Business Week: Cash Vanishes from Merchants' Accounts
In the midst of the worst economic contraction in decades, some small
business owners are experiencing an additional—and brutal—cash squeeze,
this time at the hands of their credit-card processors. The recession
and rising business bankruptcies have prompted giant credit-card
companies such as Denver (Colo)-based First Data and Atlanta-based
Elavon to demand that some business owners maintain a cash reserve with
the processors in order to protect against the possibility that
customers may require refunds after the merchants have gone belly-up.
Most processing agreements give the transaction giants the right to
accumulate those reserves simply by holding back money the merchant is
supposed to be paid after a credit-card transaction has cleared, often
with little or no warning.
Dan Price, chief executive officer and co-founder of Gravity
Payments, a card processor in Seattle, says he has seen "dramatically
more" cases of reserves being created for small accounts in the past
year. He says he has not asked any of his clients for reserves but has
requested regular financial statements from customers that might pose a
risk. Price says the size of reserves varies greatly, but it is common
to require an amount equal to one or two months' worth of transactions.
The ramifications on even a well-established company can be
dramatic. "In two weeks we would have been in bankruptcy," says Angie's
List CEO Bill Oesterle, whose processor, Elavon, tried to withhold a
reserve of $2.5 million from his $35 million company. Oesterle was
instead able to change processors quickly, and with help from his
lawyers, got his money back in about three weeks.
When a processor agrees to clear a company's credit-card
transactions, the processor then becomes responsible for providing
customer refunds. When an unhappy consumer asks their credit-card
company for a refund, the credit-card issuer gets that money from the
processor. The processor, in turn, pulls the money from the merchant's
account. If the merchant has gone under, the processor has to eat the
loss. With business bankruptcies on the rise, processors fear dishonest
merchants might close up shop and skip town, leaving the processor on
the hook for any refunds. "Before bankruptcy, some [unscrupulous]
merchants will create lots of transactions," says Richard Speer, CEO of
financial consultancy Speer & Associates, based in Alpharetta, Ga.
Common triggers for the establishment of a reserve include a sudden
surge in activity and individual transactions that have large dollar
amounts.
The Danger of Success
Ironically, that may mean that the processor decides to hold a cash
reserve just as a business appears to be booming. That's exactly what
happened to Oesterle, whose Angie's List compiles consumers' reviews of
contractors, doctors, and other services. The Indianapolis-based
company and was growing at more than 50% per quarter as of July 2008,
when Oesterle got a call notifying him that Elavon was holding on to
$2.5 million in his credit-card transactions and intended to use that
money for a reserve. Elavon also wanted to examine the 356-person
company's financials, and cited Angie's List's surge in credit-card
transactions as the reason for its concern. Holly Lytle, a spokeswoman
for Elavon, says that while the company cannot comment on individual
customers, it has not changed its policies on reserves and that the
triggers for creating a reserve are stated in customers' contracts.
Oesterle was lucky. He got a phone call. Ron Gregory, owner and
chief executive officer of 3-person Cheyenne (Wyo.)-based trucking
company RAD Enterprises, says he found out First Data had withheld
nearly $7,000 from his account when he happened to check the balance in
March. Gregory had dumped a previous processor because of its high fees
and signed on with First Data in February after seeing a promotion at
his local Sam's Club.
Gregory says First Data canceled his contract after he complained
but told him they planned to hold onto his $7,000 for six months.
Gregory aired his woes on ripoffreport.com and says his next stop will
be small claims court. These days his $1.5 million company will only
accept cash, checks, and money orders. "I can't afford to hand someone
$7,000 and not earn any money on it," Gregory says. Elizabeth Grice, a
spokeswoman for First Data, says the company cannot discuss individual
clients for confidentiality and security reasons. In an e-mail, she
says that although the company has not changed its risk management
process, due to the tough economy, "merchants' financials may not be as
strong now and thus they fall into a higher risk category." She adds
that in the overwhelming majority of cases, customers are not required
to carry reserves.
Bad PR
Jerrod Menz used a different tactic when Wells Fargo Merchant
Services tried to create a $200,000 reserve against his company's
sales. The president of A Better Tomorrow, a $4 million, 50-person drug
and alcohol treatment center in Murrieta, Calif., noticed in February
that some credit-card transactions weren't appearing in his corporate
account. When Menz called to complain, he was told his business was
"high risk" and that unless Menz put up a $200,000 reserve, Wells would
hold onto his cash until it accumulated that amount. It had already
held back $18,000.
Menz says a $200,000 reserve may have forced him to make layoffs, so
he put out a press release blasting Wells. Within a day, he says, a
Wells executive called him and the money was released. In a statement,
Wells spokeswoman Allison Olson says that while the bank can't comment
on specific cases due to customer confidentiality and privacy issues,
the situation was "resolved to the satisfaction of the customer." The
bank says reserves are only taken when businesses present a "high risk"
and that doing so protects consumers who may need refunds.
Unfortunately, it does so at the expense of entrepreneurs who are
already struggling with a nasty economy and an unwelcoming credit
market.
