by Karisse Hendrick
One of the most important steps in launching a web-based business, product or application that accepts credit card payments is setting up your merchant account. Your Merchant Account Provider is one of the most important business relationships you’ll have, as this partner will process and fund your customer transactions.
The process of selecting a merchant account provider can feel overwhelming, even for those who have been through the process before. The people who understand the process best are often those selling the service, which complicates matters even more. The purpose of this article is to help you become familiar with the terminology and the process in order to make the best choices for your business.
Issuer: A financial institution that issues credit cards and maintains a contract with cardholders for repayment.
Merchant: An authorized acceptor of credit cards for the payment of goods and services. For the sake of this piece, you should visualize your business as the Merchant.
Acquirer/Merchant Processor: The acquirer (financial institution or merchant bank) that contracts with the merchant for credit card acceptance and enables card payments from customers, and deposits the funds into your bank account.
Sponsor Bank: All acquirers and merchant processors must either be, or be sponsored by, a member bank. A member bank has a direct relationship with the card networks. This sponsorship requires that the bank verify the financial stability and suitability of the acquirer or merchant processor that will be marketing on its behalf.
Open Loop System: Any credit card processing system where the issuer and acquirer are different entities such as Visa and MasterCard branded transactions. In merchant processing, both Visa and MasterCard are accepted in all open loop accounts.
Closed Loop System: Any credit card processing system where the issuer and acquirer are the same entity such as American Express and Discover. There are some open loop processors that will handle Discover relationships along with Visa and MasterCard. You will need to ask your prospective merchant sales representative if they support this, or if you will need to contact them directly along with American Express to open separate accounts that will be linked to your open loop merchant account.
Payment Gateway: An e-commerce service that authorizes and settles transactions for online retailers. It is the equivalent to a physical point of sale or terminal in a physical retail location.
Selecting an (OpenLoop) Processor Choosing a merchant processor is a lot like choosing a home loan provider. Although they all provide the same basic service, each provider has its’ own unique terms and offerings. Also, like applying for a home loan, while it’s important for you to choose a provider, they will also be selecting you through an underwriting process. It is important for a processor to assess the risk of a business since, ultimately, the financial liability of the transactions processed falls on the processor if the merchant bank account does not have the necessary funds. All banks have requirements and thresholds to be approved in the underwriting process.
Some factors that may be assessed will be:
- The length of time a business has been established
- Card present or not present environment
- Business type (Per the card networks, the most risky business types are: direct marketers, travel services, outbound telemarketers, inbound tele-services, adult, and betting. However, each processor maintains their own high risk list)
- Legal Entity of the business
- Business credit information
- History of processing statements
Specifically for new merchants:
- Investor Information
- Principal’s credit information
- Personal Guarantee from a principal leader
- Expected average transaction amount, and expected monthly volume
Based on the information provided, the underwriting department may determine to accept or deny your application. They may also accept your application with contingencies. The most common contingencies, especially for new merchants in this cautious economy could be one or a combination of the following:
- Required deposit or reserve ( commonly a percentage of the expected monthly volume)
- Delay on deposits (range varies)
- Higher processing fees (discount fees) for an introductory period
Types of Processors
The biggest differences between processors stems from whether they are a large sponsor bank, community bank or ISO (Independent Sales Organization).
Large Sponsor Banks: These are typically National banks that are large enough to be considered a sponsor banks by the card networks.
Community Banks: These are medium sized banks which are typically sponsored by larger banks, but accept liability and provide service for the merchants in their portfolio.
ISOs: These are non-financial institutions that pay a fee to a sponsor bank to market and sell the service under their own brand and pricing structure.
Generally, if you are a new company, the best place to start is the financial institution that holds your company bank account. Typically, banks that offer merchant services will have more lenient upfront underwriting criteria as they have insight into your other financial products and bank balances. Other positives with this option are the ability for next day funding, and a strong relationship with a single account representative. However, fees can range based on the size of the bank, and some require long term contracts to be signed.
ISOs can also offer competitive rates and terms, and may also be more accepting of riskier business models, as banks tend to be more conservative.
