What is a High-Risk Merchant?For many small businesses unfamiliar with the category, being labeled a high-risk merchant may come as a bit of a shock. The designation may feel arbitrary or overly judgmental, leaving owners to wonder if it may affect the way customers look at their business. Fortunately, being classified as a high-risk business isn’t anything unusual. In fact, a surprising number of seemingly mundane ventures, such as legal firms, travel agencies, and software companies, are categorized as high-risk by financial institutions. Generally speaking, a business is considered high-risk if it operates within an industry known for volatility or a high rate of merchant failure. Simply put, merchant service providers such as banks and credit card companies worry that businesses in high-risk industries will end up costing them money over time because they are less likely to generate consistent revenue. In the world of payment processing, there is no “in-between” when it comes to risk assessment. Businesses are either “low-risk” or “high-risk.”
How Processors Determine RiskPayment processors and banks consider a number of factors when determining risk. There is no comprehensive list of high-risk businesses and some processors may be more risk-tolerant than others, but they all have a clear idea of what types of customers are more likely to cost them money in the long run. Generally speaking, however, there are a few key qualities that will usually get a company labeled as a high-risk business.
High Chargeback RatesA chargeback is a payment dispute that occurs when a credit card holder questions the validity of a transaction and requests that it be reversed. This is distinct from a refund, which is strictly a return of funds directly to the customer. From a processing standpoint, refunds are initiated by the merchant, but a chargeback is initiated by the customer and requires the processor to get involved to determine the validity of the request. Since chargebacks involve more work on the part of the processor, a business in an industry associated with high chargeback rates is usually labeled as high-risk.
Overseas BusinessWhile many businesses are headquartered overseas and sell to US customers, the complications imposed by differing banking regulations and national laws make the potential for fraud much greater. If something goes wrong and a processor needs to recover money from an overseas business, there is a good chance that it will have to engage in complicated legal maneuvering to do so. Merchant services typically account for that possibility by labeling such businesses as high-risk even if they’ve never been associated with fraud.
Poor Credit HistoryAs with any financial service, payment processors evaluate an applicant’s credit history when assessing risk. They will want to know if the business has a history with other merchant accounts and whether or not it repays its creditors and financial partners on time. This extends beyond the company itself to focus on the business owners. A business that operates in a traditionally low-risk industry may still be labeled a high-risk merchant if the processor has concerns about the owner’s personal credit.
Company LongevityStartups and newer businesses are inherently riskier than more established companies that have been around for many years. That’s because new ventures lack a track record of good business practices and financial viability. A processor can reasonably expect a company that’s been in business for a decade to still be around five years from now, but it may be warier of a new merchant that’s just getting underway and could go bankrupt within a year.
Known High-Risk IndustriesRightly or wrongly, some industries have an established track record of high risk. Even a well-run business in these sectors is more prone to chargebacks, volatility, and regulatory scrutiny. Businesses that rely on low-volume, high-cost purchases may also fall under this category. Some examples of traditionally high-risk industries include:
- Pawn shops
- Furniture sellers
- Payday lenders
- VoIP services
- Travel agencies/tour operators
- Firearms dealers
What Makes High-Risk Merchant Accounts DifferentWhen a payment processing service labels a merchant as a high-risk business, that doesn’t mean it won’t work with them. Instead, it provides services through a special high-risk merchant account, which differs from a standard business account. In order to protect the processor from risk, these accounts typically come with a few specific conditions. High-risk credit card processing fees are typically much higher than the rates offered to merchants in less risky industries. These fees are in place to account for the greater risk of chargebacks and often come with strict terms and conditions that limit how many chargebacks can be processed before fees are increased. Since high-risk merchants typically have less bargaining power when it comes to choosing a payment processor, they are often forced to agree to long term contracts that limit their flexibility. While low-risk merchant accounts are typically short term (sometimes even month to month), high-risk merchant accounts often run between three to five years and feature automatic renewal clauses and early termination fees. The other way that payment processing services hedge against risk is to require high-risk merchants to maintain reserves. A merchant account reserve ensures that the processor will always get paid, even if the merchant encounters problems of some kind. There are typically three types of merchant account reserves:
- Up-Front Reserve: The processor withholds all funds from credit card transactions until a predetermined reserve balance is met.
- Rolling Reserve: Processors hold back a percentage of daily revenue for a period of time, releasing it to the merchant as more funds arrive in the future.
- Fixed or Capped Reserve: Similar to a rolling reserve, this approach withholds a percentage of transactions until a reserve cap is reached. Future revenue will not be withheld unless the reserve needs to be tapped to cover fees or other payments.