Credit Card Processing Blog

Merchants are often surprised by the thoroughness of the review process they are subjected to when applying for a credit card processing account. They typically expect that, because they are offering their prospective processor the opportunity to make money on their transactions, the contract will be signed up without much fuss.

The reality, however, is very different and there actually are good reasons for the processors’ caution. Before underwriting a merchant account, processors will often go to great lengths to verify that the applicant business and its owners are sufficiently creditworthy and do not present an unacceptably high risk. But what risk? After all, the merchant only gets paid after the processor itself gets paid by the card issuer, right? So if no money comes into the processor’s account, no money goes into the merchant’s account. What can possibly go wrong? Well, unfortunately it is not as straightforward as that. Let me explain.

What Is the Processor’s Risk?

From a processor’s point of view, a merchant account is a form of a line of credit, extended for the amount of the approved annual bank card processing volume. So if your application is approved for a $500,000 in annual processing volume, that is your “line of credit.”

As with underwriters of the more conventional types of lines of credit, during the application review processors try to establish that the applicant is “good” for the requested amount. More specifically, they try to verify that the merchant is a legitimate entity that is capable of handling the amount of business that would generate the volume that is being considered.

More to the point, and here is where the risk factor comes in, the applicant must prove that they can do business without incurring unacceptably high levels of customer disputes and chargebacks. Why is this so important? Well, ultimately the processor is liable for all of their merchants’ obligations. So if a merchant goes out of business, the processor is liable for all of the unfulfilled orders, as well as for all chargebacks. To make matters worse, chargebacks can be initiated for up to six months after the transaction date. You can easily see how even a completely legitimate business can create a huge liability if it gets in trouble.

How Do Processors Evaluate Risk?

To protect itself against such unpleasant prospects, before approving an application a processor will typically perform the following actions:

• Credit check, background investigations, and reference checks of the applicant business.
• Credit check of:
  • The owner, if the merchant is a sole proprietor; or
  • The partners, if the merchant is a partnership; or
  • The principal shareholders, if the merchant is a corporation.
• Inspection of the physical premises and records to ensure that the merchant has the adequate facilities, equipment, inventory, agreements and staff. If the merchant has more than one outlet, the processor will inspect at least one of them.
• Check the business license or permit.
• Inquiry into the Member Alert to Control (High-risk) Merchants (MATCH) system. If a processor enters into an agreement with a merchant that is listed in the MATCH system, it will be held responsible for all fraudulent transactions.
• Investigation of the merchant’s previous processing agreements, if any.

Typically, a processor will not conduct a credit check on a public or private company that has annual sales revenues in excess of $50 million, provided the most recent annual report and financial statements raise no further questions. However, a private company that cannot produce a recent audited financial statement will be subject to a credit check and inspection, even if it does more than $50 million in annual sales.

The Takeaway

What you need to understand is that your processor does hold liability for your merchant account activities, even as it holds you liable for all potential losses that can result from them. This is why you are asked to provide all these documents during the application process.

In fact, higher risk businesses (e.g. providers of subscription-based services, timeshare advertisers, dating websites, etc.) are required to produce even more paperwork, which may include financial statements and tax returns for the latest two years, as well as processing statements with the current processor for the latest six months.

Yet, most businesses’ merchant account applications are easily approved and yours will be too, if you work with your processor and provide all of the requested documents. Remember that the processor wants your business and the review process is designed to identify and reject the fraudulent applications and the ones that present unacceptably high risk. That’s reasonable enough, isn’t it?

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

The merchant account application review is a fairly straightforward process that typically takes a day or two to complete, but more often than not it drags on for a bit longer, due to insufficient paperwork. Merchants are often surprised with the amount of documentation needed and are not always prepared to produce all of it at once. Additionally, there have been some recent changes in the list of requirements for new applicants, so I thought that a fresh overview is in order.

General Requirements for U.S. Merchant Account

All applicants for U.S.-based merchant accounts need to be compliant with the following general requirements:

• Legal presence in the U.S. All merchant account applicants must be legally incorporated as businesses in the U.S. or at least registered with the local city or town and obtain a “Doing Business As” (DBA) name.
• Physical presence in the U.S. All applicants must maintain a physical address in the U.S. that can be verified. A P.O. Box is insufficient.
• U.S. bank account. The bank account into which the merchant would have their funds deposited must be set up with a U.S. bank.

Once these requirements are met, the merchant can proceed with the application process.

