1. What’s embedded financing and how does it work?
Embedded financing is the seamless integration of financial services (such as credit products) into a traditionally non-financial service/product/platform or app (the “indirect model”). More broadly speaking, embedded financing also refers to the new type of lending service that is embedded into the borrower’s system/platform (the “direct model”).
Under the “indirect model”, embedded financing infrastructure enables customer-facing digital platforms (the Hosts) such as e-commerce platforms, payroll systems, and ridesharing platforms to “embed” financial services in their platform and offer it to their customers in-context and entirely within their platform (i.e., without having to redirect the customers to a third-party lending platform). It enables “native” FinTech experiences “inside” the non-FinTech digital platforms, which are the closest to the customer.
This new model creates a win-win scenario for every stakeholder. For the non-FinTech digital platforms (the Hosts), creating a fintech arm within the organization requires significant capital expenditure, multiple years to build, and a long time to be profitable. Embedded financing infrastructure reduces the barrier for these digital platforms to natively offer financial services to their customers. With the embedded financing solutions, the Hosts can drive their revenue up and potentially improve their user retention. Users of the Hosts’ services (e.g., consumers, employees) can more easily apply for credits/get loans.
Another type of embedded financing is what I call “direct model”. Under this model, a Host is no longer needed. The embedded financing infrastructure will be integrated into the borrower’s (usually the borrower will be a business in this model) backend system, read the borrower’s financial data in real time, and display lenders’ offers without requiring the borrower to file an application at a third-party website.
To sum it up, the biggest difference between embedded financing and the traditional non-embedded financing is the convenience for the borrower to get a loan.
Embedded – lenders move closer to borrowers, making it easier for borrowers to apply for loans and lowering the financing cost by having a more comprehensive understanding of the borrower’s financials after gaining direct access to the borrower’s financial data (e.g., under the direct model).
Non-embedded – lenders wait for borrowers to submit loan applications at the lender’s website and then make a decision.
At a very high level, embedded financing is more an innovation on the product strategy side than a disruptive new technology. The fundamental technologies enabling these embedded financing solutions have existed for decades, while the embedded financing startups came up with these new business models and products to increase convenience and/or lower the financing costs for borrowers by building a closer connection between the lenders and the borrowers.
| Type | Indirect | Direct |
| Typical borrowers | Consumers, employees, small merchants | SMEs with a stable recurring revenue |
| Typical lenders | Consumer loan providers, small business loan providers | Small business loan providers |
| Lender examples | Business loan/working capital providers such as Credibly, FORA Financial, Payability, bfs capital, ondeck, Lendr, and many more. (See figures below) | Business loan/working capital providers such as Credibly, FORA Financial, Payability, bfs capital, ondeck, Lendr, and many more. (See figures below) |
| Typical Hosts | D2C brands online shops, e-commerce websites, marketplaces, payroll systems, etc. | N/A |
| Typical embedded financing product | A whitelabelled API integrated into the Host’s website (e.g., checkout page) A whitelabelled API integrated into the marketplace’s (the Host’s) merchant dashboard | A platform that connects the borrower’s backend system (financial system), reads its financial data in real time, displays loan offers from lenders, and collects repayments from the borrower’s revenue directly |
| Embedded financing startup examples | Lendflow | Pipe, Bridg, re:cap |
| Value proposition | To borrowers: enable them to get “loans” conveniently To hosts: drive revenue and increase user retention | To borrowers: help them to lower financing cost and get loans more conveniently |
| Stakeholder | Major responsibilities |
| Borrowers (e.g., consumers, e-commerce merchants, early-stage SaaS companies) | Give access to financial data (for business borrowers) Choose the embedded financing option as payment method (for consumer borrowers) |
| Hosts (e.g., e-commerce platforms, D2C online shops) | Customer (borrower) acquisition |
| Embedded financing platforms | Data integration/collection (tech stack), lender acquisition, initial risk assessment, logistics (loan distribution/repayment collection, legal documents, etc.) |
| Lenders | Underwriting |
2. Evolution of lending marketplace
The embedded financing platforms are essentially building a new type of lending marketplace. There are two reasons why these platforms do not want to become a lender. First, they would love to maintain their status as a “tech company” to achieve high scalability using an asset-light model. Second, there will be potential conflicts of interests between the embedded financing platforms and lenders if the platform becomes a lender itself while providing leads to the other lenders. The other lenders will question if the embedded financing platform will hold the best leads for themselves.
