The first wave of the Fintech revolution was mostly characterised by the emergence of companies focused on infrastructural, payments and transactional systems improvements in both the consumer and B2B sector.
Global fintech ‘Unicorns’ like Paypal, Stripe, Square, Adyen and Klarna emerged, as the focus was on overhauling slow and archaic payment systems through faster, more effective technological and digital solutions.
This allowed for the rapid growth in eCommerce globally and the scaling of internet businesses at speed.
At the same time, traditional banking was also heavily disrupted by digital-only transactional banking brands like Revolut, Monzo and B2B focussed brands such as Starling in the UK.
This is only a very modest snapshot of the enormous number of new world banking providers that have emerged over the past decade or so. Though mostly focussed on the retail banking market, this impacted the B2B sector as well.
Embedded finance refers to the integration of financial services into non-financial platforms and applications. This integration allows businesses in various industries to offer financial products and services seamlessly to their customers, enhancing user experience and convenience. They don’t need to be a financial institution or hold a banking licence to offer these additional services to their customers.
A recent example of this has been the emergence of ‘BNPL’ (Buy Now Pay Later) in the consumer retail sector. Clearly a fairly straightforward integration of financial services, BNPL at its core is based on straightforward ‘static’ credit rating on smaller ticket items at massive volume levels, deployed with high interest rates that reduce exposure to potential default. It is as you might imagine, a lucrative business.
The concept of embedded finance enables fintech companies to extend their reach beyond traditional financial institutions and reach customers in new ways. It also enables non-financial companies to offer financial services without having to become licensed financial institutions themselves.
Several factors contribute to the potential of Embedded Finance
Convenience: By integrating financial services directly into their platforms, businesses can offer a one-stop-shop experience for customers.
Personalization: Embedded finance allows companies to leverage user data to provide tailored financial solutions that meet individual needs.
Wider Reach: Non-financial companies can use embedded finance to cater to underserved markets and expand their customer base.
Partnerships: Fintechs can collaborate with various industries, leading to innovative financial solutions and new revenue streams.
Competitive Advantage: Early adopters of embedded finance may gain a competitive edge by offering differentiated and holistic services.
Haven’t tech investments slowed dramatically I hear you ask?
Is there really another wave of innovation in Fintech on the way?
It is true to say the markets have certainly gone slightly soft on Tech Brands over the past 18 months. In many cases, investors have reduced their exposure in Tech brands due to lower levels of growth versus the overly optimistic forecasts being bandied about in the period during and immediately after the apex of the COVID-19 pandemic.
There is significant evidence that 2021 was in fact an outlier, the market was probably far too bullish.
In 2022, funding for private tech startups in Europe declined 22% to $83 billion from $106 billion in 2021. That pattern is set to accelerate as funding for Europe’s venture-backed startups is forecast to decline further to $51 billion in 2023.
(Source: Ryan Browne, CNBC, June 2023: “European Startups funding to drop a further 39% this year as tech rout continues”)
According to Browne, “Technology firms have come under huge strain over the last year and a half, with companies being pushed to prioritize profitability over growth at all costs”.
Therein lies the crux of the matter. For years, the metric of success has been demonstratable ability to scale, acquire customers, technological advancement. The cold hard reality of delivering profitability is what VC’s now demand from the Tech Sector.
There is no doubt that there is a ‘readjustment’ occurring in the VC markets. But the news it not all bleak for technology.
In its very recent report, ‘The state of European Tech First Look 2023’, Global Venture Capitalist firm Atomico commented that “However, when looking at the tech slowdown in H2’22, and comparing those numbers to the first half of this year, we see a degree of stabilisation”.
In addition, 2023 has seen the true emergence of a transformative technology that is seeping into every part of human life at a frightening speed – Generative Artificial Intelligence (AI). Who hasn’t heard about Chat GPT?
Atomico reports evidence of a change in sentiment:
“There are important structural green shoots appearing already: Europe is closing the early-stage funding gap with the US; Europe is increasing its investment in AI companies…”
This year to date, Generative AI companies have captured 35% of all funding going to European AI/ML companies, the highest share ever, having previously expanded from 1% in 2019 to 5% in 2022
Atomico are predicting an “AI supercycle to drive a golden age of innovation. European tech will have a key role, and the potential for huge value creation.”
