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Merchant Services 101: Everything You Need to Know About Merchant Processing

Maddie Shepherd

Contributing Writer at Fundera
Maddie Shepherd is a former Fundera senior staff writer and current freelance writer. Maddie has an extensive knowledge of business credit cards, accounting tools, and merchant services, but specializes in small business financing advice. Maddie has a bachelor's degree in Spanish and Latin American cultures from Barnard College.
Editorial Note: Fundera exists to help you make better business decisions. That’s why we make sure our editorial integrity isn’t influenced by our own business. The opinions, analyses, reviews, or recommendations in this article are those of our editorial team alone.

As any small business owner will tell you, the way you accept and process payments is a crucial part of your day-to-day operations. And—what makes this process all the more important, is it’s not as simple as taking cash and putting it in a drawer or swiping a credit card through a terminal—the behind-the-scenes processes, often referred to as “merchant services” are what allows you to accept different payment methods, physically take customers’ payments, and finally, actually get paid for these transactions.

But, what are merchant services?

One of the reasons that merchant services are so confusing to business owners and laypeople alike is because this term is used to refer to a variety of financial services and processes that are used by businesses—most typically, to accept and process payments. At one time, the term “merchant services” was only used to refer to the services required to accept credit cards payments, but as payment technology has involved, so has the definition broadened into an umbrella term used in regard to many of the tools, companies, and processes involved with payment processing in businesses.

In this guide, therefore, we’ll break down merchant services 101—explaining how merchant services work, what kind of providers and technology are involved in merchant processing, and finally, how to find the right merchant services for your business.

What Are Merchant Services?

As we’ve mentioned, one of the problems with the term “merchant services,” is that it’s become so broad. A general definition then, could be—the services and technology that a business uses to accept and process payments.

With such a vast definition, however, it makes it difficult for anyone to understand how merchant services work—and for business owners, what they need to know about these services in order to run their business. Therefore, let’s get into the details involved with merchant services and how they relate to small businesses. We’ll break it down like this:

  • How merchant services work: The behind-the-scenes processes that are required for a business to take and accept a payment
  • The tools involved: The technology, including hardware and software that business owners may need to accept and process payments
  • Merchant service providers: The companies who provide these services for business owners
  • Pricing: How does pricing work for merchant services and what the cost might look like for small businesses

How Merchant Services Work

So, how do merchant services work?

Ultimately, the answer to this question will depend on a few factors—how you’re accepting payments, what kind of payments you’re accepting, what provider you’re working with, etc. However, on the whole, there’s a basic process involved.

This process starts when a customer hands you their credit card and ends when the transaction is approved. In this way, the term merchant services doesn’t normally apply to cash payments—after all, you really don’t need any type of “service” to take cash payments.

With this in mind, then, the merchant services process usually involves a card processing terminal and the technology (which comes from a merchant service provider) that will be necessary to run debit or credit card payments through it. So, what is a merchant service provider responsible for when you swipe that credit card? Essentially, the unseen process boils down to this:

  • You swipe a customer’s credit card or enter the information into the terminal
  • The payment processor transmits this data and checks with the customer’s bank before accepting or denying the information
  • If the customer’s bank approves the transaction, then you can accept the payment through your terminal and the purchase will be complete
  • Once the purchase is approved, the payment processor takes their fees (which we’ll discuss later) and deposits the remaining funds into your merchant account (the bank account required to accept credit card payments)

There’s no doubt that this process is complicated, and yet, it happens within seconds when you swipe or input a customer’s card information. Ultimately, this process—handled by a merchant service provider, also often called a payment processor—is a crucial part of what is involved in the term “merchant services.” Without the companies that facilitate this process, or provide this service to merchants, businesses wouldn’t be able to accept credit card payments from their customers.

merchant services

Merchant Services Products

As we mentioned above, much of your merchant processing will depend on how you’re accepting payments, the types of payments you’re accepting, and the provider you’re working with.

Therefore, the next essential part of what makes up “merchant services,” is the different tools involved, in other words, the products that merchant service providers offer to businesses in order for them to actually be able to accept and process payments in a way that works for them and their customers.

Payment Gateways

If your business is accepting online payments, you’ll need to get a payment gateway from a merchant service provider. A payment gateway is a piece of software that works with your website or ecommerce store and allows you to take and process secure credit card payments online.

Essentially, the payment gateway serves in the place of a credit card terminal in the process we described above.

Credit Card Terminals

On the other hand, if you’re accepting in-person payments, at the very least, you’ll need a credit card terminal—that is the physical device that you use to swipe, dip, or tap a credit card. As we explained above, this device will connect to your merchant service provider and will facilitate the process required for you to take, verify, and actually receive a payment.