Lending marketplace is not a new idea, and companies such as Lending Club have existed for more than a decade. However, traditionally, the borrowers always need to file an application at the lender’s platform or at the marketplace. With the embedded financing solutions, borrowers do not need to leave their familiar environment (e.g., the D2C online shops, the e-commerce platforms, the payroll systems, or the borrower’s own backend system) to apply for loans.
3. Why does embedded financing make sense and why now?
3.1 Hosts – revenue growth and higher user retention rate
Small brands/platforms do not have the resources to develop their own fintech products (as Amazon and Shopify do), while offering loans to their customers/merchants can help the hosts/channels to retain customers/merchants and increase CLV.
3.2 Supply side (lenders) – lower user acquisition cost, high-quality deals, and increased operational efficiency
First, lenders can acquire borrowers at a lower CAC by partnering with the embedded financing platforms, whose products will be integrated into the hosts’ websites or into the borrowers’ financial systems directly.
Second, for lenders targeting business borrowers (e.g., e-commerce merchants and early-stage SaaS companies), these borrowers are very attractive as they have a very predictable revenue stream with a relatively low risk (for SaaS contracts) and long terms (3-4 months as of MCA versus 12 months for SaaS contracts).
Moreover, for borrowers such as SaaS companies, their contracts are low-risk assets, while they have not been fairly priced in the loan market as SaaS companies traditionally raise funding mainly from equity investors. By working with Pipe-like companies, the business loan lenders can tap into a new and big market.
Lastly, the embedded financing platforms also provide the lenders with automated deal sourcing and payment collection process. Pipe-like platforms will automatically show the applications that match the lender’s criteria and automatically collect the repayments for the lenders, saving lenders a lot of time on collecting repayments.
3.3 Demand side (consumer borrowers) – more convenience
Consumers are always looking for more convenience (purchasing and getting loans happen at the same place) and better purchasing/borrowing experience (seamless borrowing experience within the context).
3.4 Demand side (business borrowers) – increased efficiency and access to cheaper financing
First, there should be a more efficient way to serve the digital business borrowers such as e-commerce merchants and SaaS companies. For traditional small business borrowers such as restaurants, it makes sense to ask them to apply for loans at the banks or loan providers’ websites, as these borrowers are not digitized and it’s hard for the lenders to get their data automatically. However, the new online business borrowers have a full suite of digital systems where their financial and operation data is well recorded. Therefore, these borrowers could be served in a more convenient way.
Second, the early-stage SaaS companies deserve a better non-dilutive financing solution that fairly reflects their risk level. Traditionally, most early-stage tech companies will raise funding from VCs through equity financing, while company-backed debt financing is not popular as debt is a liability and the interest is high. However, the early-stage SaaS companies might not be as risky as the other early-stage startups. They are like utility companies, and their revenue is relatively stable once the contracts are established. Therefore, the cost of the existing financing options – equity financing and debt financing – do not match these SaaS companies’ risk level. The new type of SaaS-contract-backed financing options offered through the embedded financing platforms can be a good alternative.
Lastly, on the macro level, there will be more small-cap SaaS companies, while these companies may find it more and more difficult to raise money from VCs. As most of the big opportunities such as cloud and payment have already been captured by companies such as Amazon AWS, there will be more and more small-cap SaaS companies such as the vertical SaaS platforms (e.g., predictive maintenance platforms for manufacturing, fleet management platforms, property management platforms) and the small-to-medium-cap horizontal SaaS platforms (e.g., data labeling platforms, synthetic data generation platforms, enterprise AI model building/monitoring platforms). These small-cap SaaS companies may not be attractive to VCs due to their capped market potential (VCs are usually looking for high-risk/high-growth/high-reward opportunities) but could be good borrowers for small business loan lenders, who usually look for companies with stable recurring revenue and do not care about growth.
4. What’s next?
4.1 Embedded financing solutions for different verticals
On the consumer lending side, there are already a lot of BNPL (Buy Now Pay Later) companies, and there might not be many opportunities left. The market will be easily dominated by a few companies as these BNPL solutions are just a new type of payment option that can be embedded into any check out page with a few lines of code.
However, the situation will look different on the business lending side, and there could still be many great opportunities for embedded financing platforms for the following reasons.
