When Credit Card Companies Can’t Process Hyperlocal Risk
Disclaimer: I do not nor have I ever worked in the credit card industry. I am not an expert, and I don’t know anything more than my personal experience while running Lucky Ant.
A few days before my crowdfunding company for local merchants, Lucky Ant, was scheduled to launch, we were turned down by our credit card processor — despite promises that the process was just a formality. No big deal. Running a business had taught me a long time ago that sometimes things don’t go your way, and there is always a solution. A few days later we found a replacement processor and we were ready to go.
But three weeks into an incredibly successful launch, and after funding our first project for $5,000, we received an email from our processor telling us that they had not previously “read our application”; after further review, Lucky Ant would be shut down again.
For those of you that have no experience with card processing, here is what you need to know: In order to process credit cards you need two players: a gateway and an underwriting bank. The gateway gathers the information and the bank guarantees the payment (exactly like a loan).
In theory, the level of risk you represent allows the bank to set the rate they will charge you. The risk in question is determined by the likelihood that customers will request a refund or, worse, initiate a chargeback. For example, if you run a clothing store, then the risk of chargeback is pretty low because the customer receives the product immediately and if anything goes wrong he can come back. On the other hand, if you run a publishing company which charges a yearly subscription, then the risk is high because you are bringing a lot of revenue for a product that you won’t deliver for months – should you close down, then the credit card processor might be liable for all the unshipped issues. It seems simple enough, if you are low risk, you pay a low rate, and if you are high risk you pay a higher rate.
So why is Lucky Ant so risky? For simplicity’s sake, processors lumped Lucky Ant in with companies in the daily deal business. It makes sense. We host projects for merchants (just like deals), we have a funding goal (like a tipping point), and when we’re done the users get vouchers to redeem at the merchant. There are two problems with this from a processor’s perspective. First of all, we are payment aggregators. That means that we lump a bunch of payments together towards a larger goal. Second, and more importantly, they call us “third-party processors.” In other words, we are not the end providers of the goods or service — our merchants are. In essence they know us and trust us, but they don’t know the merchants we work with and therefore don’t trust them.
The reasons for being wary are legitimate. Should consumers demand refunds because one of Lucky Ant’s merchants does not provide said goods or services, the underwriter would be left holding the bag. This is ridiculous because crowdfunding actually has lower chargebacks than other industries — you don’t offer to help in an altruistic act of community spirit and then later ask for your money back! That’s beside the point though, if Lucky Ant is a higher-risk profile, then we should simply have to pay a premium on our rate to cover that risk.
Unfortunately, what Lucky Ant learned is that the credit card industry still operates as it has for a very long time, and has not completely made the transition into the 21st century. Rather than pricing the risk that they assumed to undertake with Lucky Ant, processors repeatedly turned down the account because it was simpler to say no than to figure out a way to say yes. This business was just too new and too different from their perspective.
From my understanding, this is a problem that a lot of daily deal startups had to go through and I would expect is a problem for a lot of young startups that are trying to work in the hyperlocal space. If you are working with merchants in any capacity and processing payments for them, then you can probably expect credit card processors to give you a hard time. They might accept your account and then shut you down, or charge you prohibitive fees and cap the amount you can process, stifling growth.
There has to be a smarter system out there for dealing with the risks involved in new business models. The current system is prohibitive for startups that are trying to innovate. If you don’t fit into the mold, then you are just not welcome. I applaud startups like Square and PayPal that have simplified the bureaucracy that is credit card processing, but that is only half the solution. While those services are great, they are also bound by the fact that they have a fixed rate and therefore cannot price risk.
Thankfully Lucky Ant found a processor that was willing to listen to what we have to offer and we’re up and running again, though not completely in the clear. Our hope is that over the next few months we will be able to prove to the processing industry that chargebacks are less frequent in crowdfunding than they think — and get ourselves a deal that can support our growth.