Credit card terminals come in a variety of shapes and sizes—from simple magstripe swipers to handheld terminals.

Point of Sale Systems

Your credit card terminal may also be part of a larger system, a point of sale system. A point of sale system typically consists of the software and hardware required not only to accept payments, but also to manage a business’s general day-to-day sales and processes.

Most point of sale systems will allow you to accept payments, process sales, run reports, track inventory, manage employees, reconcile tips and commissions, and even accept gift cards and set up loyalty programs.

Because point of sale systems usually encompass everything a business needs to manage their sale and payment processes, “merchant services” and “point of sale” are often used synonymously.

Merchant Cash Advances Are Not Merchant Services

Although you might hear otherwise—mostly from merchant cash advance providers themselves—merchant cash advances shouldn’t really qualify as merchant services. It is true, however, that merchant cash advances and merchant services are inextricably intertwined. In order to get a merchant cash advance, your business will need merchant services.

This being said, however, merchant cash advances being considered within the broad merchant services definition isn’t ideal. Many merchant cash advance providers have begun to cross over into the merchant services industry—and vice versa—and, as a whole, merchant cash advances are one of the most expensive forms of business funding a company can offer. So, if your merchant services provider tries to push a merchant cash advance onto your business, you’ll want to think twice before taking them up on this offer.

merchant services

Merchant Service Providers

Of course, at the heart of the merchant services industry are merchant service providers, the companies that provide all of the financial services that we’ve described thus far, to businesses. In essence, if you’re a small business looking to accept credit card payments, you’ll need to find a payment processing company to work with to provide you with the tools (hardware and software) you need and to facilitate the behind-the-scenes processes.

This being said, generally, merchant service providers are separated into two distinct categories: Merchant account providers and payment service providers.

Merchant Account Providers

Considered the more traditional of the two types of merchant service providers, merchant account providers are unique because, as their name implies, they provide businesses with merchant accounts. As briefly mentioned above, a merchant account is the bank account required to accept credit card payments. When you work with a merchant account provider then, you receive this account through them and they work with you to get your account set up and functioning.

In addition, of course, a merchant account provider also gives you the tools you need to accept payments—whether a POS system, payment gateway, or mobile credit card terminal.

Generally, in comparison to payment service providers, merchant account providers require a longer and more involved application and set up process, but can also offer some of the lowest merchant processing fees. Some examples of merchant account providers include Payment Depot, Payline Data, Fattmerchant, and Dharma Merchant Services.

Payment Service Providers

The major difference between payment service providers and merchant account providers is that payment service providers do not include unique merchant accounts for their customers. Instead, payment service providers aggregate all of the funds from their different clients into a single merchant account and then distribute the funds from this account to each individual business bank account.

Just like a merchant account provider, however, a payment service provider can offer a variety of different tools—POS hardware and software, payment gateways, and more to allow a business to accept and process payments.

On the whole, it is much faster and easier to set up and use a payment service provider and these companies typically have flat-rate, easy to understand fees. This being said, however, because payment service providers combine all of their customers’ funds into one account, they’re also often associated with account instability.

Some of the biggest names within the merchant services and payment technology industry are actually payment service providers—including Stripe, PayPal, and Square.

Pricing for Merchant Processing

Another important part of merchant services for small business owners is, of course, pricing. How much will merchant processing services cost your business? Unfortunately, there is no simple answer to this question—in fact, even after you decide on which provider to work with, the ultimate cost of their services will likely vary.

This being said, the lack of transparency and the inherently complicated nature of merchant services pricing is a common criticism of the industry. In recent years, however, companies like Square and Stripe have tried to stand out against this standard by offering flat-rate pricing that’s easily accessible and explained on their website.

Nevertheless, the ultimate cost of any merchant processing services you use will depend on the company you work with, the type of services you need, and how you use the services. For example, the cost of working with Square to process in-person payments using a register-based point of sale system is going to be inherently different than working with PayPal to accept online-only payments on your online store.

Plus, the overall cost of any merchant processing services will involve not only the tools you need (the POS system or payment gateway, in the examples above), but will also include credit card processing fees. What are credit card processing fees? In essence, these are the fees that a merchant service provider charges to process payments—as we described in our example above—”once the purchase is approved, the payment processor takes their fees.”

These fees, in fact, are distributed among the various players involved in the payment process—the issuing bank, the credit card network, the receiving bank, and the payment processor. Regardless of the type or specific merchant service provider you work with, you’ll be subject to these fees, as well as possible one-time or incidental fees.

