*DISCLAIMER: Not financial advice*
Yes that's right - they're not as magical as they seem! If you’ve been anywhere near the twitter sphere in the past year you’ve probably heard some discussions about how important it is that we’re all using merchants of records when selling online or else, you will go to jail (quite literally).
👉 This is the propaganda that some of the biggest companies in the industry have been spreading and it has worked.
Merchant of Records are now bigger than ever and this doesn't look like it's going to change. Now before a war breaks out in the comments from what some will view as treasonous comments, I need to clarify that there are some cases where using a merchant of record would have a net benefit, however for the most part, the importance of a merchant of record is wildly overrated.
Before I provide some substance to these outrageous claims, let's make sure we’re all on the same page for what exactly a Merchant of Record, or MoR for short, actually is.
MoRs originated in part from the complex sales tax laws involved when selling digital products online. When buying or selling physical products, sales tax (or VAT as we call it in the UK) is fairly intuitive: a flat percentage often between 10-20% is added on the price of a purchase and goes to the government of the country where exchange took place - simple right?
This gets slightly more complicated when selling digital products where the customer could be based anywhere in the world and even the company selling the product may not have a physical location in any country.
This led to legislation mandating that, for digital products only, sales tax is charged in the country where the customer is located instead of where the seller is based.
Not only that but it's the seller’s responsibility to collect and file in every jurisdiction where they’ve sold a product - this could be hundreds of tax filings every year.
Now obviously, for most creators and small businesses, this would be physically impossible. To pull this off you’d need more than just a full time accountant, you’d need a team of tax experts specialising in tax laws from all over the world.
This is where the Merchant of Record comes in. Essentially, they collect all payments from your customers, do the boring legal and tax stuff and send you your earnings at the end of the month, minus their fees. In the eyes of the tax man, you only have one customer, the MoR.
Image courtesy of Paddle
Now by this point you're probably wondering, why on earth do merchants of record suck? If anything it sounds like they’re doing us all a favour and improving the efficiency of thousands of businesses around the world. Of course, this is exactly what they want you to think…
Reason 1: Your customers pay more
Using a Merchant of Record will mean that your customers pay more.
This is because when someone purchases your product the MoR knows what country they are located in and can add on the sales tax for their region automatically.
Now, unless you’re a seasoned tax evader, you’re probably thinking: even if I'm not using a merchant of record I still need to collect sales tax. And yes while this is true, it fails to consider one important point: nexus thresholds.
These are simpler than they sound. In essence, this is the amount of revenue that you need to generate in a particular tax jurisdiction before you’re required to collect sales tax.
For example, if I sell $50,000 worth of products to my customers in Arizona, I legally don't have to collect sales tax. In fact I could sell up to $100,000 in just Arizona alone before having to collect sales tax. Many other states have a similar threshold with some states, like California having a threshold of up to $500,000.
Unfortunately, when you use a merchant of record, they are over the nexus threshold in every tax jurisdiction and therefore charge sales tax on all of your sales, meaning your customer pays more.
If you have ever taken even a basic economics class you will have learnt of the inverse relationship between price and demand: The higher the price, the less you sell.
Reason 2: Higher fees - the cost of convenience
Reason number two: You pay more! Typically, you will pay upwards of 5% for the privilege of using a merchant of record.
Granted, using a MoR will mean you don't have to use a payment processor where you’ll typically pay 2%. This 3% difference may not sound like a lot but if you calculate the monetary value of 3% of your yearly revenue, you might change your mind.
Not only this but merchants of records will charge a flat fee per transaction, most commonly $0.50 so If for example your product is $10 you can expect to pay the 5% fee which is $0.50 plus the flat $0.50 fee totaling $1.
This is 10% of your initial price, far higher than the 2% fee you’d otherwise be paying with a traditional payment provider, and yes some of these charge flat fees as well but you’d struggle to find one charging $0.50 per transaction.
Lemon Squeezy fees 2023
Reason 3: Say goodbye to your customers
The next reason is slightly less obvious, when you switch to a Merchant of Record you quite literally have to say goodbye to your customers.
Due to the nature of how a MoR works you are effectively bundling up all your existing customers in exchange for one big customer: The merchant of record.
Generally they will have a migrations team to help you move your customers from your current payment processor and subscription manager to their system and once that is complete you are at the mercy of your MoR.
We haven’t seen any major catastrophes where a Merchant of Record has gone under in recent history but that doesn’t mean it can’t happen, and who knows what will happen when it does.
We can only hope that they will make every effort to transfer your customers back to you but this kind of uncertainty is a risk that many would rather not take if they knew the full extent.
Reason 4: Delayed Payouts
If you are a business owner then you know that cashflow can make or break a business.
Even if you have enough cash on paper, if you have to wait even a few weeks before the money lands in your account this could lead to payroll being missed and suppliers getting paid late. A merchant of record will not only handle payments for you but they also handle refunds along with pesky chargebacks.
In order to make sure that they don’t payout to you, the business owner, and then get hit with a bunch of refunds or chargebacks, typically the MoR will hold onto your money for between 1-3 months before sending it to your account.
Whether this is a dealbreaker or not for you, I'm sure everyone would agree they would rather get their money sooner rather than later. Even if you don’t need the cash to keep your business afloat, that money could be sitting in a bank account earning interest - far more logical.