What are Upfront Reserve?

Finding a reputable payment processor who charges a reasonable processing fee and offers secure and reliable credit card processing services is challenging for a high-risk business. One of the most frustrating requirements is the upfront reserve. So, what exactly is it? Why do you need it? Keep reading to learn more about upfront reserves for a merchant account and why they are needed.

A business categorized as high-risk, whether because of the high chargeback ratio or the industry it operates in, is supposed to deposit an upfront reserve for a merchant account. Although it’s not mandatory for all, most high-risk merchant service providers require businesses to keep a small portion of their earnings aside for security reasons. This reserve protects the payment processor and the business from the risk of unforeseen events, such as chargebacks or fraudulent activity that results in a significant financial loss.

Note that payment processors have varying reserve requirements. While some might not need an upfront reserve, others keep a significant part of your income in reserve. Rest assured that this money won’t go anywhere. They will keep it for a small duration and eventually deposit it into your bank account.

How Much Upfront Reserve is Required?

The total amount kept aside for upfront reserve varies depending on your monthly credit card processing volume. Your payment processor will discuss the reserve requirements before approving your application. They mention how long they will keep the reserve. An upfront reserve is usually 50-100 percent of the monthly processing volume you are approved for. For instance, if your merchant service provider has approved you for $30,000 per month, you will be required to keep anywhere between $15,000 and $30,000 in the upfront reserve.

It’s only fair for the acquiring banks and your merchant service provider to keep this money aside as a security for unpredictable financial losses. For instance, if your chargeback ratio spikes or your business has to shut down due to a legal issue or a major financial loss, the merchant service provider can use the reserve amount to recover the loss. It gives them a sense of security. However, from the merchant’s perspective, the upfront reserve negatively affects the cash flow.

Who Needs a Merchant Account Reserve?

A payment processor can ask each merchant, irrespective of their risk level, to deposit an upfront reserve, but the vast majority of them require this for high-risk merchants. As mentioned previously, upfront reserve serves as a way for the merchant service provider to protect themselves and the business from unexpected liability.

A high-risk merchant is more likely to experience constant chargeback requests and refund requests. Due to the nature of the business and its high processing volume, they are also at an increased risk of fraudulent transactions. To mitigate the risk of financial loss, these payment processors hold a reserve that works as a safeguard against financial, legal, and other issues. Here’s how it helps the merchant service provider.

Protection From Chargeback: A customer is likely to issue a chargeback request if they notice an unusual transaction on their credit card statement. Sometimes, these chargeback requests result from a friendly fraud where a customer issues a chargeback against a company without a valid reason. Either way, paying the chargeback fee can put a great deal of financial stress on the business, which is why payment processors ask high-risk merchants to put a portion of their income aside to prevent the risk of financial loss from chargebacks.

Fraud Prevention: A fraudster usually targets a high-risk merchant, as these companies process high-ticket and high-volume transactions. For instance, a subscription-based service provider or a jewelry store is more likely to experience fraud than a regular grocery store. Sometimes, a fraudulent transaction can put a merchant out of business and make the payment processor susceptible to financial loss. To deal with such fraudulent activities, merchants are required to hold an upfront reserve.

Business Failure: A business operating in a legally controversial industry, such as those offering gambling services, adult content, prescription and non-prescription drugs, and weapons, is at risk of sudden closure. Payment processors who work with these merchants will likely require an upfront reserve to ensure protection against financial loss from a sudden business failure. They use this reserve to deal with unresolved chargebacks.

Overall, the main purpose of keeping an upfront reserve is to protect the merchant service provider from financial loss due to chargeback, fraudulent transactions, sudden business failure, legal controversies, and other risky transactions. Not only does the reserve reassure the processor that they will be covered in the event of a financial loss, but it encourages the merchant to engage in fair business practices.

They are more likely to implement advanced fraud detection tools and best-in-class security protocols to avoid fraudulent transactions. They might also take measures to lower the chargeback ratio and improve their customer service. The payment processor can reduce the upfront reserve amount if the high-risk merchant proves their credibility and maintains a good credit card processing history.

How Upfront Reserves Work

Reserve accounts hold a predetermined sum of money to cover any financial liabilities. The type of reserve might vary, but they all have the same purpose—to protect your payment processors from unexpected financial loss. Upfront reserve, as the name suggests, is collected as soon as you open your merchant account with a payment processor. In some cases, your processor might put your transaction money into the reserve account as you generate income from credit card processing. The transaction funds go into your reserve account until the balance requirements are met.

Note that upfront reserve (or any kind of reserve for that matter) is not a fee. These are temporarily held into a separate yet inaccessible bank account just to offset the risk of financial liability associated with your business. The amount will be transferred back to your bank account within a specific timeframe. Additionally, upfront reserves are a great way to increase your monthly credit card processing volume. For instance, if you are currently approved for a monthly processing volume of $50,000, a good processing history can help you increase it to $100,000 and more. However, you need to add $50,000 to your reserve account in that case.

As mentioned before, there are two ways to maintain your upfront reserve. You will be asked to pay the entire reserve amount at once, i.e., at the time of opening your merchant account, or do it incrementally. If you are a startup with no processing history or you fall into the high-risk category, you will most likely need to keep your funds in the reserve as you make income from credit card payments.

In other words, your merchant can agree to keep your full income aside in the reserve account until they meet the predetermined dollar amount. Suppose you are approved for a processing volume of $20,000 a month and have signed up for an upfront reserve. You have not paid the entire amount in advance and would rather have your income from the credit card sales deposited into your reserve account. In that case, your merchant will hold all your profits until the reserve balance reaches $20,000. Once it’s done, you will get your money back.

The reserve account is like an escrow account. The amount is held in a non-interest-bearing bank and is transferred to your merchant account once the reserve requirements are met. Since this account is linked to your merchant account, you can check the balance anytime you want.

