Fraud Awareness for Small Businesses: Merchant Fraud

"Fraud is the daughter of greed." – Jonathan Gash

Fraud isn’t always obvious. While most business owners worry about being scammed by a dishonest customer or vendor, one of the biggest unseen risks is merchant fraud—when entire businesses are created for the purpose of committing fraud. Whether you realize it or not, these schemes can impact your business, from damaging your industry’s reputation to making it harder for you to access financing and partnerships.

What is Merchant Fraud?

Merchant fraud occurs when a business—or something that looks like a business—is set up to process fraudulent transactions. Sometimes, these businesses are completely fake; other times, they start as real operations but get taken over or misused for fraud. In either case, financial institutions, payment processors, and lenders respond by increasing their risk controls—making it harder for legitimate businesses to prove their credibility.

Common Types of Merchant Fraud

1. Shell Companies & Fake Invoices

Some fraudsters create shell companies—businesses that exist only on paper—with no actual operations, inventory, or customers. These fake businesses can be used to:

• Launder money by processing fake transactions.

• Secure loans or lines of credit they have no intention of repaying.

• Issue fraudulent invoices, sometimes to real businesses, in an attempt to extract payments.

Red Flag for Business Owners: If you receive an invoice from a company you don’t recognize or can’t verify, it may be an attempt at fraud.

2. Transaction Laundering

Transaction laundering is when a business with a legitimate merchant account allows another, often illegal, business to process payments through them. This can happen in several ways:

• A fraudster sets up a business, then secretly processes payments for illegal activities.

• A struggling business allows outside parties to use their payment system in exchange for a cut.

• Stolen credit card information is run through a seemingly legitimate business before being cashed out.

Impact on Small Businesses: If you unknowingly work with a supplier or service provider engaging in transaction laundering, your payment processor could flag your business as high-risk or even suspend your account.

3. Bust-Out Fraud

Some businesses engage in what’s known as bust-out fraud—a scheme where a company builds creditworthiness over time, takes out large amounts of debt, and then disappears overnight. This leaves lenders and suppliers with massive unpaid balances.

What This Means for You: If your industry has a high occurrence of bust-out fraud, lenders may be more hesitant to offer financing—even to legitimate businesses.

How Merchant Fraud Affects You

Even if you’re not committing fraud, the perception of risk can affect you in ways you might not expect:

• Stricter Lending Criteria – Banks and lenders scrutinize industries with a history of fraud, making it harder to get approved.

• Payment Processor Issues – If your industry has frequent fraud cases, you may experience higher fees or even account suspensions.

• Damaged Reputation – If a fraudulent business in your industry collapses, customers may be more hesitant to trust businesses like yours.

Protecting Your Business

• Verify vendors and suppliers – Make sure businesses you work with have a real presence, customer history, and legitimate operations.

• Monitor transactions closely – Unusual or high-risk payment activity can be a sign that someone is trying to use your business for fraud.

• Maintain strong documentation – Keeping accurate records can help prove legitimacy if you’re ever questioned by financial institutions.

Final Thought: Fraud is a reality, but awareness is your best defense. Understanding the tactics used in merchant fraud can help protect your business from direct financial losses—and from the reputational damage that comes with being in an industry affected by fraud.

Stay tuned for the next post in our Fraud Awareness series, where we’ll dive into Loan and Grant Fraud and how small businesses can avoid getting caught in financing scams.