Inside the Black Hole

Often, when we receive a merchant account application, the applicant leaves the field for the “annual credit card volume” and “average credit card ticket” blank. Typically, the omission is made by an applicant with no previous processing history, but it is not rare that an experienced merchant fails to provide its processing volumes or average ticket. But why is this field included in the application in the first place and what should you answer if your business is new and you have no idea how much revenue it will bring in the first week, never mind the first year?

In order to answer this question, we will first have to look at the application process through the eyes of the underwriter, i.e. the processing bank. From your processor’s perspective, you are applying for a line of credit. This is often difficult for merchants to understand, because, from their stand point, a merchant account has nothing to do with extending any credit. Well, this is not exactly so, even though it is true that typically the processing bank gets paid before it pays the merchant (after subtracting its processing fee from the transaction amount). The problem processors are faced with is that fraudulent and other invalid transactions can be charged back, i.e. reversed, up to 180 days after the transaction date. If it is still operating, the merchant will bear the liability for these transactions. However, if the merchant has closed down shop or if its merchant account has been terminated (which can happen for any number of reasons), the processor will bear the liabilities.

One of the processor’s major objectives when evaluating a merchant account application is to estimate its own potential liability and to do that, a key piece of data each credit manager relies on is the merchant’s expected annual credit card volume. After all, the processor’s liability cannot exceed the total amount processed by the merchant.

It should be emphasized here that, provided you keep your merchant account in good standing, you will be allowed to accept credit card payments, even if you exceed your stated annual processing volume. Issues are certain to arise, however, if your track record is less than perfect, in which case your account may be frozen.

Moreover, all underwriters set an annual volume threshold, which varies by processor, but is typically around $450,000. All applications that list processing volumes above the threshold are automatically subjected to a more rigorous examination and applicants may be required to provide additional supporting documentation.

Of course, there are other risk factors that come into play and they are taken into account as well. For example, some industries are typically prone to higher levels of chargebacks. Prime examples are adult-oriented websites, third party collection agencies, used car dealerships, etc.

Certain factors, however, go across industry lines and the average sale’s amount is among the more important ones. The reason is that the bigger the average sale’s ticket, the bigger the potential chargeback or fraud liability. Even if sales take place in a face-to-face environment and the potential for fraud is minimal, consumers are much more likely to have a change of heart and dispute a $1,500 purchase than a $10 one.

Now that you understand what your prospective processor’s priorities are when evaluating a merchant account application, what should you enter in those two fields? First and foremost, you should try to be as accurate as possible. If you have been in business for some time and are looking to switch processors, this should not be an issue. For new merchants, unless you are absolutely certain that your sales will exceed the annual volume threshold mentioned above, provide a figure that is below $450,000. As the year progresses, you can request an update, if necessary.

Regarding your average credit card ticket, you should provide a figure at the higher end of the expected range. For example, if your sales will range from $50 to $500, enter $450. Your processor will not mind seeing sales in lower amounts than the stated one, but higher-amount sales will be raising red flags, especially if processed on a consistent basis. The reason again has to do with fraud and liability. A fraudulent transaction is much more likely to be for a large amount than a small one.

With all that in mind, you know your business better than anyone and should be able to provide a fairly good estimate of your expected sales amounts. When in doubt, it is better to state a figure closer to the higher end of your estimates than to the lower one.

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).

Credit history is a determining factor when lenders make a decision on a personal credit application, whether it is for a credit card, personal loan or a mortgage. The information your personal credit file contains tells creditors how creditworthy you are, i.e. how likely you are to repay the loan. But how does a personal credit history affect a merchant account application?

Before we answer this question, let’s first take a look at the list of documents that are required from applicants for merchant accounts. The list may be different for each applicant, depending on the way the business is organized, the type of merchant account that is needed and other factors. Certain items, however, are always required, in order to help payment processing companies to evaluate the credit worthiness of both the business and its principals. Typically, applicants will be required to provide one or more of the following documents:

• Most recent tax returns (business and personal).
• Most recent personal and business financial statements.
• Most recent bank statements.
• Fictitious name statement (for DBAs).
• Partnership Agreement (for Partnerships).
• Articles of Incorporation (for Corporations).
• Dun and Bradstreet or other third party agency report showing the same legal name and address as the applicant along with a description of their location / facilities.
• IRS Confirmation of Non Profit Status – 501(c)(3) status – or other supporting documentation (for Non Profit Organizations).
• Government Entities must submit a Request for Approval of Proposal to do Standardized Government Business on Form “A”.

For new organizations, or if the business is a sole proprietorship, the principals’ tax returns are typically requested as a substitute to the financial statements. Additionally, unless the applicant business is a publicly traded company, the principals are required to provide their social security numbers, so that the processor may pull up their credit files from one of the major credit reporting agencies.

In order to understand why processors go into such great lengths to ensure that their prospective merchants handle credit in a responsible fashion, we need to first understand exactly what a merchant account is, from the processor’s perspective.