Combining AI advancements with the fact that Fintech still retains the #1 position in terms of the sector that has attracted the most investment again in 2023, those fintechs that can show they are working towards profitability, while leveraging the power of Artificial Intelligence to effect real disruption are set to be the clear winners over the coming 18 months – 2 years.
As many of the legacy infrastructural issues have now been resolved through the rapid digitisation of the banking system, the focus switches to deploying additional value-added services that can benefit from this new, improved digital environment.
As mentioned earlier, BNPL in the Consumer sector is an example of one such value-added service delivered via Embedded Finance.
A number of factors have contributed to the growing theory that the latest fintech wave may revolve around Business Lending as the next major use of Embedded Finance.
The introduction of EU wide standards such as PSD2 in 2015 facilitated the emergence of what is known as ‘Open Banking’, where banks and other financial institutions, with their customers approval, can grant open access to bank account information by third party providers in real-time through the use of APIs (Application Programming Interfaces). Funders no longer need to review company performance based on outdated historic accounts.
Real time access to customer bank accounts allows for ‘right now’ analysis of how a company is performing, the digitization of the data also means more accurate trending conclusions can be made about likely future patterns of trade.
Like so many other areas, the adoption rate of companies to operating their accounting in the cloud has been rapid. Once the domain of the larger enterprises, the increasing trend of small and medium sized companies collaborating with e-commerce players and integration with other online applications, like automated bank feeds, electronic billing and payments, among others, has catapulted the adoption of accounting software.
According to a 2022 report by the Aberdeen Group, 70% of companies will have adopted to Cloud-based accounting software by the end of 2023.
This makes it possible for lenders to access real-time accounting information from customers. This allows funders to make much more informed funding decisions based on both previous performance as well as facilitating predictive modelling to dimensionalise the likely future performance of companies.
More importantly, these decisions can now be automated.
Safe extension of credit relies on the quality of the credit engine. For years, a combination of static credit rating and historic accounts and banking information have been the basis on which business funding decisions are made (it still is in many more traditional banks and funders!).
Combining open banking and accounting information brings a new level of transparency and quality of data to arrive at credit decisions. Layering AI based dynamic credit scoring brings a whole new level of comfort to funders, way beyond the traditional static credit scoring systems of the past.
Innovative new world rating agencies like Italy’s ModeFinance are leading the way on AI based credit scoring. Combining financial expertise with technical knowhow, their flagship product, the Tigran Risk Platform, offers an AI powered platform to rapidly evaluate company information and its own proprietary credit scoring model – the MORE score. (Multi Objective Rating Evaluation).
Tigran’s modular structure overturns the traditional approach to credit risk management, combining all stages of the credit decision-making process into a single framework, from pre-feasibility and due diligence to final approval.
This end-to-end fully automated 360° evaluation of companies combining accounting, banking and AI features is the fuel that will power fintech lenders in an Embedded Finance world and gives them the confidence to provide their services via 3rd party non-financial service-based companies.
Successful mitigation of risk at scale using these sophisticated technologies that provide holistic credit profiles will make Embedded Finance the most obvious channel for Lending Fintechs to grow at supersonic levels.
The more traditional banking players, aware that perhaps they are not best placed to provide the speed of innovation that the modern consumer demands are instead looking to these newer, more innovative fintechs, to provide it for them.
Why? In many cases these fintechs are laser focussed on very specific elements of the banking and finance eco-system and ways of improving it. In some cases, they are operating outside the restrictions of a banking licence. Collaborations, partnerships or outright acquisitions of these fintechs are just some of the ways the more traditional financial services giants are staying relevant in a very changed financial world.
This is particularly true in the case of alternative forms of business funding, where the legal status of traditional banks as a lender in the first instance restricts them from offering some of the more innovative forms of funding like Revenue Based Finance or Invoice Finance.
So, what is the market potential for Embedded Finance. According to Simon Torrence, Founder & CEO, Embedded Finance & Super App Strategies, Embedded Finance offers one of the most exciting new digital growth opportunities to incumbent financial institutions: an addressable market worth over $7 trillion, or roughly double the market value of the world’s top thirty banks today.
Given that B2B Sales dwarf B2C sales, it is clear that Embedded Finance for B2B is set to grow at an exponential rate. In research conducted by Dealroom, in Association with ABN AMRO, the two areas set to benefit the most from this are Business Lending and Insurance.
