Merchant Account Reserve: What It Is and How Rolling Reserves Affect Cash Flow

Getting approved for your merchant account is only the first step in bringing in revenue. As a part of your account setup, you’ll have to agree to specific terms and processing fees. If your company is considered a higher risk, you may be required to have a merchant account reserve.

Reserves are used to offset the processor’s risks. For the merchant, they can lead to reduced cash flow and less access to the merchant’s revenue. How it impacts your business will depend on the type of reserve and the amount.

To learn more about how reserves work, read on.

TL;DR

• A merchant account reserve is when the processor holds a set percentage from each transaction or requires a fixed reserve amount upfront. This is done to offset the processor’s fraud and chargeback exposure.
• Reserves are more common with businesses that have high risks, subscription payments, international sales, delayed fulfillment, and high chargeback rates. 
• How the reserve is structured and the amount can vary based on your risk level, volume, and overall financial stability. Upfront, capped, and rolling reserves are the three main types.
• Rolling reserves involve holding back a percentage of your daily sales on a continuous basis.
• Upfront reserves are charged at the start before you begin using your account. The lump sum serves as collateral.
• Capped reserves involve holding back a percentage of your daily sales on a temporary basis until a limit is reached.
• A high reserve requirement can strain your working capital, slow growth, and lead to a higher need for external financing. 
• Reserves can be negotiated. Improving your processing data, implementing fraud prevention measures, and lowering your chargeback rate can help.

What Is a Merchant Account Reserve?

A merchant account reserve is when a portion of the merchant’s funds is held in reserve for a set amount of time. The goal of this type of account requirement is to protect the payment processor from fraud or chargebacks. Because of this, reserves are more likely to be required from high-risk businesses. The amount of funds that need to be held in reserve depends on a range of factors, such as the merchant’s volume, risk level, and chargeback history. 

For example, one account may be required to have a 5% rolling reserve with a 90-day release period. If a customer purchases $100 worth of products, $5 must be held as a rolling reserve for 90 days.

How Processors Determine If a Reserve Is Needed: A Quick Checklist

Payment processors review a wide range of factors to decide if a merchant account reserve will be necessary and how large it should be.

• Business Industry and Risk Level: Some industries have a higher risk of chargebacks. For example, CBD, travel, gambling, and digital goods are considered high-risk businesses, so they often have to deal with account reserves.
• Processing History: Companies that have stable, clean processing histories can often avoid reserve requirements. 
• Business Model: Some business models, such as subscriptions, pre-orders, and delayed fulfillment, have a higher level of chargeback exposure.
• Average Ticket Size: When transactions have high values, a single chargeback can be costly. To counterbalance this added exposure, processors generally require reserves.
• Chargeback History: If a merchant has a history of chargebacks or has previously been in chargeback monitoring programs, a processor will likely require reserves to defray that risk.
• Refund and Return Patterns: Frequent refunds and returns indicate that there is something wrong with the company’s operations or sales practices. Dissatisfied customers are more likely to use refunds, returns, and chargebacks, so this type of pattern indicates a higher risk level.
• Processing Volume: A higher monthly processing volume creates an increased liability for the processor, so the processor will impose reserve requirements.
• Financial Stability: As a part of their review, processors will look at your cash flow, financial statements, business health, and liquidity to determine if there are any risks present.
• Delivery Timeline: As the order fulfillment timeline increases, the likelihood of cancellations and chargeback disputes rises. Delayed fulfillment is especially common in travel, hospitality, and certain kinds of manufacturing.
• Fraud Risk: Unusual decline patterns and past issues with fraud increase a merchant’s overall risk level.
• Geographic Region: If you sell in certain international regions, there is a higher risk of fraud. Additionally, any cross-border transactions are also more complex because of the regulatory differences and currency exchange involved.
• The Owner’s Creditworthiness: In some cases, the processor will evaluate the credit history of the business owner. This is especially common in new businesses that don’t have a processing history. While good credit leads to better processing terms, poor credit increases the likelihood of reserves.
• Regulatory Requirements: Strict compliance and regulatory rules often involve more legal and financial risk.

Types of Merchant Account Reserves 

There are multiple reserve types that payment processors may require, depending on the merchant’s risk level, business model, and other factors. Each type will impact your cash flow in a different way.

Rolling Reserves 

Rolling reserves are generally considered the most common type. Basically, a percentage of your daily sales is held in reserve. After a 90- to 180-day period, the reserves are released. This balance is held to offset any chargeback risk, although it can end up impacting your company’s cash flow.

Upfront Reserves

Meanwhile, upfront reserves are a lump sum that payment processors require at the start of the merchant’s processing agreement. The lump sum is essentially a deposit that is held as collateral. Upfront reserves ensure that processors are immediately protected from potential risks.

Capped Reserves

Capped reserves are also known as accrual reserves. This is where a predetermined amount is withheld from each transaction until a set amount is reached. Once the cap is attained, the processor won’t withhold any more funds.

Basically, this is an in-between option. It provides early protection for the processor like rolling reserves, but merchants don’t have to commit as much upfront as they do with upfront reserves.