As far as merchants are concerned, a merchant account is a service that enables them to accept their customers’ credit card payments and then to have their money deposited into the merchants’ bank accounts, after the processor subtracts the transaction processing fees. At first glance, it looks like the processor is not taking much of a risk. After all, the merchant only gets its money after the processor gets it processing fee. So why are processors so cautious?

From a processor’s standpoint, a merchant account is a form of credit. When merchants accept credit or debit card payments, these payments are authorized by the card issuer and settled by the processor. While the processor does get its transaction fees before the merchant gets its money, the processor is also fully liable for the transaction amount, in case of a fraud or a chargeback. While any fees resulting from fraud and chargebacks are typically passed on to the merchant, if the merchant becomes insolvent or goes out of business, the processor must cover all such expenses. To further complicate matters, transactions can be charged back for up to six months after the transaction date, which leaves plenty of room for unforeseen events to take place. Moreover, in case of a fraud, in addition to the financial responsibility, the processor may also face legal challenges.

Personal credit history is just one of the factors that influence a processor’s decision when reviewing a merchant account application. Typically, it will only be an issue if there are many derogatory items in the credit file, especially if it shows a bankruptcy. For most applicants, however, an average credit score will be sufficient to pass the test.

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).

Businesses operating in certain industries are not allowed to set up U.S.-based merchant accounts. The decision on who exactly should be placed on this “black list” is made by the Credit Card Associations of Visa and MasterCard and is mandatory for all of their member banks. What this means is that no U.S.-based processing bank is allowed to acquire transactions from blacklisted entities. Processors are free to make additions to the list and they take full advantage of their prerogative.

The biggest factor in determining whether a particular type of business should be prohibited from setting up a merchant account with a U.S.-based processor is the chargeback generation potential. Visa and MasterCard historical data show that in some industries the chargeback rate is simply unacceptably high. Both Associations require that member banks monitor their merchants’ chargeback rates on an ongoing basis and calculate the merchant’s chargeback-to-transaction ratio (CTR) for each calendar month. Members are required to file monthly reports with the Associations for their:

• Chargeback-monitored merchants (CMM) – merchants with a CTR in excess of 0.5% and at least 50 chargebacks in a calendar month.
• Excessive chargeback merchants (ECM) – merchants who, in each of two consecutive calendar months, have a minimum CTR of 1 percent and at least 50 chargebacks in each month. If a merchant’s CTR is higher than 1 percent for three consecutive months, the processor is required close the merchant account, although it will probably do that much earlier.

Processors keep a very close eye on their merchants’ chargeback ratios, not least because they get charged a fee for submitting each CMM or ECM report to the Associations, not to mention issuer reimbursement fees and violation assessments for excessive chargebacks.

With that in mind, it is understandable that processors can be very picky with new applicants. Although restrictions vary, typically applications from merchants engaged in the following activities will not be considered for U.S.-based merchant account, regardless of exception:

• Any merchant engaged in Illegal activity.
• Adult oriented products or services (all media types: internet, telephone, printed material etc.).
• Internet / MO/TO pharmacies (where fulfillment of medication is performed with an Internet or telephone consultation, absent a physical visit with a physician).
• Re-importation of pharmaceuticals from foreign countries.
• Internet / MO/TO firearm or weapons sales (including ammunition).
• Internet / MO/TO cigarette tobacco sales.
• Occult materials.
• Online gambling.
• Lotteries, raffles, illegal gambling.
• Escort services.
• Collection agencies engaged in the collection of uncollectible debt, as defined by the Associations.
• Credit repair agencies.
• Sports forecasting or odds making.
• Get rich quick schemes.
• Medical marijuana.
• Foreclosure protection / guarantees.
• Lifetime subscriptions (any product or service).

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).

Industry regulations require processors to ensure that merchant account applicants meet certain qualifications, before processing their paperwork.

All applicants must comply with the following requirements:

• Be legally registered within the U.S. Individuals are not allowed to set up credit card processing services. Foreign organizations are also excluded. Applicants must be either legally incorporated as businesses or they must be registered with the local municipality and obtain a “Doing Business As” (DBA) name.
• Have a physical address within the U.S. Applicants must have a physical office that processors can inspect. Home-based businesses are acceptable.
• Have a U.S. bank account. The bank account into which you will have your funds deposited must be opened with a U.S. bank.

Provided your organization is qualified to apply for a merchant account, there are a number of requirements that will still need to be met and, to understand why the process is so stringent, you need to understand exactly what is it that you are applying for.