Paperwork Required of Merchant Account Applicants

The required application documents will vary depending on the applicant’s risk categorization, which is determined based on a list of factors, including line of business, monthly processing volumes, previous processing experience, etc. However, all applicants will be required to provide the following documents:

• Application form. A form that collects basic information about both the applicant business and its principals, including address (business and personal), tax ID, phone number, email address, web address, bank account information, processing volumes, average sales amount, etc. The pricing agreement may be part of the application form or separate from it.
• Personal guarantee. Processors look to limit their liability for fraudulent transactions by requiring the principals of all privately held businesses to provide a personal guarantee. Publicly traded and non-profit entities are exempt from this requirement.
• Articles of Incorporation. Incorporated entities are required to provide a copy of their incorporation paperwork.
• Business license. If the applicant business requires some form of a permit or license, either a federal or a state one, it will have to be submitted.
• Voided check. A voided check is needed for the bank account into which the merchant’s funds will be deposited. It must be a permanent check, i.e. it must have the business name pre-printed on it. If a permanent check is unavailable, it can be substituted with a bank letter stating the bank account details and signed by a bank manager.
• W-9 form. This is the application form for a federal Tax ID. It can be substituted with the SS-4 form, with which the Tax Id is received.

The following paperwork may be required of applicants that are categorized as higher risk:

• Business financial statements. Typically required for the preceding two fiscal years.
• Personal financial statements. Also typically required for the two latest years.
• Processing statements. Required of merchants with previous processing experience, typically for the latest three or six months. Most processors will not consider applications from certain high-risk business types if they lack processing experience.

As you can see, these are all documents that should not be difficult to produce. If the processor receives everything it needs at once, there should be no delay, so just double check your paperwork before faxing or emailing it.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

We have clearly (I think) indicated on our website that we can only provide credit card processing services to U.S.-based businesses. Yet, we keep getting inundated with inquiries from India, the U.K., Malaysia, Indonesia, the Netherlands, Romania, Vietnam and many other countries.

The reason we can’t work with foreign businesses is not that we don’t want to, we do, but that industry regulations only allow us to do so under certain very strict conditions. We have written on this topic before, but evidently we haven’t done a good job of it. So let me try and do it again in this post.

Requirements for Setting up a U.S. Merchant Account

In order for a merchant account application to be even reviewed, the following three conditions must be met:

• The applicant business must be either incorporated in the U.S. or registered with a “Doing Business As” (DBA) name in a U.S. city or town. Individuals cannot apply.
• The applicant business must have a physical U.S. address.
• The applicant must have an active account with a U.S. bank.

These are the three minimum requirements and there is no exception to the rule. The point is that, although the business owner does not have to be a U.S. citizen or permanent resident, the business itself must be a U.S. legal entity.

What Should a Foreign Business Do?

Full disclosure, I am not at all familiar with the local credit card processing rules in Europe, India or anywhere else outside of the U.S., so I can’t make any comments on whether or not the setting up of a merchant account in the U.S. is worth the trouble for foreign businesses.

Additionally, I will not discuss the various third-party options for accepting payments. You can contract with a U.S. company to process your transactions through their own merchant account or to run your entire sales process, including taking orders, shipping merchandise, providing customer service, etc. Such alternatives will no doubt work well for some businesses, but this is an entirely different type of service.

If a foreign business does decide to set up a dedicated merchant account in the U.S., it will need to be prepared to make a certain investment to achieve and maintain compliance with the above requirements.

There are many companies that can help you set up a business in a state like Nevada or Delaware and you can easily find them. You will need to have a registered agent in the state of incorporation and the company you hire can help you with that, as well as with the setting up of a bank account.

Once you have done all that, you can proceed with the application process.

The Takeaway: Dedicated Merchant Accounts Are not for All Foreign Businesses

The bottom line is that, unless you have already built a customer base in the U.S., a merchant account is probably not for you. A better option would be to use a third-party service until your credit card volumes grow to a level that justifies the switch to a dedicated service.

Additionally, if you operate a high-risk business, a third-party option will probably be the only one available to you. That is to say that, if you run an online pharmacy or something like that, don’t waste your time trying to set up a merchant account in the U.S., as you won’t get it.

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• One rate for all types of MasterCard and Visa cards (including rewards, commercial, etc.).
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• No merchant account application or set-up fees.

Merchants are often surprised by the length of the list of documents required when applying for a merchant account – the generic name of the service that enables businesses and non-profits to accept credit cards and other forms of electronic payments. What I have found out from talking to hundreds of first-time applicants over the years is that they often don’t understand exactly what it is they apply for and, more importantly, how the service is viewed by the processing banks that provide it. So let me explain what a merchant account really is and why processors can be so fussy about application details.

What Is a Merchant Account?

As far as a processing bank is concerned, and beyond the technical aspect of the service, merchant account is a line of credit that the processor extends to a merchant. So when the merchant accepts a card payment, the processor “acquires” it by automatically depositing the payment amount, after first subtracting the processing fees listed in the merchant agreement, into the merchant’s bank account.

