Are Third-Party Payment Processors Right for Your Business?
Starting a business can feel like learning a foreign language, and the decisions you make early on can have major implications for your company’s future success. Deciding how to process payments is one of those big decisions, so it’s important to know the ins and outs of payment processing. Let’s start with the basics.
When it comes to setting up an account to process customer payments, you have two main choices: you can either
- set up a merchant account; or
- opt to go with a third-party payment processor.
Many small to mid-size businesses will use third-party payment processors because they fear the start-up fees that come with opening a merchant account. While there are certain benefits to working with a third-party payment processor, it’s not always the right option for everyone (and in many cases business owners underestimate the fees involved).
So, let’s take a look at third-party payment processing and what it entails to determine whether it’s the best option for your business.
What are third-party payment processors?
Third-party payment processors, or aggregators, are companies that interface between the merchant (you) and a merchant services provider, so you can accept payments without setting up a merchant account.
Third-party payment processors have one big merchant bank account for all of the businesses they work with, so they generally let you start processing customer transactions the same day you sign up without requiring you to go through the extensive business analysis and underwriting process you need to open a merchant account.
Since there are no set-up costs involved with third-party payment processors, small business owners often see them as the more economical option–– however, this is not always the case, and we will talk about why in a minute.
Square, PayPal, and Venmo are some of the most well-known third-party payment processors.
What are the advantages and disadvantages of third-party payment processors?
Let’s look at some of the pros and cons of third-party payment processors to help you decide if they’re right for your biz.
Pro: Easy account set-up
One of the most attractive benefits of dealing with third-party payment processors is the fact that they’re account set-up process is quick and easy.
Unlike traditional merchant account providers, which typically implement an underwriting process that can take days or even weeks, third-party processors can approve your account within hours. In some cases, you can get up running in minutes, with the whole process taking place online.
Pro: No monthly or annual fees
For the most part, third-party processors don’t tack on any monthly or annual fees, nor do they charge PCI compliance fees or gateway fees. This makes the billing much simpler, and you only pay the processor when you charge a transaction.
Heads up: simpler doesn’t mean cheaper. (More on this in a bit.)
Pro: No long-term commitments and an easier cancellation process
While many merchant account providers require you to sign long-term contracts (usually 3 years) and implement automatic renewals, third-party processor don’t have the same stringent contracts.
Note: If long-term contracts aren’t your thing, some merchant account providers like Payment Depot don’t lock you into a long-term agreement. With Payment Depot, you can cancel your account anytime without penalties.
Canceling your account with a third-party payment processor is also pretty easy. While traditional merchant accounts typically require that you give them a call and go through a cancellation (with penalties and fees), companies like Square and PayPal will let you cancel your account right online, without a fuss.
Con: Higher transaction fees
Because of the ease of getting up and running with a third-party processor, it’s easy to think that the process of working with them will be friction-free, and many SMBs get set-up with third-party payment processors in thinking that it will help save them time and resources on payment processing.
However, with third-party payment processors, you pay for the convenience in other ways. While there isn’t a lump sign-up or monthly fee, third-party processors make their money by deducting around 2.7% or more from each transaction––which equates to dollars from almost every sale.
So, if you operate a full-time retail business, you’ll probably end up paying more in the long run by opting to go with a third-party processor.
Con: Your account isn’t as stable
If third-party payment processors had a motto it would be “accept merchant transactions now, evaluate later.”
While third-party payment processors don’t do a lot of underwriting upfront, they will evaluate your business once you start working together and if your payment processing volume increases.
If a processor evaluates your account and deems it inappropriate, your account can be terminated with little to no notice.
Con: Customer support leaves a lot to be desired
Many third-party processors operate primarily online, so getting a customer service rep on the phone isn’t always easy. If you have a question or need help with your account, you will likely have to go through the provider’s online resources — i.e., their website, FAQ page, or help center.
Is it better to work with a third-party payment processor or to open a merchant account?
Here’s the short answer:
If you value convenience above all else and don’t want to deal with a lengthy underwriting process and complicated merchant account statements, then a third-party payment processor could be the right option for you.
Additionally, if you’re tech-savvy and don’t need a lot of hand-holding with operating your account, then you’ll likely do well with a third-party payment processor.
Just remember that convenience may come with a price, as these processors typically charge higher fees — which could add app, particularly if you process a lot of credit cards and have higher ticket items.
The longer answer is that it depends on a few different factors: how many payments your business processes per month, the size of each transaction you process, and how forgiving your customers would be if your account was shut down without notice.
Merchant accounts are best for mid to large-size businesses, as well as companies that don’t want to risk alienating consumers with an unexpected service shutdown (a’ la Target) as they grow to scale.
With a merchant account, your payments go directly from your account to your business account without needing to interface with a third-party payment processor, so merchant accounts are also referred to as direct accounts in the business realm.
The main downside of setting up a merchant account is that it’s more time-consuming than just downloading an app or ordering a card reader for your mobile phone like you would in getting set-up with a third-party payment processor.
The set-up process can be tedious. But a merchant account is the way to go if your business is in it for the long haul because they offer increased security, reduced fees per transaction, and no risk of the sudden shutdowns that can come when you outsource your account functions to a third-party payment processor who runs their business on short-term or nonexistent contracts.
What are the best third-party payment processors?
Third-party payment processors aren’t all bad, and the reality is that you may have no other option than to go with a third-party processor until your business brings in enough revenue to invest in a merchant account. With that said, let’s take a look at what type of fees 4 of the top third-party payment processing companies charge, as well as what they offer to merchants who use their service.
Square: Square is the most cost-effective third-party payment processor on swiped transactions, charging 2.75% for swiped transactions and 3.5% + 15 cents on keyed in transactions. Square also offers easy set-up. Once you download the app, you simply plug in a card reader to your smartphone to start accepting payments instantly–– which is why Square is currently the third-party payment processor Payment Depot recommends for retailers who aren’t ready to open a merchant services account.
PayPal: PayPal is the most popular third-party payment processor, with an estimated 20% of all ecommerce transactions taking place through the platform. PayPal charges 2.9% + 30 cents per transaction. Customers who buy online trust PayPal and not having the platform available for transactions may mean losing out on sales.
Stripe: Stripe is on par with PayPal cost-wise, charging 2.9% plus 30 cents per card transaction. The differentiating factor with Stripe, however, is easy set-up. It’s a simple copy/paste to add Stripe Checkout to your existing online store.
AliPay: AliPay is a different type of payment system that bypasses banks altogether. AliPay is just beginning to become available in the U.S., but Bloomberg reports that in China, third-party payment providers are expected to earn 40 percent of the money merchants pay to accept credit card transactions by 2020, which in the U.S. equates to 90 million a year. AliPay wins as the payment platform to watch as it begins to penetrate the American market.
Bringing it all together
Accepting customer payments is, like many things in the SMB space, a lot more complicated than it appears at first glance.
However, when your business is ready to take your payment processing to the next level, Payment Depot’s trusted in-house customer service reps will work with you to help you determine how and where to open a merchant account that’s right for your unique business model––so you can reap all of the financial and security benefits of having a merchant account without the headache.