Merchant account is a form of line of credit that a processing bank (member of Visa and MasterCard) extends to the merchant. When you accept a card payment, your processor will “acquire” it, usually at the end of the day, together with your other transactions, and will automatically deposit the payment amount, after subtracting the interchange fee and its own processing cost, into your designated checking account. At the same time it will submit a request for payment to your customer’s card issuing bank. Your processing bank will pay you before it gets paid. Moreover, even after the processor gets paid, your customer has six months to dispute the transaction and, if the dispute is valid, the transaction must be reversed (charged back). If you have gone out of business or cannot cover the chargeback amount, your processor is the one who will take the hit. That is the reason why the application process is set up to establish the credit worthiness of both the applicant organization and its principals. Following is a list of requirements that you will have to meet and documents you will have to provide:

• Application form. The application form will collect information about both your business and yourself, including address (business and personal), social security number, Tax ID (if applicable), phone number, email address, web address, bank account info, etc.
• Personal guarantee (for-profit organizations only). A personal guarantee is required from the principals of all privately held businesses. Sole proprietorships often do not require a personal guaranty. Non-profits and public companies are not required to provide a personal guarantee.
• Articles of Incorporation. Unless you are a sole proprietor, you will have to provide a proof that it has been legally incorporated.
• Business license. If your business activity is regulated and requires a license, either a federal or a state one, you will need to provide it.
• Business financial statements. Unless your organization has been formed recently, you will have to provide its financial statements (typically it is required that you produce financial statements for the two years preceding the application date).
• Personal financial statements. Typically requested in place of business financial statements, personal financials may also be requested in addition to them. Personal tax returns for the latest two years are typically sufficient.
• Business and personal credit history. Processing banks will check your business’ Dunn & Bradstreet credit file (if applicable). The businesses’ principals will also have their credit files reviewed.
• Business profile and marketing materials. Merchants are required to provide a description of all products and services they offer, as well as copies of all relevant marketing materials. The product type helps processing banks estimate the business’ risk type. Certain business types of products and services will put the applicant business on the restricted merchant list while others may place it in the prohibited list.
• Processing statements. If you are currently accepting credit cards and are looking for a new service, you will be asked to produce your three latest processing statements.
• Voided check. You will need to provide a voided copy of a check for the bank account into which you will want your money to be deposited. The check must have your “Doing Business As” (DBA) name pre-printed on it. If you have not yet received your permanent checks, you can substitute with a signed bank letter stating your account details.
• Compliance with the Payment Card Industry (PCI) Data Security Standards (DSS). Compliance with the PCI DSS will ensure that customer account information is adequately protected.
• Site inspection. The processor may conduct a site inspection of the applicant business’ offices and warehouses (when applicable). Exceptions to the site inspection requirement typically include:
  • Dentists.
  • Health practitioners.
  • Hospitals.
  • Optometrists.
  • Physicians.
  • Colleges and universities.
  • Publicly held companies.
• Business policies. The merchant’s billing, shipping and return policies will be reviewed to ensure compliance with industry regulations. A representative of the processing bank may also place and then return an order with the merchant, as an additional inspection step.
• Other requirements. In case fulfillment of orders is handled by a third party, information should also be provided about this establishment and a site inspection will be conducted at its premises as well. The Internet Service Provider may also have its physical controls inspected. Other requirements may also need to be met.

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).

In the payment card industry, reserve is a specified percentage of the merchant’s sales deposits that is retained by the processing bank in an escrow account to serve as a protection against future chargeback exposure or to cover existing chargebacks. The reserve’s amount is determined during the merchant account application process and is estimated as a portion of the expected monthly revenue from the applicant merchant’s card transactions.

Reserves are typically imposed on merchants that operate in high-risk industries or have little or no card processing experience. Reserve accounts do not last indefinitely and after the satisfactory completion of a predetermined period – typically six months to a year – the withheld amounts are returned to the merchant. In the case of a rolling reserve, a predetermined amount is held every month for a certain period. On the month following the expiration of this period, the first month’s reserve amount is released to the merchant. The next month the merchant gets the second month’s reserve amount and so on until there is no longer a reserve.

Certain business operations are considered higher risk than others, because historically they have generated higher levels of chargebacks. All merchants that operate in a card-not-present environment fall into this category. Mail order, telephone order and e-commerce merchants are prime examples. Yet, only a small percentage of these businesses will be asked for a reserve, as most merchants within this category do not present a huge chargeback liability. The biggest factor that influences an underwriter’s decision on whether or not a reserve should be required is the level of risk that the applicant merchant’s operations present. Typical high-risk operations display one or more of the following characteristics:

• Selling specific types of products or services, such as adult products, auction houses, companion / escort services, coupons / certificates / prepaid or gift cards, dating services, diet / weight loss programs, membership-based services, etc. If an applicant’s operations fall into one of the above listed category, this could be sufficient for imposing a reserve.
• High average transaction amount.
• High overall processing volume.
• The applicant business has previously had its merchant account terminated.

Underwriters may also impose a reserve on an applicant with bad credit history, in addition to requesting a personal guarantee. When a reserve is required, the minimum reserve amount is typically set at about 20 percent of the anticipated card processing volume. New merchants are usually allowed to build up their reserve by sending in transactions which are not withdrawn until the minimum reserve amount is accrued. After that, the merchant is allowed to withdraw the excess funds for transfer to their designated bank account.

Each processor has its own underwriting policy, so it is a good idea that you request several credit card processing proposals, when looking for a merchant account, and compare the proposed terms. It is likely that one processor will ask for a reserve, while another will not. A reserve requirement, however, is just one of the factors that you should consider when selecting a payment processor for your organization. Processing costs, customer service, transaction reporting capabilities, chargeback and risk management tools, fraud prevention services are all very important and should be carefully evaluated.

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).