What is embedded finance?

Embedded finance is when non-financial companies offer their customers access to credit through their technology platform. The customers can be individuals or businesses, and the credit can be offered by the company or by a third party. Examples of embedded finance and embedded lending: when an online furniture retailer allows you to pay for your sofa over 18 months rather than paying upfront, or when an HR software provider helps companies provide employees access to money between paydays.

If you haven't heard of embedded lending or embedded finance, you've likely heard of (mostly) synonymous terms like "just in time" lending, headless finance, or "buy now, pay later" (BNPL). Alternatively, perhaps you've seen BNPL options offered by companies like Affirm or Klarna when shopping online.

It's hard to overstate the magnitude of embedded finance. Oracle estimates that the embedded finance market will be $7 trillion over the next decade—an amount that is twice as much as the combined value of the world's top 30 banks today. Simply put, consumer- and business-facing finance is moving away from banks, and it's not likely to return.

It isn't just consumer lending that's affected, though that is probably the most familiar example for many readers. Embedded finance can also be business- and merchant-facing. For example, let's say you run an online business that sells fire pits. Sales have been great all year, but fall's coming soon, and you anticipate a large increase in orders from around the country. How might you finance the purchase of new inventory before the season starts? Well, you may be able to obtain credit from your payment processor. The payment processor will look at your transaction history, decide your business is creditworthy, and offer you a loan so that you can stock up on merchandise in advance.

Now, imagine the process a consumer or business might have had to go through to secure credit under the traditional banking model. It would likely have been slow and cumbersome, and the purchasing decision would have blocked on the credit decision. Whether purchasing a sofa or financing an increase in production, it is often faster, cheaper, and more convenient for individuals and businesses to secure credit through a non-bank technology platform.

For one thing, there's no interruption of the purchase or operational workflow. Additionally, it's often the case that the technology platform has more and more relevant data on the creditworthiness of the individual or consumer than a financial institution does, which means the borrower ends up with better terms.

Why is embedded finance taking off?

Lightyear Capital estimates that embedded finance will generate over $200 billion by 2025. While there's no one single factor that explains the rise of embedded finance, the key factors for its rise are the customer expectation for flexible financing, the introduction of plug-and-play platforms that enable businesses to lend to customers (i.e., decreased barriers to entry), and the availability of new (alternative, non-financial) data sources that allow businesses to effectively underwrite their customers.

If it's true that "every company will be a fintech company," it's embedded finance that is the most likely first fintech offering for most companies.

What is specialty finance?

Specialty finance is lending that takes place outside of the traditional banking system. If this sounds suspiciously similar to embedded lending, it's because there's no agreed-upon nomenclature for the rapidly growing field of non-bank finance. So what's the difference between embedded finance and specialty finance?

In our experience, the key difference is that you'll hear "embedded finance" used to refer to companies that offer individuals or their consumers credit at the point of sale (let's call them "New School Lenders"), while you'll hear "specialty lending" and "specialty finance" used to describe the interactions between the private credit investors and banks that offer credit to New School Lenders.

To oversimplify things, embedded finance is when a large online furniture retailer allows its customers to select "Pay $100 a month" at checkout. Specialty finance is when that same online furniture retailer goes to a bank for a $50 million credit facility to ensure that it can scale its homegrown BNPL program without having to tie up the cash on its balance sheet.

Seen from this perspective, specialty finance is the "back-end" financing that companies need to set up in order to be able to provide their customers with the "front-end" offering of embedded finance. (Note, however, that specialty finance also covers other types of middle-market lending and is not limited to fintech.)

Embedded finance and specialty finance have a symbiotic relationship and have seen parallel growth trajectories. Embedded finance grew because it allowed merchants and other companies to offer their customers flexible, rapid financing outside of the traditional banking ecosystem. Specialty finance grew because banks and private credit firms wanted to underwrite fintech platforms (and other corporate borrowers) with asset-based finance rather than revenue-based finance (outside of the existing capital markets ecosystem).

Want to learn more?

Embedded finance can help non-finance companies establish new revenue streams and differentiate themselves from competitors. However, entering the world of embedded finance also requires companies to quickly develop new competencies in debt capital planning and management. If you're interested in learning more about software that can help you accelerate and derisk your embedded finance operations, just request a demo of Finley. We'd love to chat!

All information presented herein is for informational purposes only, and Finley Technologies, Inc. does not assume any liability for reliance on the information provided. Before making any decisions that may affect your business, you should consult a qualified professional advisor.


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