What makes a merchant high risk - Heartland mobile terminal

What makes a merchant high risk?

Monday, December 08, 2014

In today’s landscape, small business owners like you have to accept payment cards to be successful. And in order to do that, you need a merchant account – whether through a traditional financial institution or a third party payment processor. But, if your business poses a high risk to merchant service providers, what do you do next? In this article, we’ll take a look at merchant accounts, how businesses become high risk, and what to do if you find your business in this position. To start, let’s talk about merchant accounts and why they’re important.

What is a merchant account?

First, let’s talk about merchant accounts. Merchant accounts allow businesses to accept multiple forms of payment at checkout, including credit or debit card transactions, Automated Clearing House (ACH) transactions, mobile payments, and online payments. Businesses can work with a bank or another financial institution to set up a merchant account themselves, or they can work with a payment processor to utilize the payment processor’s merchant account.

Typically, more newly-established businesses will lean toward working with a third party payment processor because of the strict underwriting requirements banks have. Either way, your business needs a merchant account to accept payments at your business. Without a merchant account, businesses like yours can’t accept payments besides cash. 

During a transaction, the acquiring bank or the payment processor receives funds for the transaction and then moves them to your merchant account. Once funds from a transaction are placed into a merchant account, the transaction is complete. After the transaction completes, the funds are then transferred into your business’s bank account. Merchant accounts essentially serve as a holding account to protect banks and payment processors so they don’t get burned by fraud or chargebacks.

Now that you know more about merchant accounts, let’s take a closer look at the difference between high-risk and low-risk merchants.

High-risk vs. low-risk merchants

When your small business applies for a merchant account, either through an acquiring bank or through a third party payment processor, they’ll evaluate your business to determine if it could be a financial or regulatory liability. Acquirers and payment processors are very good at mitigating risk, which is why they’ll classify your business as either high risk or low risk. The liability your business presents is a combination of factors, and could include the industry in which your business operates or the general consumers you deal with.

Because it’s easier to discuss the characteristics of a high risk business first, let’s talk about high-risk merchants.

High-risk merchants

Put simply, high-risk merchants are those who pose a risk to the acquiring bank or payment processor. Calculating risk is difficult, and as you might expect, it’s the product of multiple factors. Since each merchant services provider is different, the following list contains some of the biggest factors acquirers and payment processors use to determine your liability:

  • A new business with no prior processing history.Erratic or high average monthly sales volume – usually over $20,000. 
  • Erratic or high average ticket amount – usually over $500.
  • Erratic or bad credit score (business or personal credit).
  • Card-not-present sales – ecommerce, mail, or telephone orders.
  • Recurring sales or subscriptions.
  • Located in a high risk country.
  • Placement on the MATCH list – a database of merchants who’ve had payment processing privileges revoked.
  • Fraud or bankruptcy history.
  • High return or refund history.
  • High chargeback activity – from either the business or the industry.
  • A new or unique industry.
  • A highly regulated industry where there is a greater probability of regulatory oversight. 
  • A limited regulation industry with common consumer complaints.
  • A higher likelihood of customer dissatisfaction or fraud based on the product or service.
  • Products or services that may be illegal in some states or areas.
  • Reputational risk that the bank doesn’t want to deal with.

Again, these factors are not a complete list and each merchant services provider will weigh your risk differently. 

There are some industries that payment processors and acquirers almost always consider high risk. This is because these types of businesses tend to show a high rate of chargebacks and are more prone to fraud. These industries typically include the following: 

  • Casinos, gambling, or gaming
  • Telemarketing, calling cards, VoIP
  • Pharmaceuticals, nutraceuticals, online drug providers
  • Cigarette, e-cigarette, CBD, or vape shops
  • Adult entertainment, dating services
  • Travel, accommodations, ticketing agents
  • Attorneys, bail bonding services
  • Subscription services (magazines, collectibles, etc.)
  • Credit repair/debt reduction counseling
  • Pawn shops
  • Fantasy sports websites

If your business operates within one of these industries, you’ll want to consult with your merchant services provider to determine if you’re in the high-risk merchant category because of your industry. Now let’s take a look at low-risk merchants.

Low-risk merchants

A business that doesn't pose any risk or threat to the acquiring bank or payment processor is considered a low-risk merchant. These businesses tend to be more stable, in lower risk industries, process a lower volume of transactions, and have lower average ticket amounts per transaction. They also typically have a much lower chargeback ratio than their higher risk counterparts. It’s important to note that these categories are not set in stone. As your business grows or fluctuates, so does your risk level. Just because your business is currently a low-risk merchant does not guarantee that it will be so in the future. 