How is the Money From the Upfront Reserve Transferred to Your Merchant Account?

Now that you have deposited the required amount in your reserve account, you might wonder when you will get it back. As mentioned earlier, you need to have a solid payment processing history to set up the incremental reserve release. You can work with your payment processor to determine the duration in which the reserve will be credited back to your account.

They will decide the stages in which the full amount is transferred to your merchant account. For instance, if you have a good processing history and receive no chargeback, your payment processor might transfer 20% of your reserve balance to your account. If you urgently need money, you can talk to your account manager, who will further discuss the reserve release requirements with your payment processor. They will either speed up the release process or transfer the entire reserve balance to your merchant account.

It’s important to read the merchant agreement carefully to know the duration by which your reserve funds will be released. In some cases, the payment processor permanently holds the reserve and releases it only when you end the contract with them. There’s a possibility that your upfront reserve, which is 100% of your approved monthly sales volume, can be held aside for 5-10 years, or as long as you have an open merchant account with your payment processor. To mitigate the risk of chargeback-related financial loss, your processor might keep the funds for up to 120 days after your account closing. That’s because the time limit to issue a chargeback is four months from the purchase date.

Who Needs an Upfront Reserve Account?

This depends on the payment processor you choose and their reserve requirements. However, in most cases, merchants with a high-risk level need to deposit money into the reserve account to offset the risk.

If you are a high-risk merchant, you will most likely need to fund your merchant reserve account no matter which payment processor you choose. Although the percentage of the upfront reserve and the duration until which the reserve will be held might vary from processor to processor, most of them implement an upfront or rolling reserve for high-risk merchants. This starts from the day you are allowed to process credit card payments with your processor to the end of your agreement.

Sometimes, the merchant isn’t asked to keep an upfront reserve, but if they are unable to prove their credibility or their risk level increases in the future, the payment service provider might ask them to keep a reserve to mitigate the risk of financial loss. Here’s what makes you a high-risk merchant, making you highly likely to deposit an upfront reserve:

• A poor or no payment processing history
• A poor credit score
• A business that sells controversial and risky products, such as firearms, cannabis, adult content, gambling services, furniture, precious jewelry, and other high-end products.
• High monthly processing volume
• Large average transaction size
• Selling in international countries, especially areas that are highly prone to fraudulent activities
• Operating in an industry that has a history of high chargeback ratio

Note that the reserve requirements aren’t a one-time thing. This will most likely last for the entire duration of your agreement with the processor. You will get the entire reserve amount back once your contract ends, and you decide to continue with another payment processor. However, that’s only when you have no chargebacks, refunds, or pending transactions.

Different Types of Merchant Account Reserves

Not every payment processor has the same criteria for holding your money in the reserve account. The up-front reserve is held at the beginning of the agreement and is released in a fixed percentage every month. Here are some other options for merchant reserve accounts:

Rolling Reserve

The most common type of merchant reserve is the rolling reserve. Instead of keeping a lump sum aside at the time of merchant account opening, your processor will keep a fixed percentage of your income aside every month to meet the rolling reserve balance.

This can be between 5 and 15 percent of your income or more, depending on the processor you choose and your risk level. Suppose your agreement states that 10% of your income from credit card processing will be deposited into the reserve account for the next five months. Your processor will hold 10% of your income in the reserve and transfer the rest to your merchant account. They will continue this for five months. They will start releasing the money in the same ratio as they held your reserve after the predetermined period.

Your processor will keep depositing the reserve until your agreement. Unlike upfront reserves, there’s no cap on the amount your rolling reserve account can hold. It depends on your monthly sales and processing volume.

Capped Reserve

The capped reserve is similar to the rolling reserve. The payment processor withholds a specific percentage of your income into the reserve account. The difference between the two lies in the limit. The capped reserve has a limit past which the processor can’t withhold the money. No matter your monthly sales volume, the reserve amount is withheld up to the limit. This reserve will stay with your payment processor till the end of your agreement.

Suppose your monthly sales volume is $20,000, and the capped reserve is $10,000. Your agreement says 10% of your income will be withheld into your reserve account, which makes it $2000 per month. This will be transferred to your reserve account until the limit, i.e., $10,000, is reached.

In addition to these reserve types, payment processors might have their own special reserve accounts and varying procedures to hold merchant’s money. PayPal, Stripe, and nearly every payment processor have a reserve requirement that’s based on the processor’s security and other requirements.

Managing Your Upfront Reserve

You can’t avoid upfront reserves, but there are ways to manage your hard-earned money in the reserve and get it back. Here’s how you can manage your merchant reserve:

• Understand the terms of your merchant reserve agreement. Know how much reserve is required, when it will be released, and other conditions related to the reserve requirement.
• Improve your processing history to negotiate the reserve terms with your payment processor.
• Manage your chargeback and respond to customer disputes promptly.
• Try negotiating your merchant reserve conditions with your processor.
• Ask your processor to lower the reserve percentage or the duration for withholding the reserve. If you have good financial standing and a decent processing history, they might consider your offer.
• Monitor latest trends in reserve management.
• Look for a reliable payment processor with a transparent pricing policy and reasonable reserve requirements.

Conclusion

No matter the level of financial strain they put on your business, upfront reserves are a great tool for high-risk merchants facing difficulty getting approved for a merchant account. It shows your acquiring bank the financial responsibility you are willing to take. Besides, keeping a portion of your income aside for unforeseen events is always a good idea, as it helps you deal with financial issues later.

Your business won’t take a financial hit if you have an upfront reserve with your payment processor. Likewise, it’s a protection tool for your payment processor. They are more likely to offer you the best service if they are assured of protection from chargebacks, fraud, and other financial losses.