Payment processing – Merchant account or PayPal?
January 18, 2009 at 5:33 pm | Posted in Software as a Service, Sofware Startup | 4 CommentsTags: credit card, mastercard, merchant account, paypal, software, startup, visa, web 2.0
Over the past few weeks we undertook the effort to obtain a merchant account so that we could process transactions on the MioWorks.com web site. I always heard that this was a daunting process and that most businesses would never be able to satisfy the requirements. At first we were put off by these urban myths and looked at using PayPal for our payment solution. We used PayPal in the past and it worked just fine, but we didn’t feel it was optimal. Therefore we took this opportunity to look into what else was available. As we researched the differences between having a merchant account/payment gateway and an all in solution we unraveled the mysteries and made our decision. This post helps to explain the differences and then talks about our choice.
First let me explain how credit card processing works over the internet. In scenario one with the all in payment solutions you can feed to them items to maintain in a shopping cart or you can send an entire shopping cart to them when the user selects to checkout. Typically at this point of the process the user is then redirected to the payment web site and they log in or complete the transaction with the 3rd party. At the end of the transaction the user is returned to your website and a record of the transaction comes along with them under the covers for you to process. In scenario two, your web site has a shopping cart. This shopping card collects the items that the user wants to buy and then formulates a total amount for the purchase. When the user decides to make the purchase, your shopping cart application then contacts a payment gateway to request an authorization. There are many payment gateways out there with some of the more popular being authorize.net and trustcommerce.com. The payment gateway interacts with the banks and gains the approval for the transaction. The payment gateway then interfaces with your merchant account to credit you with the sale and then a few days later the money is actually transmitted through your merchant account to your banking account where you can access the funds.
Sit back with a coffee and get ready to read
Since we were in research mode we wanted to fully understand the differences between the solutions. We printed out the terms of use of the all in one services and read through them highlighting the costs and risks to the business. Then we did the same with the documentation for one of the programs with a large banking institution. In our case the first document was the Merchant Service Program guide weighing in at 44 pages of exciting legal jargon and rules. The second document was 41 page pricing terms. Just the reading time and analysis took several days (due to boredom) to complete. In the end we uncovered some interesting differences.
With merchant accounts, rates aren’t that simple
When you use a merchant account and payment gateway the rate structure is rather complex. I was provided a 41 page pricing terms document that requires a Phd in logic just to follow along. From my analysis the end result is that there are two different rates that the merchant can be charged for each transaction. There is the qualified rate and the non-qualified rate. The qualified rate is the “teaser” rate that the bank provides you to get your business. In our case it was 2.5% of the transaction. But the non-qualified rate can be upwards of 6-7% for a single transaction and then there are additional gateway fees on top of that. What makes a transaction non-qualified? Well there are two possibilities. The first is that you don’t follow the rules for processing the transaction. This means that for different types of transactions (Visa, MasterCard, American Express) there are a list of different rules. Rules on when you must process your batch versus when you authorize, rules on how the transaction code is formatted, rules on how you prevent fraud. This actually doesn’t cause us any pain, we are fine with knowing the rules and making sure we follow them. But there is another side to non-qualified, the card type. This is something that we as a vendor have absolutely no control over. The type of card that your buyer uses can negatively impact your bottom line if you don’t plan ahead for it. Those great bonus mile cards and cash back cards, they all cost the vendor more when they are used. There are some cards that are a 7% charge no matter what. Imagine if you are running a commodity business with slim margins and all your customers have these cards. Your profit can go right down the drain to the bank. This brings up our first business point. Make sure you know the cost of processing credit cards before you set your price!
Gateway Processing Fees & other fees
In addition to a percentage of each transaction the vendor also must pay a fixed rate per transaction. This fixed rate goes to the transaction gateway. In our case the fixed rate is $.30 per transaction which includes address verification. ($.25 for transaction and $.05 for address verification). Lastly there are extra fees that you’ll be charged on a monthly or yearly basis. There are statement fees ($7.50), monthly service fees ($31), setup fees ($299), charge back fees ($31) and annual compliance fees ($40). Make sure that you get a full list of all these fees before you agree to any deal that seems too good to be true.
Compare to PayPal or Amazon Payments
All of this complexity is eliminated when you use an “all in one” service such as PayPal or Amazon Flexible Payment Service. The fee structure is much easier to understand (PayPal, Amazon) where you are paying roughly 2.9%+ $.30 per transaction. They don’t have a wacky fee schedule based upon card type. It’s one rate fits all. In addition, there is no credit check and you can setup and start using an account in just a few days. The entire system is automated and you never have to deal with any humans. Another benefit of PayPal is the handling of foreign currencies. If you plan to offer your service in several countries, PayPal makes it simple to accept those currencies and then eventually convert them back to U.S. dollars (or another currency if so desired).