Simultaneously with acquiring the transaction, the processor files a payment request with the customer’s card issuing bank. Here is the first important detail you need to understand: the processor gets paid only after it pays the merchant. What this means is that, if for a legitimate reason (fraud, processing error, etc.) the issuer refuses to fund the transaction amount, the processor stands to lose the transaction amount.

To further complicate matters, an issuer has as long as six months of the transaction date to dispute the validity of a payment. If the dispute is valid, the processor must pay back the transaction amount. Of course, the processor can get its money from the merchant, but only if the latter is still in business. You may be surprised how often merchants go out of business, leaving a huge amount of debt resulting from disputed transactions behind them.

The application process is designed to establish the credit worthiness of both the applicant business and its owners and minimize the processor’s potential liability.

How Processors Manage Risk in the Merchant Account Application Process

In addition to the regular paperwork, including application form, incorporation documents, any applicable business permits and licenses, voided check for the applicant’s bank account, etc., the processor may request some additional paperwork to help estimate the risk. Such documents may include the following:

• Business financials. Typically required are financial statements, including profit and loss statements, for the two years preceding the application date.
• Tax returns for the principal owners. Similarly to the above item, two years worth of tax returns are sufficient.
• Processing statements. Merchants currently accepting card payments with another processor are typically required to produce their processing statements for the latest three to six months.

Additionally, the processor will perform the following actions:

• Credit checks and background investigations of the applicant business. If the credit check raises questions, the processor may also do a credit check of the business’ principals.
• Inspection of the business’ physical location. The goal is to verify the applicant’s physical address and to ensure that the business is capable of supporting its operations, as described in the merchant application.
• Check the MATCH file. Processors will reject an application from any business listed on the MATCH file (also known as Terminated Merchant File).

The bottom line is that a processor will do everything it can to ensure that a merchant account applicant is a legitimate business, one that manages its finances in a responsible manner and that has the resources to support its operations. If the business cannot demonstrate that, the application will be rejected.

Accept credit cards at one flat rate!

Accept credit cards with our flat rate e-commerce merchant account with no fixed monthly fees! You will get:

• One rate for all types of MasterCard and Visa cards (including rewards, commercial, etc.).
• No mid-qualified and non-qualified fees.
• No merchant account application or set-up fees.

Processors go into great lengths to ensure that each merchant account they underwrite is used according to the terms and conditions set out in their processing agreements. Before setting up the account, the processing bank will closely scrutinize the financial situation of both the applicant business and its principals. The evaluation process includes examining the owner’s credit report and the business’s operations, premises and previous processing history (if available), to help establish the applicant’s credit worthiness. If they are not entirely satisfied by what they’ve seen there, the processor’s credit managers may request additional documentation, such as the owner’s tax returns and the business’s financial statements.

Once the merchant account is approved and set up, the processor will monitor its activity to ensure it is used as agreed. If they see something suspicious, the processor’s risk managers will contact the merchant and request a clarification. For example, if the merchant has stated in its application that the average transaction amount would be $150 and then starts accepting payments averaging $500, that would raise a red flag. Similarly, if the approved annual processing volume is reached in a couple of months, an explanation will be requested. However, if the merchant responds promptly to its processor’s request and provides the necessary documentation, the issue will probably be resolved quickly.

There are circumstances, however, that can result in the suspension of a merchant account. There are three main reasons why this can happen:

• Fraud. The first and most obvious reason that will automatically lead to a suspension is fraud committed by the merchant. Fraud can take many shapes and forms. Misusing personal information like credit card numbers and details, overcharging, not delivering products and services as advertised are just a few examples.
• Excessive chargebacks. Another reason your processor may shut down your merchant account is a consistently high level of chargebacks. Chargeback is a transaction that is returned to the merchant as a financial liability. It is generated when a cardholder disputes a transaction or when the merchant does not follow proper card acceptance procedures. In essence, it reverses a sale. The importance of keeping chargebacks under control cannot be overstated. Both Visa and MasterCard require that merchants keep chargebacks below one percent of the total number of transactions they process. In reality, your processor will suspend your merchant account long before you reach one percent, to avoid being fined by the Associations (Visa and MasterCard).
• Multiple merchant accounts. Processors typically will not allow you to have another active merchant account while you are using the one they have underwritten. Some will close an account if they find out that you have opened one with a competitor.

It should be emphasized that fraud and excessive chargebacks are a huge problem in the payment card industry and processors are required to closely monitor their merchants for signs of unusual activity. Most of the time, such activities are completely legitimate and it is easy to prove it. It is important that merchants respond promptly to all information requests and cooperate with their processors. Keep in mind that your processor does not want to suspend your merchant account. The only way they can make money is to have you as a customer. Work with them whenever they reach out to you and help resolve the issues before they deteriorate to the point where the processor is forced to take an action you might not like.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).