Merchant of record. VAT. Payment fees. Stripe or Paddle?

Updated April 2023

If there's one thing that I've learned in six years as the founder of a payments company, it's that most founders are confused about what they need and what they'll actually end up paying when it comes to payment processing. I come across threads like this daily, where founders ask questions like:

• Should I use Stripe or Paddle?
• I'm based in Europe—what do I need to handle VAT?
• What does "Merchant of Record" mean?
• How much am I going to end up paying for payment processing?

I set out to write a guide to make sense of it all—what I found in the process surprised me.

The vast majority of founders—many of whom were experienced founders that vehemently insisted that they knew exactly what they were paying for payment processing—didn't know the actual effective rate they're currently paying to process payments.

Let's make sense of this topic once and for all so you know what you need and what you'll pay, starting with a few important definitions.

Merchant of Record

A merchant of record (MoR) is the entity that is authorized, and held liable, by a financial institution to process a consumer’s credit and debit card transactions. The MoR is also the name that appears on the consumer’s credit card statement.

VAT (Value Added Tax)

VAT is a tax that's applied to most goods and services bought for consumption or use in the European Union.

As it pertains to selling subscription based digital products there are a few important items to consider:

• First, VAT is sometimes included in the total cost of an item rather than being calculated on top of the advertised price of the product or service. This is often referred to as tax inclusive or tax exclusive pricing.
• Second, there are additional specifics in terms of how VAT is displayed at checkout and on invoices that need to be considered in order to be compliant with EU regulations.
• Finally, there are thresholds for each country in the EU—if you're processing less than these amounts you don't need to worry about VAT at all. Founders in the EU can start processing payments with any product they like without worrying too much about VAT... that is until their sales volume crosses certain thresholds.

With these terms understood, let's tackle the tough questions founders often face.

Should I use a Merchant of Record?

There are a growing number of companies out there—like Paddle and Gumroad—that act as a merchant of record on your behalf. If you choose one of these products to process payments for your business, your customers are technically transacting with these businesses rather than yours. There are both pros and cons to this to consider:

Pros

• The primary benefit of using a merchant of record is convenience around VAT—they'll handle VAT for you. They remit all taxes and paperwork then send you the remaining funds—in essence these companies issue your business a payout as if you were an affiliate after they've paid the required taxes. This is particularly useful if you're an individual creator without the resources required to file corporate taxes in Europe.

Cons

• You'll pay a premium price to work with a merchant of record. For example, Paddle charges 5% per transaction and Gumroad charges 10% per transaction plus Stripe fees. But in either case, there's fine print—if you're selling subscription products internationally, you'll be charged at least another 2% on top of these fees. That means paying fees of 7%-14% per transaction is very common when using a MoR.
• Customers will see the name of the merchant of record on their bank statements rather than the name of your business. This is a common source of confusion that you'll need to plan to address. It's a substantial enough issue that an awful lot of Paddle's website is devoted to deflecting support volume from customers trying to figure out why they were charged by Paddle.
• You'll be subject to slower approval processes when you start your business. A merchant of record assumes responsibility for all of the products and services sold via their platform—as a result they have slower approval processes to get started.
• You open your business up to significantly higher platform risk. If a merchant of record sells a product on their platform that's not permitted, all sellers that use the platform are at risk—your ability to process and collect payments can be shut down altogether. It's worth educating yourself on the platform risk associated with merchant or record payment processors.

My own two cents—if you're the founder of a start-up in the EU that sells one-time products, I think the convenience offered by using a merchant of record makes a lot of sense as you're getting your business off the ground. But if you sell subscription based products, I'd be uncomfortable paying 7%-14% of my revenue in perpetuity for the convenience a merchant of record affords.

Also, it's important to note that Paddle can only be used by founders of SaaS companies. That's not the case with Gumroad—I think it makes a ton of sense that Gumroad acts as a merchant of record given their focus on processing payments for individual creators.