Our decision: Merchant account and Gateway solution
For us it all boils down to ease of use for our customers. When you use PayPal or Amazon Flexible Payments you give up control of the process. You have to fit your business to the way that they process a transaction and in some cases this can dissuade your customer. Our hope is that we can make the payment processing a very simple effort without additional logins and redirects to third party websites. We also have the special requirement of a recurring billing system so that we can charge our customers every month, yet we don’t want to store ANY credit card information in the MioWorks.com application. This requires a special service from our processing gateway so that we can rely on them to maintain PCI compliance and security of the credit cards. This is not to say that PayPal of Amazon Flexible Payment Service wouldn’t do the job, it is our preference to go the route of a merchant services account and payment gateway.
The process of obtaining a merchant account
Once we made the decision to go with a merchant account we had to get it. Obtaining the merchant account was not as difficult as the urban myth suggests. I started out by doing research on the different banks and their “marketing” offers. I then called a couple banks to talk more about the details and find out the real deal behind the glitz of the marketing. When I finally selected the bank that I wanted to deal with I gave them a call. The initial phone call was to get the process started. After answering my questions, the agent took my application over the phone. One item to note is that you must personally support the credit request for a merchant account. In our case we are an LLC with multiple partners. Each partner had to provide SSNs and agree to be bound by the terms of the credit extension for the merchant account. If you have bad credit, or don’t have credit established yet, you can stop now and evaluate PayPal or Amazon Flexible Payment Service. After the application was completed the agent emailed it to me and I sent it off to my partners for signatures. Our team reviewed all the materials, made appropriate signatures and then returned the documents to the agent. The next day we received a preliminary approval on our application pending a copy of the mock ups for the website. The bank wanted to make sure that what we were selling was appropriate and fit the parameters they set forth. A few days later I had the website mock ups and the legal documentation for refund policy, terms of use and privacy policy. I sent this to the agent and everything was finalized. The process took about a week total and some of that was delayed due to the fact that we have a brand new solution that needed documentation.
At the end of the day, the final decision is up to you and your team. You have to weigh the complexities against the control. And you really need to look at your process and determine if the control you are gaining by doing it yourself will simplify the process. We have gone down the slippery slope and as the business develops I’ll be able to reference this post and compare our anticipated outcome to what really happens. Maybe PayPal/AFPS are better solutions…..but only time will tell!
Help me decide what to write next!
Dual tracks – build an application, build a business
January 5, 2009 at 4:11 pm | Posted in Software as a Service, Sofware Startup | Leave a commentTags: Entrepreneur, SaaS, startup, web 2.0, Web2.0
Within a few weeks of putting the team together the software application was under development. The technologists began building the data models, security frameworks and application frameworks. The designer came up with what I think is a terrific visual for the application and the pieces were starting to progress. Everything was humming on the product side. Now it was up to me to build the business.
The business is the part of a start up that is hardest for innovators. Unfortunately there are hundreds of moving parts, legal issues and other issues that must be taken care of before you are really a company. This can be a full time job just to get things established. I’m fortunate that I learned all of these pieces while working for other companies. We knew what needed to be done, it was just a matter of making decisions and putting everything together.
Our first major decision was on business formation. In the USA we have several options on how to structure the business. Partnership, Corporation, S Corporation and LLC are just some of the options. In our case we decided that a Limited Liability Company was our best course of action. The main reason is that the company is owned by the founders and we want to keep it that way. In an LLC the profit/loss of the company is passed directly through to the members (owners) of the LLC. We felt that this structure would minimize double taxation (as in the case with a Corporation). We also felt that the LLC supported our goal of building a software company from the ground up using our own resources.
Once we determined the type of business to create now we had to decide what state to establish the LLC in. After some research and forward thinking we decided to create an Oregon LLC. I utilized LegalZoom.com for the formation, filled out the online forms and paid the fees. A few weeks later the name Mio Partnerz LLC was secured and the paperwork was filed and approved by the Secretary of State in Oregon. Once the articles of business formation were received I then contacted the IRS to obtain an employer identification number for the business. This is necessary for opening a bank account so it’s important to get it right away.