Special Reserve Accounts

Capped, upfront, and rolling reserves are the most common reserve types. Besides these standard options, some processors create their own reserve accounts that have specific features, rules, and requirements. This kind of arrangement is especially common in high-risk industries or where regulations demand clear segregation between different funds.

How Are Rolling Reserves Different From Capped and Upfront Reserves?

Rolling reserves differ from capped and upfront reserves in the timing and ongoing cash flow. Upfront reserves occur at the beginning of the merchant’s account and affect cash flow immediately. Capped reserves begin at the start of the merchant’s account and end once the limit is reached, so the impact is temporary.
In comparison, rolling reserves continue throughout the life of the merchant’s account. This causes a long-term impact on cash flow.

Which Businesses Are More Likely To Face Reserve Requirements?

Not every industry faces high reserve requirements. Additionally, merchants have the ability to negotiate better terms if their risk level changes. For example, fewer chargebacks or a longer payment history can help lower a merchant’s perceived risk level.

As a merchant, you can expect to have a reserve requirement if your company is in any of the following situations.

• High-Risk Industries: These industries are more likely to have disputes or operate in legally complex industries. For processors, this means that these high-risk industries have more volatility and potential losses.
• E-Commerce Companies With High Chargebacks: Online businesses involve card-not-present (CNP) transactions, which increase risk. Additionally, digital goods are delivered instantaneously, complicating potential refunds. If an e-commerce company already has a history of excessive chargebacks, processors will likely expect a reserve.
• Regulated Industries: When industries have stricter compliance expectations, there are added risks involved. Violating legal regulations can lead to fines, unexpected shutdowns, and other issues for the processor, so they must find ways to counterbalance that risk.
• New Businesses: Because new businesses pose an unknown risk level, processors take extra precautions when the account is starting out.
• Companies With Delayed Order Fulfillment Timelines: When products are shipped months later or trips are booked far in advance, there is a higher likelihood of buyer’s remorse, no-shows, and last-minute cancellations. If the customer isn’t able to cancel the order or get a refund, they may file a dispute instead.
• International Sellers: Cross-border sales carry extra risks because of currency fluctuations, shifting regulations, and increased fraud rates.
• Subscription-Based Businesses: From forgetting to cancel a subscription to billing confusion, there are many reasons why subscriptions tend to involve higher chargeback and refund rates. To balance out these risks, processors generally require reserves.

How High Reserve Requirements Impact Your Company’s Cash Flow

A merchant account reserve directly impacts your cash flow from transactions. If 5% to 10% of your daily transactions are held in reserve, that’s a significant amount of cash that isn’t available for your company. This is especially problematic if you function in a low-margin industry, such as restaurants, retail, or transportation.

Lower cash flow can strain your working capital and growth. To bridge any shortfall in funds, you may need other financing sources, such as lines of credit or loans. Over time, this can lead to added costs and financial pressure on your business.

Ways To Negotiate Lower Reserve Requirements

From merchant account limits to reserve requirements, your account terms can have a major impact on your day-to-day operations. By understanding effective strategies for negotiating your account terms, you can improve your cash flow and lower your reserve requirements.

Reduce Chargebacks

One of the major reasons why processors require reserves is because of chargebacks. If you can lower your rate of disputes, you can potentially use that improvement to negotiate better terms.

Chargeback rates can be improved by creating transparent refund policies and providing good customer support. Accurate product descriptions and subscription payment reminders can also help you avoid chargebacks. 

Adopt Better Fraud Prevention Tools

Fraud is another reason why reserves may be expected. Address verification system (AVS) checks, 3D Secure (3DS) authentication, card verification value (CVV), and similar measures can help you spot fraudulent transactions before they are approved. As soon as these measures are installed, you can immediately use them to negotiate better terms.

Improve Processing Stability

If your company experiences sudden spikes in volume or frequent declines, it is a red flag to your processor. Consistent, predictable processing behavior lowers the processor’s exposure, leading to fewer reserve requirements.

Provide Documentation

Documentation and hard data help you prove that you are a lower risk. You can do this through bank records, clear fulfillment policies, supplier agreements, financial statements, refund policies, and other measures.

Negotiate Terms

Don’t be afraid to negotiate your terms. Often, merchants will sign up with a processor and accept the terms that are offered. In reality, many processors will negotiate about reserve percentages, reserve types, and holding periods. If the situation changes enough, the processor may eventually be able to remove your reserve requirement completely.

Final Thoughts

Merchant account reserves are intended to protect the payment processor from added risks. Although it might decrease the processor’s chargeback and financial exposure, this approach increases the merchant’s costs. Higher reserve requirements limit cash flow, raising the likelihood that the merchant may need to rely on high-cost financing. 

The good news is that merchants can negotiate better terms by improving their processing stability and risk profile. Fewer chargebacks, better fraud prevention, and more consistent transactions are the first step in boosting your negotiating position.

Whether you want to learn about merchant chargeback rights or need help implementing fraud prevention tools at your business, we can help. Reach out to PayCompass today to learn more.