Now that we’ve defined the different types of merchants, let’s take a look at what you can expect if the merchant services provider finds you to be high-risk.

High-risk merchant accounts: what you need to know

If the acquiring bank or payment processor deems your business to be high risk, there are two likely outcomes – the acquirer or payment processor will refuse your request for a merchant account or they’ll offer your business a high-risk account. If you continue with the high-risk account, you can expect to pay higher rates than low-risk merchants – including higher debit and credit card processing fees. Again, this is due to the bank or payment processor’s determination that your business poses a liability to them. Keep in mind that these rates do vary by high-risk merchant services providers. Here’s a sample of the extra fees and charges that you can expect to pay:

  • Longer contracts – The acquirer or processor will most likely require longer contracts at a certain rate, even if you lower your risk over time.
  • Chargeback fees – As a high-risk merchant, you can expect to pay higher chargeback fees than low-risk merchants.
  • Early termination fee – If you decide to get out of the contract early, you’ll likely have to pay an early termination fee. This fee varies by terms you negotiate with your payment provider or acquiring bank.
  • Liquidated damages clause – On top of the early termination fee, you could also face liquidated damages which is an additional amount you’ll have to pay based on your average credit card transactions times the number of months remaining in the contract.
  • Reserves – Some merchant service providers keep a portion of your charges to protect themselves from the risk of chargebacks and fraud. There are a few different types of reserves: 
  • Account freezes or terminations – If your business becomes even riskier, the merchant services provider may freeze or terminate your account. This is most common with payment processors who utilize a single merchant account for all of their clients’ transactions, so your risk affects their ability to service other businesses.

While it may seem like doom and gloom for high-risk merchants, there are a few positives for them. Some of the high-risk industries represent high-earning potential. So your small business may accept the risk because of this. Another advantage of high-risk merchant accounts is that you’ll most likely have limited chargeback penalties. Again, this is because excessive chargebacks is one of the reasons many businesses find themselves in the high-risk category. So even if you do process more chargebacks, your business has protections against a suspended account. Another advantage is that you’ll be able to process recurring payments or subscriptions if your business relies on them. You’ll also be able to sell internationally, opening up more potential markets for your business. Lastly, your business will be able to offer bigger ticket items and services. Now that you know the structure of high-merchant accounts, what happens when your business is categorized as one? Let’s take a look.

You’re a high-risk merchant: now what?

Based on the factors we’ve discussed in this article, let’s say an acquiring bank or payment processor categorizes your business as a high-risk merchant. Once this happens, you’ll want to begin the search for a payment processing partner who deals with high-risk merchants. As you begin the process, here are a few things your business should do to help your cause:

  • Do you research: There are a lot of illegitimate payment processors out there, and you should take your time to look for a trustworthy merchant services provider.
  • Read the contract: Contracts for high-risk merchants can be very specific and contain clauses and fees that low-risk merchants won’t have to deal with. It’s important to thoroughly understand the contract your business is signing before putting ink to paper.
  • Your business’s needs: When evaluating a payment gateway or processing solution, you’ll want to review the pricing structure and the possible integration with your current POS or ecommerce site.
  • Build your credit: As we’ve seen, low credit history is not favorable for your business. Therefore, you should take steps to increase your credit score to help increase your prospects to a potential payment processor.
  • Work to lower chargebacks: Because one of the biggest factors for high-risk merchants is the number of chargebacks, your business will want to work to lower chargebacks. There are a number of ways to do this, including shipping on time, having a clear return policy, and providing great customer support.

In this article, we’ve taken a look at the difference between high-risk and low-risk merchants. You’ve seen how merchant service providers categorize small businesses and what to do if your business is high risk. While being a high-risk merchant does come with higher fees, it’s still possible to find a payment processing partner who can help your business.

Looking for a partner who can help you understand your payment risks?

Heartland is the point of sale, payments and payroll solution of choice for entrepreneurs that need human-centered technology to sell more, keep customers coming back and spend less time in the back office. Nearly 1,000,000 businesses trust us to guide them through market changes and technology challenges, so they can stay competitive and focus on building remarkable businesses instead of managing the daily grind. Learn more at heartland.us.