Opening up a business without the ability to process credit card payments is a non-starter in almost any industry. Unfortunately, securing a merchant account from a reputable payment processor is often difficult for certain types of businesses. Many of them end up having to deal with burdensome merchant account reserves that cut into their revenue and limit their financial flexibility.
What is a Merchant Account Reserve?
In order to understand how a merchant account reserve works, it’s helpful to review how payment processing works. When a customer pays for something by credit card, your payment processor issues your business a credit from the accepted translation. This amount is typically deposited within a few business days, but that isn’t necessarily the end of the transaction. That’s because customers can potentially dispute the translation and file a chargeback claim to receive a refund. Once a chargeback claim is investigated and found to have merit, the funds must be returned to the customer.
But who covers those funds? While that responsibility technically falls to you as the merchant, the long delay between the initial payment and the chargeback claim often means that whatever funds you collected are no longer available. That puts the payment processor in a difficult position. In most instances, the merchant account provider will issue an immediate refund to the customer to avoid any liability, but they don’t want to issue a credit and then be stuck having to reclaim the amount from the merchant.
Merchant account reserves bypass this problem by creating a cash reserve that the processor can use to cover the cost of chargebacks. In effect, they function like an Escrow fund or money down on a bank loan. These reserves protect the payment processor from risk by shifting anticipated costs onto merchants.
Account Reserves for High-Risk Businesses
Processors typically require some form of merchant account reserve for any high-risk business account. The label of “high-risk merchant” can actually apply to a very broad range of businesses, many of which may not strike the average person as “risky” in the traditional sense. That’s because when banks and processors assess risk, they’re looking at the likelihood of either liability or the inability to recover credited funds.
There are a few key characteristics that might get a merchant labeled as a high-risk business:
- You process a lot of online transactions (high fraud risk).
- You sell products or services that could be considered dangerous or highly regulated (such as firearms, tobacco, or adult products).
- Your average transaction amounts are high (high chargeback risk).
- You have a high volume of transactions each month (increased fraud risk).
- Your industry is historically known to have high chargeback ratios (such as travel, telemarketing, or dating services).
How Merchant Account Reserves Affect Your Business
If your business has been labeled as high risk by a bank or processor, you will most likely be required to carry a reserve as part of your high-risk merchant account. Merchant account reserves can significantly increase your payment processing costs, especially if you’re already paying a processing fee on top of every transaction. For both new and established businesses, merchant account reserves can be very restrictive financially.
Payment processors use a few different methods to secure merchant account reserve funds from their high-risk customers. Three of the most common reserve types include:
Probably the most common type of merchant account reserve, rolling reserves hold back a percentage from each credit card deposit for a period of between six to twelve months. This ensures that the chargeback window will have long since passed by the time the funds are released and that there will be sufficient funds to cover any refunds in the meantime. These reserve amounts (typically between 5-10% of each transaction) are released on a rolling basis once the allotted time passes. Since there is no upper limit on the amount of money held in reserve, this method effectively scales with your business. The higher your sales, the higher your reserve. Unfortunately, it also means that a significant portion of your revenue is being tied up long beyond the transaction, which could distort your revenue figures if you’re not careful.
A more straightforward approach to merchant account reserves, capped methods work in a similar fashion by withholding a percentage of each transaction. However, once a predetermined account reserve amount is reached, no additional funds are withheld unless the reserve is depleted by a chargeback. Fixed amounts vary, but are typically some percentage of the merchant’s monthly processing volume (up to and including the full volume in some cases). The reserve funds are held by the processor for as long as the account remains active. This method is often accompanied by monthly processing restrictions. Since reserve payments could theoretically stop and start frequently, capped reserve systems can make it difficult to accurately assess revenue over time.
Commonly used for newer merchants with very limited credit or earnings history, an up-front reserve is based on the merchant’s expected monthly processing volume and must be paid at the beginning of the processing agreement. The reserve funds can be deposited by transferring them from another account, with a letter of credit from a bank, or by withholding 100% of transactions until the reserve has been met. This type of merchant account reserve obviously puts a significant burden on the merchant at a time when they may be extremely vulnerable from a cashflow standpoint.
Breaking Free with Transcend Pay
At Transcend Pay, we believe there are better ways of mitigating risk than by imposing onerous merchant account reserves on our customers. That’s why we provide high-risk merchant accounts for credit card processing without any reserve requirements. How do we do it? By leveraging our network of banking relationships to better distribute risk.
Whether you’re implementing our standalone merchant portal solution, integrating your existing system with our robust API, or installing our innovative Tpay platform directly on your website, Transcend Pay has the merchant account solutions that help your high-risk business get paid faster without compromising your flexibility or revenue. Talk to one of our payment processing experts to get started!