PayPal's Reserve Policy Can Disrupt Cash-Flow

Consumerist reports that PayPal has started holding back portions of some merchants’ receipts as large as 20% in a rolling reserve to cover charge backs or refunds.

It’s not just PayPal. Credit card processors of all types are increasingly holding merchants’ money in reserves, as BW’s Amy Barrett and Jeremy Quittner reported in April. Here’s why:

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.

PayPal will start processing transactions for pretty much anyone instantly, so they have a legitimate interest in managing their risk and not taking a hit on charge backs. PayPal spokesperson Amanda Pires told me that the reserve requirements are a new policy instituted earlier this year for less than 1% of PayPal sellers, and that they’re the most visible piece of a larger risk management strategy. PayPal addressed some of this in a blog post in June.

The biggest risk to small businesses here is that the reserve requirements can disrupt their cash flow, especially if the processor doesn’t adequately notify them. Some merchants in the story above (not PayPal customers) reported that they didn’t find out until the reserve withholding had already begun. The reader in the Consumerist post says PayPal did the same thing.

PayPal’s Pires says sellers get a clear email notice explaining the reserve requirement 30 to 60 days before withholdings begin. For high volume accounts, customers get a phone call. She says reserves are typically 1% to 5% of PayPal sales, but can go as high as 20%. PayPal determines whether to require reserves based on risk associated with the type of product or service being sold, the merchant’s history of charge backs, and the length of time they’ve been PayPal sellers.

Some online businesses may have all or most of their revenue flowing through PayPal, and 20% is a big chunk to have held for two months — enough to put plenty of companies out of business. Holding reserves may not be an unreasonable policy, but sellers need proper notice and the chance to change processors if it looks like the reserves PayPal wants to hold are more than the merchant can bear. Pires says customers are encouraged to call PayPal if they think the reserve is too onerous and that the processor will try to work with them. Pires says customers with questions can call PayPal at 877-729-7252.

If you’ve run up against reserve requirements, from PayPal or other processors, let us know in comments below or on Twitter.

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