First, there might not be an embedded financing platform that works for all industries and all use cases because each industry/use case has its own backend systems to integrate. For example, for the payroll use case, the embedded platforms for e-commerce merchants may not work. Instead, the embedded financing platforms need to integrate with different payroll systems or HR management systems or employee benefit platforms. For example, for the logistics industry, the embedded financing platforms may need to integrate into different trucker platforms. For example, for the healthcare industry, the embedded financing platform will need to integrate different provider systems and understand different Current Procedural Terminology (CPT) codes. A great example is Peachy Pay, which I consider to be an embedded financing platform for healthcare. Another example is Walnut.
On the other hand, since it is still in the early stage of embedded financing, no company has developed a one-for-all solution yet. Even if theoretically and technically it is possible to build integrations for different industries/use cases, it will take a long time to do so.
Therefore, it should be fair to expect to see some vertical/use-case focused embedded financing platforms that can grow big.
However, it may be hard to build a vertical embedded financing platform for verticals where there is a very high market concentration. If there is a very high market concentration, it is very likely that the dominant players will build the financing products on their own. For example, for the ride-sharing industry, Uber and Didi Chuxing (Uber for China) have already been offering financial products to their riders and drivers. For example, Flexport, a big player in the freight forwarding and customs brokerage space, is also planning to offer embedded financing solutions to their customers.
Some industry and use case examples are included below.
| Industry/Use case | Host examples | Borrower examples | Product workflow* Indicates where the financing platform is embedded into |
| HR tech | HR management systems, payroll systems, employee benefits systems | Employees | Employees <> HR systems (*) <> Lenders |
| Logistics | Trucker marketplaces | Truckers | Truckers <> Trucker marketplace backend (*) <> Lenders |
| Retail | FMCG distribution management systems | Distributors | Distributors <> Distribution management systems (*) <> Lenders |
| B2B procurement platforms | Restaurant procurement platforms, manufacturing procurement platforms, healthcare procurement platforms | Restaurants, manufacturers, clinics/healthcare professionals | Restaurants, manufacturers, clinics <> Industry procurement platforms (*) <> Lenders |
| Travel & Hospitality | Booking platforms, hotel management systems | Travel agencies, hotel operators | Travel agencies <> Booking platform backend (*) <> Lenders Hotel operators <> Hotel management systems (*) <> Lenders |
| Real Estate | Property management systems, rental payment platforms | Property owners, property management firms | Property owners/managers <> Property management systems (*) <> Lenders |
| Healthcare | Healthcare provider operating systems, healthcare service marketplaces | Patients, healthcare providers such as therapists | Patients <> Healthcare provider backend (*) <> Lenders Healthcare providers <> Healthcare service marketplaces (*) <> Lenders |
4.2 Embedded financing solutions for different markets
Another direction to find future opportunities is to build embedded financing platforms for different geographical markets.
The reasons are fairly simple. First, different geographical markets will have different regulations for the embedded financing platforms. In Europe, companies such as Pipe will need to acquire the “Financial Service Intermediary Business” license that will allow Pipe-like companies to facilitate transactions and money transfer between companies and institutional investors. If the embedded financing platform wants to underwrite loans from its own balance sheet, the regulations become even more different and complicated as the platform will be regulated as a financial institution and face deposit requirements.
Second, different markets have different lender landscapes. Most of the lenders on the embedded financing platforms are small consumer loan or business loan providers. These lenders are usually operated in a very local manner.
Therefore, it should not be surprising to see Pipe for Europe, Pipe for LatAm, Pipe for Southeast Asia, and Pipe for Africa. In fact, we are already seeing many Pipe-like companies – such as re:cap, Bridg, and Lenkie – popping up in Europe.
5. Questions
5.1 What’s the moat for the embedded financing platforms?
As discussed at the very beginning, this is not an innovation driven by new technologies. There is not that much disruptive technology involved in this product. The lending marketplace model (e.g., Lending Club) has existed for long, and the small business loan lenders have been operating for decades. Nothing has been fundamentally changed.
Then what will be the moat for the embedded financing platforms?
Lender acquisition efficiency. For embedded financing platforms, the biggest challenge will be acquiring borrowers and lenders. For platforms using the indirect model, the Host has already done the borrower acquisition part. Therefore, the embedded financing platforms need to compete by acquiring lenders efficiently.
Partner (host) acquisition efficiency. Hosts are channel partners and incentivized to work with the embedded financing platforms, but that does not necessarily guarantee the hosts will proactively approach the platforms. As there are more and more embedded financing platforms, while there might only be a few hosts in every vertical/use case, embedded financing platforms will also need to compete by acquiring Hosts in a very cost-efficient way.