When interviewing prospective merchant processors, here are some important questions to ask:
- Who is your sponsor bank?
- Do you support online transactions, and the payment gateway I am using?
- Who will be supporting my account once it is active?
- What online reporting will I have access to?
- When should I expect the funds from transactions to be deposited into my bank account?
- How and when can I request a rate review?
- (also applies to when an upfront deposit can be released)
- Is there a company similar to my business model that I can speak to for a referral?
- Is there a mandatory contract term associated with this rate quote?
Understanding the pricing structures
It’s also a good idea to perform cost comparisons against your most recent merchant statements, or if you are a new merchant, to run them against the anticipated monthly credit card revenue. Fees can come with different ranges and descriptions. It‘s helpful to break them down by who receives them.
Fees that go to the card networks/Card issuers:
Interchange-Although your processor deducts these from your sales (either daily or monthly), these fees go directly to the credit card companies that issue each individual card you process. Circumstances that affect interchange are whether the card was physically present, the card type (corporate, rewards, debit,etc.) and your Standard Industry Code (business type).
There are two types of interchange fee structures. Typically, interchange consists of a percentage of the transaction amount plus a flat per transaction fee. (example: 1.45% + $.10)
“Pass through” interchange: This is when your processor charges you exactly what the issuer charges per transaction. This is typically reserved for large merchants who have a history of processing transactions.
“Bucketed” or “Tiered” Interchange: This is when the processor categorizes the interchange into larger groupings. The most common categories are “Qualified, Mid-Qualified and non-qualified” transactions. These buckets are essentially the high, medium and low levels of interchange, easily grouped into the average rate for each.
Once you have processed transactions, and have a good idea of the card types you most commonly receive and which interchange you commonly are charged, you may want to ask your account representative for an “interchange optimization” overview, which can help you learn if there is anything you can change on your end to qualify for the best interchange rate. (For instance, requiring Address Verification Service (AVS) at the time of sale will lower your interchange rate, than if it is not captured in the transaction details)
Fees that go to the processor:
Discount Fees: Contrary to what the name may suggest, this is the bulk of the fees that your processor will receive. The structure of this may be in basis points (a percentage of the sales) and/or per transaction. This varies by processor, however it is important to know how this will impact your billing. For instance, if you were given a discount fee of .8% + $.10, and had 20 $10 transactions, you would pay $3.60 in discount fees. Whereas, if you processed 2 $100 transactions, you would pay $1.80. Typically, the discount amount is based on dividing your annual sales by your number of transactions in a year. If you expect your sales to increase after you have the ability to accept credit cards, consider requesting a rate review after 6 months or after a processing a certain number of transactions (example: 10,000).
Authorization Fees: An authorization takes place when customers enter their credit cards on your site. This process of communication with issuing banks verifies that cards are active, and have the requested funds available. Fees charged by the issuer to authorize transactions can be passed on by the processor.
Settlement Fees: The settlement takes place typically once a day and is when the daily transactions are sent for funding. This is a fee that a processor may charge each time your transactions are settled.
Chargeback Fees: This fee will be charged per dispute or chargeback, and is typically not reversible, even if the chargeback is disputed and reversed.
Other fees you may encounter: Statement fees, AVS fees, gateway fees, PCI fees, activation fee, or application fee.
Every individual processor within these categories will be unique, with unique pricing structures. The best way to learn who’ll be the best fit is to meet with representatives of more than one and go through the underwriting process.
Doing some homework pays off
You will get the most benefit from the process if you first take time to prioritize what’s most important to you: The lowest long term pricing, the lowest underwriting criteria, the lowest deposit requirements, a strong service reputation, etc. Once you have this list, do not sign any commitments until you have compared your options based on your company’s individual situation. You will also want to compare any fee proposal to your most current merchant statement. If you have not yet processed credit card transactions, then compare these to your expected credit card revenues.
Going into this process with a level of understanding and having identified your priorities will help you confidently make the important decision of who will be your best partner in merchant processing.