors into consideration:
Your business is considered less risky if you plan to process transactions in person while customers use their cards on hand. Your company is rated as more risky if you will process cards online or by phone because these transactions are more vulnerable to fraud. To mitigate this risk, some merchant account providers require address verification when cards aren’t present.
The merchant account provider will likely approve your application if your business history and transaction type make you a low-risk option. Riskier companies may still be approved, but with additional and higher fees.
Merchant account vendors have a lot on the line. They guarantee a cardholder will receive a promised good or service, so if it isn’t delivered, the cardholder is entitled to their money returned.
These are the steps taken when a credit card transaction is processed:
A payment gateway is a mechanism separate from a merchant account that sees if the cardholder has sufficient funds for the transaction. Should your business accept credit card payments over the phone or through an online portal, it requires a payment gateway: A keyed-in or card-not-present transaction is done online through a payment gateway connecting to the credit card company.
Another valuable tool is a payment gateway, which is useful if your customers frequently place pickup orders ahead of time. The best point-of-sale (POS) systems include a payment gateway that reads the cardholder’s data, and checks with the credit card company to ensure the transaction can go through.
The credit card processor you partner with can set up a payment gateway for you at the same time your merchant account is established. However, payment gateways generally cost an additional monthly fee, and card-not-present transactions usually have higher costs than card-present transactions.
If the transaction is approved, the merchant account deducts the purchase amount from the customer’s bank or credit card account – first deducting its transaction fee, usually 3% to 5% of the total. The fees vary depending on the payment type. For example, transaction fees are usually higher for American Express than Visa or Mastercard.
Next, the merchant account deposits the money into your company’s checking account. These deposits usually occur in batches at the end of the day – or even less frequently – rather than right after a transaction.
If there is a customer dispute, the merchant account will need to pull the transaction information to verify it. There is often a fee for this. If a refund is warranted, the merchant account provider will take care of it, withdrawing the funds from your account and depositing the money into the customer’s account. There is often another fee for this step.
Editor’s note: Are you trying to choose a credit card processor? If you’re looking for the right one for you, fill out the questionnaire below to receive more information from our vendor partners.
Because your business has unique needs when it comes to payments, these are different types of merchant accounts:
As businesses have gone increasingly digital, the payment processing industry has extended its reach to e-commerce companies. If you’re building an online business, you’re even in more serious need of payment processing services.
However, the merchant account types available for e-commerce businesses are different from those of brick-and-mortar stores. Here are some e-commerce merchant account categories:
Generally, merchant transactions aren’t posted to the account at the time of purchase or refund. These transactions are usually posted in a batch during the merchant’s settlement process.
The fees associated with a merchant account vary by provider. Card-present transactions are generally considered the least susceptible to fraud. This means that the rates associated with these transactions are often the lowest credit card processors offer.
In some cases, merchant accounts adhere to a fixed per-transaction rate without any additional fees. Others use an interchange-plus pricing model, which is the credit card company’s processing fee plus the merchant account provider’s markup. Finally, the tiered pricing model offers several different rates depending on the type of transaction.
Here’s a closer look at each model:
These are some additional fees beyond the pricing models:
Some fees are unavoidable, but not all are common across credit card processors in the industry. Do your due diligence to ensure you aren’t caught up in bogus fees from an unethical payment processor.
It’s possible to accept credit cards without a merchant account with one of these alternatives:
The bottom line is that if you want to accept your customers’ debit and credit cards, you need to secure a merchant or alternative account. In today’s world, most customers expect to pay with a credit or debit card; many don’t carry cash daily. Refusing to set up an account so you can accept these payment forms could upset your customers. Ultimately, not accepting credit cards can hurt your bottom line.
If you’re looking for a payment processing company that can set you up with a merchant account quickly and easily, check out Business News Daily’s reviews of the best credit card processors. These payment processors offer exemplary service to suit the needs of your business.
Adam Uzialko, Elaine J. Hom and Sara Angeles contributed to the reporting and writing in this article.