What Is a High-Risk Business? Part 1

Regardless of the industry, if you don’t understand the nature and characteristics of your business, it will be impossible to make appropriate decisions in a timely manner. Part of understanding your business is getting a solid grasp on both the actual risks involved in its operation and the degree of risk it is perceived as having, particularly by financial institutions.

We frequently hear the expression “high-risk business,” but what does it really mean? What, specifically, makes a business “high-risk”? We may understand intuitively to a certain degree, and might even implement measures to prevent or mitigate incidents that often endanger the financial health and survival of the type of business we operate. However, having your business viewed as “high-risk” also affects the relationship between the business and financial institutions, and creates certain unique challenges, requirements, and expenses, even if the company has never had any actual incidents of risk becoming reality. Because of this, it may be good to review periodically what the term “high-risk business” or “ high-risk merchant ” means in that context.

What Kind of "High-Risk" are We Talking About?

If you were to bring up the topic of “high-risk businesses” in everyday conversation, most people would probably think of a broad range of types of businesses that have a higher than average rate of failure. The failure may be caused by factors inherent to the type of business, such as the need to anticipate and keep up with changes in technology and consumer preferences, which is very difficult.

On the other hand, the higher risk could be due to the physical (geographical) location of the business. Location can affect the potential customer base, and it can increase the likelihood of the business suffering theft, violence, or other crime. Some businesses are in niche industries with customer bases that are too small for the number of businesses in the market. There are many reasons that a business venture could be highly risky.

High-Risk as it Refers to Banks and Processors

In the context of dealing with banks and other financial institutions, however, there is a much narrower definition of a “high-risk business,” with numerical criteria and other ways to measure the level of risk the bank would be subjected to if it worked with the business in question. The standards used by banks to decide whether to open a merchant account or provide other financial services to a business typically have little, if anything, to do with the degree of physical threat, etc., the business faces.

So, then, what are the things that banks and other financial institutions usually look for when reviewing an application for something like a merchant account ? What, specifically, makes a business high risk in the eyes of a traditional bank reviewing an application for financial services?

How are High-Risk Businesses Classified?

There are two general categories, or classifications, for high-risk businesses, namely “Red Zone” businesses and “Grey Zone” businesses.

The Red Zone

The “Red Zone” refers to businesses that are considered risky independently of their business history. Some of the factors that can put a business in the “Red Zone” are being in an industry that has a high risk of chargebacks, deals only with services or intangible products, deals in high-volume sales, fails frequently to comply with safety/security standards and regulations, or operates “adult-oriented” services (e.g., pornography, gambling, tobacco, weapons, alcohol).

The specific industries that are in the “Red Zone” are quite diverse, and include such industries as digital download services (intangible goods, high-volume sales), technical support (services only), accounting and tax preparation (seasonal fluctuation, strict compliance requirements, services only), debt consolidation (services only, its target customers have poor credit or are otherwise vulnerable), and consumer electronics (high-volume sales, risk of chargeback).

The Gray Zone

The “Grey Zone” refers to businesses that are considered risky because of their actual business history. Factors that can put a business in the “Grey Zone” include having a bad business credit score or none at all, having a high rate of chargebacks, being an international merchant, and accepting/dealing with foreign currency .

Businesses considered to be the highest risks are those that are in both the “Red Zone” and the “Grey Zone.” For example, an online gambling business that has repeatedly defaulted on loans and failed to pay bills on time is likely to trigger a red (and grey) flag in the eyes of banks.

What Does This Mean for High-Risk Businesses?

It should be pointed out that being considered high-risk does not necessarily mean that the business has less potential for success or that it’s impossible for the business to be stable and secure. It’s even possible to find great success when starting or operating a higher risk business. The key is to have a solid awareness of what being high-risk means for your business, and for you. If you are able to anticipate some of the challenges, unique requirements, and other difficulties you might face along the way, such as chargebacks and more stringent requirements for compliance, you can more effectively and efficiently keep such difficulties to a minimum.

In Part 2, we’ll take a closer look at some of those difficulties—what being considered high-risk means for your business—as well as some of the solutions that are available to help you and your business succeed despite the challenges of being a high-risk business.