These risk management strategies can cushion your business against abrupt financial losses.
A merchant reserve is a lump sum created when a merchant service provider (MSP) collects a percentage of each electronic sale a merchant earns according to a set agreement between the two. The MSP holds the funds in a designated account and uses them to cover any future financial mishaps the merchant might experience.
As part of a risk management strategy, reserves protect the merchant and its sponsor banks by absorbing chargeback losses and unexpected financial obstacles. For example, if a merchant incurs a chargeback it can’t afford to repay, the liability falls onto the MSP, who defaults to the reserve rather than its own resources to cover the loss.
Reserves are usually required for high-risk merchant accounts. Holdback percentages and reserve totals are determined by assessing a merchant’s sales volume and processing history. Businesses with recurring billing or trial-before-sale models and histories of high chargeback ratios, for instance, are more likely to need reserves than retailers with consistently low chargeback ratios.
A capped reserve collects a percentage of each merchant transaction until a fixed amount is met. The amount is commonly half or one month’s sales volume, or another agreed-upon amount. Once the amount has been met, the MSP holds onto the funds for the duration of the merchant agreement and releases them to the merchant at its end, or when the merchant establishes long-term financial stability.
A rolling reserve, on the other hand, collects a percentage of each transaction for a set period of time—usually six months to a year. At the end of the period, the reserve is disbursed to the merchant through its merchant account, and the process begins again as the MSP rebuilds the reserve by withholding a percentage of each subsequent electronic transaction. The accumulation and release of the rolling reserve is continued until the merchant gains more stable financial footing.
An up-front reserve is the most aggressive reserve technique used for extremely high-risk investments. The merchant provides its MSP with a lump reserve in full at the beginning of their agreement. The merchant usually transfers the funds from its bank or provides confirmation of an adequate line of credit from its bank. In some cases, the up-front reserve can originate from the MSP withholding 100% of the merchant’s card sales until the reserve requirement is met.