How much am I going to end up paying in payment processing fees?

Let me state this outright so there's no confusion around this:

"Stripe fees" are not created equal!

One of the most common misconceptions in the start-up world is that Stripe fees are simply 2.9% + $.30 per transaction. I was able to show almost every single founder that I spoke to in the process of writing this post that this is not what they're currently paying for payment processing, despite the vast majority thinking that this was the full rate they are paying on each transaction.

This is not a criticism of Stripe—Outseta is a Stripe Verified Partner and given the complexity of what they offer I think their pricing is both fair and transparent. But it is to say that the assumption that "Stripe fees" are all the same regardless of the products you use to process payments is flat out wrong. If this is an important topic to you, the devil is in the details.

Any product that creates "subscriptions" in your Stripe account uses Stripe Billing—and you're being charged extra for it

Whether you're using Stripe's own tools or third party membership software, if "Subscriptions" are being created in your Stripe account you're paying extra fees to use Stripe Billing. This ranges from an additional fee of .5% to .8% per transaction, meaning that 2.9% per transaction just became 3.4%-3.7% at a minimum. Let me be very clear about this, because this has surprised the vast majority of founders I've chatted with:

• Stripe's own billing tools aren't free—you incur additional charges to use them.
• Membership software products that create subscriptions in Stripe pass these additional fees on to their customers.

You won't find these fees if you look at your Stripe fees at an individual transaction level—they're billed at the account level. You can find these fees within your Stripe account by going to All Transactions.

The takeaway here is simple—look in your Stripe account and if you see "Subscriptions" then you're already paying for Stripe's billing products. This is even more important if you're actively evaluating membership management software. Most vendors, Outseta included, charge a fee that ranges from 1% to 5% in addition to "Stripe fees." Customers often evaluate products largely against these additional fees, but almost never stop to consider that "Stripe fees" may be different between products.

If you use any product to process payments that creates subscriptions in Stripe, you'll pay at least .5% to .8% in higher fees on every transaction.

Additional differences in Stripe fees seen at the individual transaction level

A closer inspection of your individual transactions can also reveal significant differences in what you're paying as Stripe fees. There's a lot of nuance here and it's up to you, as the consumer, to dig into what's actually being charged. Here's a specific transaction from one of the most popular membership software providers:

In the case of this particular transaction, the Application Fee represents the additional fee paid to the membership software provider. It's very clearly 1% in this scenario.

But the Stripe processing fees of $10.03 aren't as clear—it's very easy to look at this transaction and just assume it's the standard 2.9% fee. If we take out the $.30 per transaction fee, the Stripe processing fees are $9.73. This represents a 3.9% fee rather than a 2.9% fee—easy to miss, but undoubtedly higher than the assumption that all "Stripe fees" are 2.9% + .30 per transaction.

Some additional circumstances to be aware of when it comes to what you'll pay:

• Standard Stripe fees vary by geography. For example, in the US credit cards incur costs of 2.9% + $.30 per transaction. For cards in Europe, standard fees are 1.4% + .25€ per transaction.
• Cross border transactions typically incur additional Stripe fees between .8%-1.2% per transaction. This makes sense, as Stripe incurs additional costs for these transactions and passes the costs along to you. But it's worth noting that this does raise the effective rate that you're paying in processing fees by another 1% or so.
• Stripe has additional products for invoicing, taxes, and other scenarios that may also result in you paying higher fees. Here's a list of those products and the associated fees.

As you can see, there's a lot more to "Stripe Fees" than 2.9% + $.30 per transaction!

So... Stripe or Paddle?

A lot of the founders that I have this conversation with say to me, "It's just crazy that Paddle takes a 5% fee on every transaction... right?"

In short, I'd say no it's not—you're paying for the convenience of not needing to deal with VAT. While I personally wouldn't want to pay a 5%-7% fee in perpetuity, I think it's completely reasonable to do so as you get your business off the ground.