Therefore, a good team of an early-stage embedded financing platform should have some rock stars who do great in building partnerships with marketplaces and institutional investors.
6. Background reading
https://blog.thesharmas.org/2021/01/27/the-future-of-lending/
https://alexdanco.com/2021/03/10/pipe-it-platforms-funding-and-the-future/
https://alexdanco.com/2020/07/28/its-not-debt-its-better-an-interview-with-harry-hurst-of-pipe/
https://alexdanco.com/2020/02/07/debt-is-coming/
https://arfunding.com/industry-news/merchant-cash-advances-vs-invoice-factoring/
https://finbox.in/blog/what-is-embedded-finance-and-how-it-will-change-fintech-in-india/
https://finbox.in/blog/applications-of-embedded-finance-embedded-credit/
https://www.valuepenguin.com/small-business/what-is-merchant-cash-advance
https://www.fundera.com/business-loans/merchant-cash-advance
https://www.nav.com/business-financing-options/merchant-cash-advance/
https://www.nav.com/business-financing-options/invoice-financing/
https://capiche.com/e/software-yearly-discounts
7. Appendix
7.1 More details about how the B2B embedded financing works (Example: Pipe)
- For borrowers (For companies such as Pipe, the borrowers are mostly early-stage SaaS companies with stable recurring revenue)
- Connect your existing systems (e.g., financial/accounting system) to Pipe and within hours you can be approved to start trading your recurring revenue/contracts
- Once approved, you’ll see your portfolio of customer contracts ready to trade.
- See real-time bids (from investors/lenders) for the annualized value
- Accept one bid and get cash upfront
- Pipe automatically deposits the cash from investors into your account the same business day that you make the trade.
- Pipe withdraws the payments each month once your customers pay you and distributes the funds to the investors.
- For lenders
- Set your criteria (e.g., CLV/CAC ratio, ARR) for the SaaS contracts that you want to bid.
- Submit your bid for the contracts being sold on the platform.
7.2 A comparison among different financing solutions for SaaS businesses
| Merchant Cash Advance (MCA) | Invoice Factoring | Cash Advance (by selling future SaaS revenue, using the direct model embedded financing solutions) | Cash Advance (by collecting upfront cash from customers) | Venture Debt | |
| Lender | Business loan providers | Business loan providers | Business loan providers | Borrower’s customers | Venture debt providers |
| Typical borrower | Small businesses that want quick cash advance and have stable sales from credit/debit cards | Small businesses that have uncollected invoices | Early-stage SaaS companies that have long term contracts | SaaS companies that have long term contracts | Tech startups that want to get cash without diluting equity |
| Upfront Cash | X | X | X | X | – |
| How it works | Upfront cash in exchange for the right to receive a percentage of future revenue | Upfront cash in exchange for the right to collect the payment of unpaid invoices | Upfront cash in exchange for the right to receive future recurring revenue from selected contracts | Upfront cash in exchange for the right to receive future services | Debt based on the company’s overall risk level |
| Payment flow | Customers > Borrower > Lender | Customers > Lender | Customers > Borrower > Embedded financing platform > Lender | Customers > Borrower | Borrower > Lender |
| Interest | – | – | – | – | X |
| Repayment Plan | X(e.g., 10% of daily credit card sales) | – | X(e.g., the cash flow for the contracts sold for the next 12 months) | – | X(Based on the venture debt agreement) |
| Discount on Unpaid Invoice or Future Account Receivable | X(e.g., your repayment amount will be your “loan” multiplied with the factor rate. For example, if you advance $100K, you will need to repay $120K from your future revenue if the factor rate is 1.2) | X(e.g., you get cash up front that equals to 80% of the face value of the unpaid invoice) | X(e.g., you get cash up front that equals to an 80% discounted 12-month future revenue) | X(e.g., you get cash up front that equals to an 80% discounted 12-month future revenue if your customer pays monthly) | – |
| Base of Credibility | Projected future revenue of borrower | Borrower’s accrued revenue + Creditworthiness of the borrower’s customers | Projected future revenue based on the sold contracts + Creditworthiness of the customers of the sold contracts | Borrower’s future capability to provide service in the future | Borrower’s overall risk level |
| Overall Cost | High | Medium | Low | Medium | Medium |
| Cost Range (annualized rate) | 10% – 350% | 15% – 35% | TBD | 20% | 13% – 17% |
| Time to apply | Days | Days | Hours or real-time | Real-time | 2 – 8 Weeks |