The risk surrounding credit card processing is complex and nuanced. There are a number of variables that determine merchant risk. Here are just a few:

-The merchant's longevity and financial stability

-Industry, business model, billing method, products sold / services offered

-Previous processing history

The fundamental underwriting and risk management guidelines are very similar across the industry. Let's start with the fundamental reason why there is risk.

 

A Merchant Account is a Line of Credit

Merchants typically collect payment in advance of providing the product or service as well as providing some sort of quality assurance (e.g. will be delivered, can be returned, satisfaction guarantee, etc.). Therefore, the risk born by a provider is akin to providing a line of credit. If a merchant sells something that they can't deliver, don't deliver, partially deliver, deliver poorly, or that is defective in some way, and the business can't remedy the situation with their own financial resources, the merchant account provider is on the hook for all the chargebacks and losses. In addition, fraud from stolen credit cards is another large source of chargebacks and a merchant can easily fall prey to orders from fraudsters looking for free merchandise using someone else's credit card.

 

Risk Variables

Any merchant account provider underwriting a business will look at a few key areas, including:

 

1. Company longevity and financial stability

Underwriters will consider how long a merchant has been in business, their financial state, and profitability. Here are a few variables that elevate risk: being new, expecting large volumes with minimal financial resources (e.g. requesting to process $1,000,000 in credit card volume with only $10,000 in the bank), being unprofitable, having a high debt to equity ratio, a high burn rate and a high percentage of deferred revenue. None of these variables necessarily prohibit a business from getting a merchant account, they just elevate risk and therefore may limit processing ability.

Another factor underwriters look at in conjunction with the company information is the business principals' credit worthiness. Because of the similarity in risk to a line of credit, providers will generally request a personal guaranty (especially if the business is less than 2 years old) from the business owner to try and prevent bad behavior. This can be waived if financials are provided and determined adequate to mitigate the risk.

 

2. Industry

Some industries present more risk than others. The industry risk profiles are well grounded in decades of processing history by millions of merchants.  For example, restaurants, one of the lowest risk merchant categories, may have an industry average loss ratio of less than 1 basis point (100 basis points is equal to 1%). That means for a group of restaurants processing $1,000,000, the merchant account provider can expect losses of less than $100. Conversely, for the travel industry, the average loss ratio may be 10x higher. Here are some example business types by risk category :

(Note: payments taken on a website, over the phone, or through the mail or fax present much higher risk than in-person payments where the person is present and the card is swiped. Accepting tuition in person, then, is considered medium risk; if a merchant accepts tuition online, the risk is higher.)
        Low Risk - restaurants and most retailers (excluding apparel and jewelry), nationally recognized insurance sales
        Medium Risk - health and beauty products, telecommunication services, tuition for schools or universities, attorneys (excluding bankruptcy), utility payments, political organizations
        High Risk - money making products/services, charities, monthly memberships/subscription services, insurance, jewelry, software, advertising services
        Very difficult to underwrite - aggregation, online auctions, event ticket brokers, internet pharmacies, travel/tour/lodging, health/nutrition products offering guaranteed or miracle results.
        Typically prohibited by most providers - collection agencies, credit repair, firearms or weapons, bartering, bankruptcy, lifetime or multi-year memberships

    Aggregation: selling a product or service that a merchant does not own. This is one of the highest risk business models for credit card payments.

   

3. Billing Method

How a merchant accepts payment can increase or decrease the risk of their business. Accepting payments in advance increases risk; the farther in advance payment is accepted, the higher the risk. If a merchant sells annual subscriptions, for example, and then goes out of business during month 5, there's 7 months of financial liability for the merchant account provider. The same applies to merchants who sell a product that is guaranteed for a year, or a service that is available for a year. Therefore, merchant account providers will want to ensure the merchant's financial strength and previous processing history in order to approve this billing method.

On the other hand, accepting payments after the service has been provided can greatly reduce the risk on an account. A good example of this is a merchant that bills for their monthly service at month's end.

 Some merchants, such as advertisers, accept payment on retainer. This allows customers to put money into an account with the merchant, who gradually deducts their fees from that account as their services are provided. Since there is no expiration date on when that money may be used, the risk is similar to annual billing.

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