As you consider this question, you also need to evaluate Stripe's alternative to Paddle—as mentioned before, an EU customer is going to get charged 1.4% + $.25€ per transaction. If Stripe's tax product is also used, that's an additional .5% per transaction—but you're still nearly 3% under what you'd be paying Paddle on a per transaction basis.

Stripe's tax product is fantastic in that it handles VAT calculation and reporting for you, you still need to actually remit your taxes. This isn't done for you as it is with a merchant of record, so you'll likely need to expend your own time or hire someone at additional costs to file your taxes. And then there's also additional Stripe fees that could be incurred aside from just their tax product, so the effective rate that you end up paying may creep up close to 5% anyways.

My hope is this post arms you with the information needed to look at what you'd actually be paying Stripe versus Paddle.

What about Outseta?

I started digging into this topic because for the past few months we've been wrestling with arguably the most difficult product decision we've had to make in Outseta's five year history. We originally set out to build Outseta largely because there wasn't any way to create subscriptions in Stripe when we started building—we set out to build the product we wanted and needed as SaaS founders ourselves!

Stripe would start building their own subscription management and billing tools about two years after we launched Outseta, but by that point we'd already built our own subscription management and invoicing features upon which Outseta relies today. This also has it's own pros and cons.

Pros

• We have the flexibility to offer any product types and billing scenarios we want. There are a bunch of billing scenarios that we support that Stripe doesn't, on which we win business.
• We don't use Stripe's Billing products today, so we can offer substantial savings to our customers versus competitors that do use these products under the hood (which is the vast majority of our competitors).

Cons

• We need to continue to maintain our own subscription management and invoicing tools.
• There are a good number of products in Stripe's ecosystem that work "out-of-the-box" with other tools that use Stripe Billing. We can still integrate with most of these tools, but it requires more effort.

We now have a significant competitive advantage as a result of building this functionality ourselves—we don't pass the costs of Stripe Billing on to our customers as the vast majority of our competitors do. In addition, I was surprised to see how much some of our competitors are charging in addition to Stripe fees—often 2%, 3%, or 4%. Frankly, I think that's kind of nuts—we're committed to never charging more than 1%, and for our 1% fee you also get our CRM, email, help desk, and reporting tools.

And a final difference—these additional fees are almost always taken out at the point of the transaction as Application Fees. As I showed earlier, that makes it easy to miss how much you're actually paying in total fees to a membership software provider. Instead, we don't take our 1% fee out as part of the transaction—we directly bill our customers for the 1% fee each month based on their payment volume.

Honestly, this probably hurts us because we're deliberately sending our customers an invoice that shows the total payment processing fees that they're paying to Outseta. That can look like a big number but it's almost certainly substantially less than fees captured at the point of the transaction. Based on all the confusion around this topic, I'm happy that we're overtly transparent with our fees.

Here's a very common illustrative example for a US-based customer:

Outseta

• Standard Stripe fees of 2.9% + $.30 per transaction
• 1% fee (to Outseta)
• Total fees: 3.9% + $.30 per transaction

Other membership software providers

• Standard Stripe fees of 2.9% + $.30 per transaction
• Stripe Billing fee of .8% per transaction
• 2% fee (to membership software provider)
• Total fees: 5.7% + $.30 per transaction

While Outseta's pricing is a huge advantage for our customers—and frankly, something we weren't entirely aware of until now—it's worth note that we still have work to do to better handle VAT for our customers in Europe. This is currently our #1 product priority and something we're working closely with the team at Stripe on.

If you have questions on any of the material covered in this article, we'd love to hear your feedback. We hope this post help clear up a lot of the confusion around these topics that founders often struggle with!

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In addition to this post, we published a deeper exploration on the topic of Paddle vs. Stripe, when to use a merchant of record, and global sales tax compliance. This is a rapidly changing topic that we'll continue to cover on an ongoing basis.