A merchant account is a financial agreement between you and the bank that issued your merchant account, which allows you to process credit cards for your business. In the same way that banks will establish rules for, say, a common checking account, there are several requirements for merchant accounts. The most important reason for these requirements is to help both parties avoid risk. There are three types of risks associated with merchant accounts.
The first kind of risk is credit risk. This is the risk that the bank must endure with respect to the amount of money that a merchant may owe the bank. It is not the most important factor when it comes to accepting a merchant account application, especially for new businesses with small monthly credit card transaction volumes. Fraud and contingent liability risks are more significant. Merchant accounts are regularly issued to people who have no credit or little credit histories. In fact, it is also not unusual for a bank to decline the leasing application for equipment because of poor credit but grant a merchant account.
As a merchant, your credit rating becomes more significant the longer that you have been in business, especially as monthly charge volumes grows. Unless a business builds a good credit rating, only a small number merchants can succeed and stay in business over a couple of years.
The second kind of risk is fraud risk. This is a risk that takes place when a merchant unintentionally processes credit card transactions that have not been authorized by the credit cardholder. Credit card fraud typically occurs as the result of stolen credit cards or stolen credit card numbers along with crucial cardholder information. Of course, as virtually all merchants are susceptible to credit card fraud through their website online, new merchants that have an online arm are at great risk since they are not as familiar with the many methods of detecting and preventing dubious credit card transactions. In addition, some types of businesses and certain products are subject to higher fraud risk.
The third type of risk that merchants face – contingent liability – is the most significant type that they run against when they maintain a merchant bank account. It includes all the risks associated with fraud risk, however, plus all the unforeseeable risks connected to the many varieties of businesses and marketing methods.
One type of contingent liability is the kind in which the sale a merchant makes is for an item that is delivered at a much later time than the sales transaction, such as some travel industry transactions. Another is if the item itself is intangible, such as a video download service. In general, the more fleeting the service, the greater the overall risk of the sales transaction. The major risks that are associated with this type of service are because it is truly difficult or in many cases impossible for the merchant to provide proof of actual delivery.
In the case of contingent liability, it may be a good idea to take a look at a true example. In the 1990′s, a startup company offered a lifetime online professional trade “magazine” subscription for a single flat fee. Many subscribers used their credit card to pay the fee to take advantage of this offer. A few years later, this same company stopped doing business because this marketing model simply was costly and not viable. Since the company could not fulfill its lifetime account promise, subscribers demanded, and were truly entitled to, a refund of their fee.
What happened here is a prime example of contingent liability. The liability, of course, was the increasing amount of all potential refunds. Payment of these refunds was contingent on the company remaining in business and offering the service for the lifetime of the customer. Lifetime services or products represent a truly difficult scenario when it comes to contingent liability. The liability increases significantly with each new sale. If you offer a lifetime service for a flat fee, do not expect to receive a merchant account.
When a merchant provides a service or product for a specific series of future dates, contingent liability will be a factor any time that a payment is made for that service or product. Of course when something is provided right away to a customer for a discreet payment this liability does not exist. If there is too long a period of delay between product payment and ultimate delivery, merchant services providers will rarely – if ever – issue a merchant account to a merchant doing such a liability-laden business.