Let’s take a look at the most common fee structures you’ll see within merchant processing.

Flat Rate

One of the most common types of fee structure you’ll see on merchant processing services is flat-rate pricing. Typically, a flat-rate pricing model will be a small percentage of the transaction value, plus a small flat fee per transaction. As an example of this, Stripe charges a flat, 2.9% plus $0.30 per transaction for online payments. However, some merchant service providers will simply charge your business the small percentage of the transaction value, without the per-transaction flat fee, i.e. 2.9% per transaction.

With this fee structure, you’ll pay the flat-rate regardless of the type of card your customer uses, but the rate itself may differ based on how you accept a payment. For example, the flat-rate for accepting payments online (typically 2.9% plus $0.30) will usually be higher than the flat-rate for accepting in-person payments.

This being said, as we mentioned earlier, the flat-rate pricing model is often used by payment service providers.

Interchange-Plus

Another typical pricing structure that you’ll come across within the merchant services industry is the interchange-plus model. This pricing structure is a bit less straightforward than flat-rate pricing, but your monthly statement will delineate each charge, what it costs, and why it costs you exactly what it does.

In essence, interchange-plus pricing means you’re charged an interchange fee (the amount that your merchant service provider pays the credit card network) plus a set percentage or fee per transaction. The “plus” percentage or fee is the markup your provider is charging you to process your transactions.

You can see an example of interchange-plus pricing with Payment Depot, who charges interchange plus $0.15 per transaction for processing fees.

Because of the transparency associated with interchange-plus—in other words, you know exactly what is going to the card network and what is going to your merchant service provider—interchange-plus is usually considered the best and most affordable pricing structure.

Tiered Pricing

Finally, the last of the most common pricing structures you’ll find is tiered pricing. With tiered pricing, providers bundle their services into pricing tiers. Most often, these tiers are broken up based on the level of risk the processor is assuming with each purchase. A provider might have a different tier for credit card payments and one for debit card payments, as well as one for in-person transactions and one for online transactions. 

Ultimately, the processor will decide which tier any sale falls into, and therefore, how much it will cost you. Therefore, although tiered pricing will be easier to understand in comparison to interchange-plus, it will end up being one of the most costly pricing models. 

Common One-Time and Incidental Fees

As we mentioned, beyond hardware and software costs, as well as credit card processing fees, merchant service providers may also charge a variety of different one-time and incidental fees. Some providers, for example, will charge a monthly subscription fee for you to utilize their service.

On the whole, the specific fees you see will be unique to the provider, however, it’s important to recognize some of the most common fees—and which ones you should try to avoid.

  • Account fees: These are the fees a provider charges on a monthly or annual basis for you to work with them.
  • Minimum processing fee: Some providers charge a fee if you don’t process a certain number of transactions or amounts of funds within a given period of time.
  • Statement fee: This fee may be charged for your account statement, whether in-person or online.
  • PCI-compliance fee: A PCI-compliance fee may be charged for your merchant service provider to ensure that you’re in compliance with credit card security industry standards.
  • Account setup fee: Some providers will charge this fee to get your account set up.
  • Cancellation fee: Some providers will charge you a fee if you cancel your account before your contract has ended.
  • Chargeback fees: If a customer disputes a transaction and receives a refund, some providers will charge you a fee for this “chargeback.”
  • NSF fee: If your business bank account doesn’t have enough money to pay your provider, they may charge you an additional NSF, or non-sufficient funds fee.

Ultimately, these are just some of the fees you may see from any given merchant service provider. This being said, it’s important to thoroughly investigate any and all fees your provider charges and ask for clarification, if necessary. Many merchant service providers are criticized for hidden fees that business owners are not aware that they have to pay when they sign up for their account. Typically, you should be able to avoid fees for statements, account setup, cancellation, and minimum processing—especially if you’re working with a payment service provider.

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How to Choose Merchant Processing Services for Your Business

Considering all of the different facets we’ve discussed thus far, it’s easy to see why the term “merchant services” can be confusing and overwhelming—there many different processes, products, companies, and stakeholders involved in merchant services for small businesses.

With all of this in mind, however, you may be wondering how to choose merchant processing services, asking:

  • How do you know what to look for?
  • How do you compare providers?
  • What provider is best for your business?