With the business formed and the IRS number in hand I went off to a local bank to establish an account for the business. The process was relatively simple. I provided copies of the paperwork and the Tax ID Number to the bank along with about a hundred forms of my personal identification (ok – more like 2 or 3). Within a few minutes the bank account was established.
Meanwhile my marketing counterpart was taking care of getting us office space to call home for our business. We found a perfect space on the East side of Portland in a converted warehouse project. To secure the space we had to execute the lease individually. They wouldn’t allow us to execute it as the business. This is a downfall because it makes us personally responsible for the lease term, but there was no way around this. We also had to obtain business insurance at this point to take possession of the space. A few phone calls to local insurance agencies and we wrapped up a million dollar liability policy for around a hundred dollars a month.
At the beginning of December we made our trips to Ikea and got the basics we needed to setup a small office. We moved into our space and began calling it home for Mio Partnerz. Both tracks were now well under way but there is still a big moutain ahead of us to climb.
Idea in hand now what?
January 1, 2009 at 9:46 pm | Posted in Software as a Service, Sofware Startup | Leave a commentTags: SaaS, software, startup, web 2.0, Web2.0
Once I had the idea in hand I needed to find a team of people that could help me build the application. My skills are all on the product strategy, design and marketing side of the house. So I needed to find someone to be the technology leader and then a few others with skills that could compliment each other. I determined that I needed at least four people to get things started – the technical lead, a ruby on rails programmer, a designer/graphic artist and an HTML developer. I was excited about the idea and I wanted to try and find other enthusiastic entrepreneurs in the Portalnd area to get on board with the project. The only way that I could make this work without begging for money from the VCs or Angel investors was to get people to do the project as a partial owner of the business. This turned out to be much harder than I thought…
Being new to Portland I didn’t have a big network to rely on. In my short time in the city I had attended a few beer and blog meet ups and a social session with the Legion of Tech brigade. I decided to keep on poking around this group and see if I could find people interested in starting the side project. Week after week I met new people and had a good time enjoying a beer or two. But I couldn’t find anyone willing to get involved in my project without regular compensation. I was frustrated to say the least. I then changed my tactics and started looking through the network of people that I had met over the previous year. There were consultants in Romania, there were innovators in the Philippines, there were software consultants in the USA. As I combed through my list of possible alternatives I ended up convincing one of these contacts to join me as my lead technologist. Quickly after he signed on to get involved in the project we were able to convince a strong developer to also lend a hand. Back in Portland I was able to convince a friend to join us on the marketing side so that we could really focus on doing the right type of marketing from the get go. He agreed and jumped in with both feet. After a few weeks of the three of us fumbling around with designs, wireframes and HTML we realized that we didn’t have the critical element we needed to really get things underway. So once again I dug into the world wide web and linked up with a consultant that could deliver on our first layout/design. It cost some money but it was worth it to jump start the whole program. Finally the team started to take shape. Unfortunately it wasn’t in Portland like I had envisioned.
Put your money where your mouth is…
December 31, 2008 at 2:43 am | Posted in Sofware Startup | Leave a commentTags: apps, startup, web, web 2.0
I have been involved with Startup companies most of my adult career. My role started out as a sales engineer where I performed demonstrations and answered questions for Wall Street companies. I then moved into Product Management and brought to life several products for Axent Technologies including Enterprise Access Control for Windows 95 as well as for Windows NT. My trek around the county then landed me as a technical marketing evangelist for Pandesic eBusiness and then onto my first role as a Product Marketing Manager with Vignette Corporation where I focused on portals. A brief stint at a few more companies and then I found myself gracing the halls of Symantec getting my lessons from the big boys. After nearly four years of abuse in the corporate arena I returned to start up land and took the helm of a VC funded start up called Morph Labs. After an exciting year and a strange turn of events in the economy we launched our products, established our marketing presence, made a lot of noise against Google and then I quietly slipped away as I transitioned the company back to the founding VC.
So now it is my time. My time to put my money where my mouth is when it comes to building a startup. To this end I have now embarked upon a journey to create a company. Funded on a shoestring and progressing only through the appetite of my friends for success. I am now in my second month of this venture. At this stage we are pushing for an introduction release in about a month. Yes that’s right. We plan to bring to market a web based application by February that is focused on changing the way that small business connects to their customers and leverages the internet to get things done. Follow along as I write about our successes and our roadblocks. I’ll try to detail what it takes to build your own startup not only from a skills perspective but also from a passion and committment standpoint. I know that this will be an interesting ride and I would like to welcome you aboard!
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