Stripe vs Traditional Merchant Accounts

Services like PayPal, Stripe, and Square are collectively known as Payment Facilitators (“PayFacs”).  They may also be referred to as “Payment Aggregators” (an older term that defines the same model).  Very simply put, they work like this:  Instead of issuing a single Merchant Account to a single business (as in our Traditional scenario), these services have one Merchant Account that they let millions of customers use.

There are benefits to this way of doing business.  You can set yourself up to accept payments very quickly, and start getting paid shortly after you create your account.  In addition, there are no contracts and also no monthly fees.  

There’s a price to pay for this convenience, though.  Amongst others, that comes out in the form of the higher fees that these services charge.  

Another piece of the price you’ll pay when using these services is that they don’t know anything about you or your business.  They don’t know who you are, what your credit is like, what your criminal background is (have you been charged with financial fraud?), what kind of business you have, what products or services you provide, how you deliver your offering, or even IF you deliver on time.  

More importantly, Visa/MC regulations give credit card customers the ability to dispute any sale for up to 6 months after final delivery.  Can you give a 100% guarantee that your business will be around in the next 6 months?  If it’s not, then the merchant account provider won’t be able to get the customer’s money from your account, and they’ll have to pay the dispute themselves.  Perhaps needless to say, that isn’t going to make them happy.

Since they don’t know what’s “normal” for your business, and since their operations are run by algorithms, they only have one recourse if anything goes wrong.  And that’s to freeze or close the account. 

Payment Aggregators are great when your business is new, you’re still working on “proof of concept,” or if your sales are under $10k/month.  That said, aggregators like PayPal and Stripe are not intended to be a long term, scalable solution for accepting payments.

Payment Aggregators have a one-to-many business structure.  One account services many businesses.  For the aggregator, this is a benefit because the risk they take on servicing your account is balanced against all their other customers.  In essence, they’re counting on the fact that most people are honest and decent.  When they find the bad apples, they have only a few courses of action: they can eliminate your ability to accept payments, start holding your money. 

Traditional Merchant Accounts use a one-to-one business structure.  Since the company isn’t balancing you against millions of others, they’ll want to collect lots of details about you and how your business works, in a process known as underwriting.

In underwriting, a merchant account provider looks at the business owner’s personal history, personal credit, business history, and their business model.  They get to know your business and how it works, so the likelihood of them freezing or closing your account is much smaller.  If something unusual happens, like a spike in sales volume or increase in refund requests, they have other options to mitigate risk.

BUT — and this is a big “but” — you have to choose the right merchant account provider.

There are lots of these providers out there.  But only around 1% of them are “high risk” providers that do effective underwriting.  The majority of the rest are “low risk” providers who are simply using words to drum up more business.  Many of the low risk providers handle accounts a lot like PayPal and Stripe do.  They approve accounts quickly, and close them just as quickly.  This is a result of poor or no underwriting.

If your sales volume is even moderately high (over $10k/month), it’s a good idea to use a Traditional Merchant Account.  It will work better for you, and you’ll save a small fortune in fees as well.  

And if you fall anywhere on the “high risk” side of things, it’s also a good idea to use a TMA.

What does “high risk” mean in this case?  For credit card companies, risk is a spectrum.  One example of a “low risk” business would be a coffee shop.  Even if your drink is terrible, the chance you’ll call your company to dispute a $7 transaction is pretty low.  On the other hand, these companies view “higher risk” as having any of the following criteria:

• Card not present (most of ecommerce is run without a user’s card having to be present)
• Recurring billing (any continuity)
• If your product or service is impacted by the weather (as with airlines)
• If you deal with any regulated merchandise like alcohol, tobacco, or firearms
• If you promise to “deliver in the future,” as this needlessly expands the chargeback window
• If you sell anything with “subjective quality,” as in most information sales
• Any transaction over $1000
• If you offer any kind of free trial
• If you offer extreme guarantees