What is a Merchant Account?

High-Risk Merchants
If you’re a business owner, or even a shopper, you undoubtedly know the importance of credit and debit card in the modern monetary system. While we do not live in an entirely cashless society, things seem to be inching ever closer to that end point. As noticed during the COVID-19 pandemic, many businesses asked customers not to pay with cash, which only encouraged more people to switch away from carrying cash and coin and going completely electronic. Add to this the ever-increasing amount of ecommerce and you’ve got mounting evidence that the world is moving away from cash and toward cards. For better or for worse, this is a path we’re headed down, and if you’re going to run a business you’re almost always going to need to accept credit and debit cards to stay afloat. But how do you make the leap from cash to card? The answer is through what is known as a merchant account. 

What is a Merchant Account?

Simply put, a merchant account is a type of business bank account that allows the business to accept electronic transactions–credit and debit cards (and even some more obscure electronic transactions). A merchant account requires the business to work with a partnering merchant acquiring bank who facilitates all of this electronic payments. 

What is a Merchant Acquiring Bank?

When a business partners with a merchant acquiring bank, the acquirer serves as a third-party partner. The business has its own financial institution (the bank it has its accounts with) and then the merchant acquiring bank is the facilitator to make sure that the electronic payments go from the business to that financial institution.  Every time a debit or credit card is used to make a payment to the business, the merchant acquiring bank handles the processing and settlement. Generally, a merchant acquiring bank has processing relationships with the major cards such as Visa, Mastercard, and others. Some merchant acquiring banks only have relationships with some of these major cards and can only accept payment from them (which is why some businesses don’t accept American Express, for example, or Discover.) The merchant acquiring bank will charge predetermined fees of the business per their agreement. Many have a per-transaction fee as well as a monthly fee. 

How Merchant Accounts Work

Businesses with merchant accounts pay fees to the merchant acquiring bank in exchange for processing the electronic card payments. The business also has their standard financial institution, where they do their banking and keep their accounts. If a business does not accept electronic card payments then they will have no need for a merchant account or merchant acquiring bank, and the cash and checks they collect will be counted and deposited in their financial institution without ever needing a merchant account. 

Transaction Processing

When an electronic payment is made, a business will send the credit or debit card’s information through an electronic terminal to the merchant acquiring bank. From there, the merchant acquiring bank contacts the card processor (typically whoever is named on the card, like Visa or Mastercard). That processor will then contact the card issuer (the bank where the buyer has their accounts). That issuer does security checks and makes sure there are sufficient funds, and then sends approval back to the merchant acquiring bank. If approved, the transaction goes through and the buyer gets their goods and receipt, and behind the scenes, the merchant acquiring bank begins the settlement process. This all takes place in two to three seconds–the time it takes from when someone swipes their card until the time it is declared to be approved. There are fees at all of the steps along the process, from a per-transaction fee that may be a percentage (from 0.5% to 5.0%) or a $0.20 or $0.30 amount. While processing fees are highly variable, a business can expect that, altogether between the merchant acquiring bank and the card processor, they will be paying 3-5% of the transaction in fees. A business can track all of their transactions through most merchant acquiring banks’ services. These transactions and fees can be seen online, and often in real time. There will also be monthly reports that are run standard, as well as customizable reports that the business can access and investigate at any time.

How to Get a Merchant Account

Setting up a merchant account isn’t hard, as almost every business has one. The hard thing is to navigate through the sea of offers and see which merchant account is the best for you and your business. They all have different fees, features, and pricing schedules, and if you pick the wrong one it could end up costing you hundreds or thousands of dollars unnecessarily over the course of a year.  Industry standard–the most common type of account available to a small business owner–is a three year contract. Closing the account early can cost you an early termination fee, which can range in the hundreds of dollars, and in some cases a merchant account will have liquidated damages, which could cost you in the thousands of dollars. The good news is that these things are beginning to go away as the merchant account market is opening wider, and it’s possible to waive the early termination fee and even to move to month-to-month billing.

Merchant Accounts and Payment Service Providers

There is an alternative to merchant accounts, and that is the payment service provider (PSP). There are several well-known PSPs, particularly Square, PayPal, and Stripe. PSPs don’t offer the full-service that you get with a merchant account, but typically have lower costs. Processing rates are typically flat-rates, which are higher than a merchant account, but there is cost savings in fewer fees, typically using pay-as-you-go pricing.  The main drawback to PSPs is stability. A single large transaction can get a PSP account temporarily frozen or even shut down. Also, PSPs typically have very little in the way of customer service support other than their websites.  Consequently, PSPs are a good option for a business that does a small amount of sales a month (a few thousand dollars) while a merchant account is a better option for a bigger business.   

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