At the end of the day, there are hundreds of merchant service providers on the market—and certainly, there is a provider that will be the right fit for every business. This being said, however, if you’re looking for the right merchant processing services for your small business, here are questions you’ll want to keep in mind as you start your search and begin comparing your options:

  • How you’re accepting payments: Is your business going to be accepting payment solely online, or will you be taking in-person payments?
  • Type of payments you’re accepting: Are you going to be taking credit cards, debit cards, contactless payments?
  • Type of hardware or software you need: Do you need a full POS system or a simple credit card terminal? Do you only need a payment gateway?
  • Payment service provider vs. merchant account provider: Does your business need a unique merchant account? Would you prefer to be able to set up your account quickly and easily online?
  • Pricing structure: What kind of pricing structure do you prefer? What costs will you need to pay besides processing fees? What does your budget look like?

By asking yourself questions like these, you’ll get a better sense of exactly what you need from your merchant processing services, and therefore, what you’re actually looking for in any provider. With these qualifications established, you’ll be able to compare different providers and see which one will be able to best fulfill your needs.

Top Merchant Service Providers for Small Businesses

If you’re looking for a place to start, you might consider any of the following providers below. Ultimately, it will be up to you to decide which payment processing company is best for your business—but depending on your needs, any of these options may be able to serve you well.

Merchant Service Providers for Online Processing

If you need online processing, you’ll want to look for merchant services that offer payment gateways. As a reminder, payment gateways will allow your business to securely process online card payments from your customers.

Essentially, payment gateways will function a lot like a traditional merchant services bundle, minus the physical credit card terminal.

Authorize.Net

With Authorize.Net, your business will be able to process online payments from all major credit card networks. Should you opt for this payment gateway option, your online business won’t have to worry about opting out of in-person payment systems, because it’s built specifically for ecommerce merchant service needs.

Plus, with one of the most secure payment data protocols on the market, Authorize.Net will be able to simplify your business’s PCI compliance and ultimately grant the peace of mind that comes with knowing your customers’ information is secure.

Veem

Alternatively, if your business is operating in a business-to-business structure, then you might want to consider Veem as your go-to online payment processor.

Veem is changing business-to-business bank wires for the better. In fact, Veem has managed to make secure, free money wires available to small businesses everywhere.

So, if your business is operating through remote, large transactions, then Veem could very well be the most cost-effective and most convenient merchant service provider for your business.

Merchant Service Providers for In-Person Processing

If your business relies on in-person transactions, then your business’s merchant services should—at the very least—be able to process payments through credit card magstripe readers, if not through credit card chips and contactless payment methods, as well.

Plus, the very best merchant services for in-person transactions will be full point of sale systems with features like inventory and employee management. Although these options may seem costly, considering the need for both software and hardware, their all-in-one nature actually makes them some of the most cost-effective choices on the market.

Square

Square point of sale systems come in many shapes, sizes, and costs. In fact, with a Square account, your business will have the choice to opt for a completely free point of sale hardware and software.

With the free Square magstripe card reader, along with the free Square Point of Sale software, you’ll be able to convert a smart device (like an iPad or iPhone) into a powerful point of sale.

Therefore, if your business already has a smart device, the only cost you’ll have to take on for Square’s merchant services will be the payment processing fee of just 2.6% + $0.10 for in-person payments.

Clover

Similar to Square, Clover is a point of sale system with a few different options. Clover offers two software plans as well as a variety of hardware choices, including fully-functional systems that don’t require a smart device.

This being said, although Clover POS doesn’t offer a free plan, their software starts at $14 per month with processing fees of 2.7% plus $0.10 per in-person transaction, making it an affordable and functional solution.

Moreover, if you’re looking for a POS system through a merchant account provider, many companies work with Clover to offer point of sale solutions.

The Bottom Line

So, what’s the final word on merchant services for small businesses? Ultimately, as we’ve seen, the merchant services industry is wide-ranging and complex, but that doesn’t mean you can’t find the right solution for your business. 

If you break down your needs and preferences and take the time and effort to explore different solutions to see what they offer, how they price their services, and how they stand up to your requirements, there’s no doubt you’ll be able to find a credit card processing company that will work for you.

It’s important to remember, however, with all of the companies, products, and processes that make up merchant services, there is a lot of room within the industry for confusion and uncertainty. Therefore, as you explore merchant service providers and their solutions, you shouldn’t be afraid to ask questions, request clarification, and say “no,” if a company doesn’t seem like it’s the right fit.

Maddie Shepherd

Contributing Writer at Fundera
Maddie Shepherd is a former Fundera senior staff writer and current freelance writer. Maddie has an extensive knowledge of business credit cards, accounting tools, and merchant services, but specializes in small business financing advice. Maddie has a bachelor's degree in Spanish and Latin American cultures from Barnard College.

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