What is a Merchant Account? A Guide for Small Business Owners

Gusto Editors

Recent research and data on the use of credit cards, debit cards, and other forms of non-cash payments confirmed what consumers and retailers already know: People like the convenience of paying with plastic and not having to carry large amounts of cash around with them. In fact, TransUnion credit bureau released a report that revealed about half the population in the US (161.6 million people) had access to a credit card in the second quarter of 2022, up from 153.3 million people just a year earlier.

With an average sales transaction of $112 (versus $22 for cash payments), consumers also spend more when paying with plastic (e.g., Visa, Mastercard, Discover, or American Express) instead of using cash. Businesses that do not yet accept a range of payment methods may be losing money to the competition. For your business needs, the time has come to start accepting credit and debit card transactions. This means the first thing you need to do is establish a merchant account.

What is a merchant account? How does a merchant account work?

A merchant account is a type of business bank account that makes it possible for your business to accept credit card payments and other non-cash transactions. The company holding the merchant account acts as a go-between for your company and the customer. Funds from the customer’s credit card swipe go into your merchant account immediately after the merchant services provider confirms with the credit card issuer (aka issuing bank) that the customer has sufficient credit available to cover the transaction.

You do not have to wait for your customer to pay the credit card bill to receive payment for the sale. The credit card issuer assumes the risk of consumers paying their bills on time when approving them for an account. Your company receives a payout from the company holding the merchant account each month after it settles (or deducts) its fees.

Types of merchant accounts

Once you decide to set up a merchant account for your business, you need to determine if your business will swipe or key most transactions. 

Swiped Transactions

Swiped transactions normally take place in person. Your employees either swipe the customer’s card at the cash register or they do it themselves using a customer-facing credit card kiosk. Here are the primary categories of businesses that are most likely to process swiped transactions for customer payments:

  • Hotels and other forms of lodging: These businesses process credit card transactions similar to retail merchants except that they may manually adjust the settlement amount based on additional charges incurred by the customer during their stay.
  • Restaurants: Sit-down restaurants that accept tips on behalf of servers initially receive approval for the ticket total without the tip. However, the tip will appear in the final settlement a few days later.
  • Retail merchants: Employees of brick-and-mortar stores accept credit cards on the sales floor and often have the customer sign a sales receipt if their total exceeds a predetermined amount at checkout.
  • Wireless and mobile: These transactions occur in person using a small credit card reader. A pizza delivery driver or someone who sells goods at a flea market are two examples of who would use wireless and mobile payments with credit cards.

Keyed transactions

Keyed credit card transactions refer to when a merchant takes a customer’s information by phone, fax, or online. Examples of the types of businesses that key credit card transactions include:

  • E-commerce: People purchase items online and make online payments by manually enter their credit card information into a payment gateway system or third-party payment processor. The company offering the payment gateway system handles the payment processing in real-time and transfers funds to the online retailer’s merchant account after receiving approval from the credit card company.
  • Mobile: Merchants with a mobile business can choose whether they want to swipe or manually enter credit card information from their customers. Many choose the manual option since it tends to be less expensive.
  • Telephone and mail order: Employees of these types of businesses take credit card information from customers manually. They either key it into a virtual terminal or enter it into an on-site credit card terminal.

How much do merchant accounts cost?

Most businesses are aware that they must pay a per-transaction fee when accepting credit cards. Merchant account providers charge a flat rate, such as 30 cents, plus a percentage of the sale, such as a three percent processing fee. Along with processing costs and payment card industry fees (i.e., PCI compliance fees), the additional fees associated with setting up and maintaining a merchant account include:

  • Annual fee or monthly fee: Providers charge a set amount to maintain your merchant account that they bill to your company annually or monthly.
  • Batch fee: This is a flat amount assessed against your business account when the credit card processor calculates your company’s total transactions for the day and sends the money to your merchant account.
  • Chargeback fee: Your company must pay this fee if a customer disputes a charge on their credit account and can prove they did not receive the promised product or service.
  • Early termination fee: This fee only applies if you close your merchant account before the end date indicated on your contract.
  • Monthly minimum fee: Merchant account providers may set a minimum that clients must pay in fees each month. The company will round up to reach that fee if your company did not reach it with transactions.
  • Setup fee: You only pay this fee one time to establish your account.
  • Statement fee: You may have to pay this fee if you request to have a statement mailed rather than emailed.

Before picking a payment service based on the pricing structure, processing rate, setup cost, and extra merchant account fees, also consider hardware requirements, monthly sales volume, and must-have and nice-to-have features.

How small businesses can get a merchant account

You will need to take several steps as a small business owner to ensure you are ready to apply for a merchant account. 

Step 1: Establish a business bank account

Your credit card processing company is unlikely to approve an account with funds going into a personal account.

Step 2: Prepare financial statements

Gather financial statements that prove your company’s volume of sales and increased revenue over time.

Step 3: Get your Employer Identification Number

Apply for an Employer Identification Number (EIN) with the Internal Revenue Service (IRS). The process is free, and you can apply online at this IRS webpage. This number identifies your business with the IRS in the same way a social security number identifies you as an individual.

Step 4: Determine if your merchant account service provider requires any licenses

You may need one or more business licenses if your company operates in certain categories. For example, you may need a special occupational license or a sales tax registration license before you can set up a merchant account.

Step 5: Gather additional supporting documents

The merchant account provider you apply to could request to see a copy of your business plan, marketing materials, shipping and returns policy, and other documents in addition to those that prove financial stability. Take the time to locate these documents before you apply to avoid delays with the approval process.

Step 6: Prepare your website if you plan to sell online

If you are applying for a merchant account to sell merchandise or services online, keep in mind that providers typically require clients to meet several criteria before granting approval. You will need detailed product descriptions, customer service contact information, a returns and cancellation policy, and your physical location all displayed prominently on your business website.

Step 7: Submit your application and wait for approval

Fill out the application in full, including uploading or mailing copies of supportive documentation. Be sure to check with the merchant account provider if you don’t receive a response within several days.

Merchant Account FAQs

How long does it take to open a merchant account?

The process typically takes two to five business days. However, the timeline depends on how many applications came in ahead of yours and whether you provided enough information to process the application without delay.

What do I need to open a merchant account?

You should have a business checking account, an Employer Identification Number from the IRS, financial documents showing responsible spending and upward growth, a business plan, and any other documents required by the account processor.

What are merchant account services?

Merchant account services include the hardware and software your company needs to process payments. Your merchant account provider works with you from the point of sale to the settlement of your account and disbursement of funds.

Can I use one merchant account for all forms of payment?

Yes, although opinions vary regarding whether it is better to have one merchant account or multiple accounts for all payment options. You might consider having more than one merchant account if you process a high volume of online transactions or operate in a high-risk industry.

Gusto Editors Gusto Editors, contributing authors on Gusto, provide actionable tips and expert advice on HR and payroll for successful business management.
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