This convergence, driven by rapid improvements in Financial Technology has the potential to reshape the lending industry as we know it.
Looking ahead, the trajectory of lending fintech’s points toward ubiquitous embedded finance. As more and more fintechs recognise the potential of embedding their solutions within the digital ecosystem, the lending landscape will continue to evolve, offering greater accessibility, convenience, and efficiency.
Just as consumer focussed lending has focussed on the point of sale or checkout area of eCommerce, B2B lending in the digital ecosystem is starting to realise that the game has changed, there is a new playing field. Doesn’t it make far more sense to align with existing homogenous groupings and networks of businesses, rather than the traditional method of attempting to build a standalone, singular branded ‘front door’ and try to drive customers towards it?
That is the behaviour that you would expect from a traditional bank – build a digital brand to compete with the already existing banking system. This is a slow and expensive approach, not aligned with the pace of change we are seeing in the global B2B lending market. It also means a focus on the banking sector, and not where the focus should be – the businesses that badly need more agile, convenient and faster alternatives.
We are seeing that the future battle for B2B lending will take place in two distinct arenas: within existing Financial & Accounting Software and B2B Platforms.
Probably the most natural ‘fit’ for embedded finance is with financial & accounting cloud-based software providers like Xero, Sage & Quickbooks. Having a source of ‘ready to go’ funding that allows users to access any shortfalls in cashflow at short notice from the same platform they are managing cashflow makes lots of sense for all 3 parties – the finance provider, the accounting platform and the end user.
These are digital marketplaces or online platforms that facilitate transactions and interactions between businesses rather than between businesses and consumers. There are several main types of B2B platforms, each catering to specific business needs and industries. Here are some of the main types:
eCommerce and Procurement Platforms: These platforms serve as digital marketplaces where businesses can buy and sell products and services. They often include features like catalogue management, order processing, invoicing, and payment integration. Examples include Alibaba, Amazon Business and Shopify.
Supply Chain and Logistics Platforms: These platforms focus on optimizing supply chain processes, such as inventory management, order fulfilment, and logistics. They help businesses streamline their operations and improve efficiency. Examples include SAP Ariba, Oracle Procurement Cloud, and JDA Software.
Sourcing and RFx Platforms: These platforms are used to manage sourcing processes, request for proposal (RFP), request for quotation (RFQ), and other procurement-related activities. They help businesses find suppliers, evaluate bids, and negotiate contracts. Examples include Coupa, GEP SMART, and Jaggaer.
Collaborative Commerce Platforms: These platforms enable collaboration and communication between businesses throughout the supply chain. They often include features like document sharing, communication tools, and project management capabilities. Examples include TradeShift and Exostar.
Industry-Specific Marketplaces: Some B2B platforms cater to specific industries or niches, offering tailored solutions for the unique needs of those industries. Examples include ThomasNet for manufacturing and GlobalSpec for engineering.
Financial and Payment Platforms: These platforms focus on facilitating financial transactions between businesses, including electronic invoicing, payment processing, and trade financing. Examples include Tungsten Network and Basware.
Vertical Integration Platforms: These platforms offer end-to-end solutions for specific industries, connecting various stages of the value chain, from production to distribution. Examples include Fishbowl (for inventory management in manufacturing) and ShipMonk (for e-commerce fulfilment).
Market Intelligence and Analytics Platforms: These platforms provide businesses with market insights, data analytics, and business intelligence to help them make informed decisions. Examples include Dun & Bradstreet and Nielsen.
HR and Workforce Management Platforms: B2B platforms in this category focus on managing human resources, workforce scheduling, talent acquisition, and other HR-related functions. Examples include Workday and Kronos.
API and Integration Platforms: These platforms facilitate the integration of various software systems used by businesses, allowing them to streamline processes and share data seamlessly. Examples include MuleSoft and Zapier.
Proprietary Large Enterprise Platforms: A hybrid of many of the above also exists for larger National and Multi-National Companies, to manage their suppliers, manage RFI’s, manage project and make payments. In many cases, the ‘price’ of participation by the supplier with these blue-chip clients is having to contend with extended credit terms. This is where Embedded Finance can play a significant role – allowing suppliers to access funding earlier than the contracted terms, while allowing the debtor to maintain the credit terms they wish to implement.
Any platform that deals directly with cashflow management, project finance or invoice payment are clearly the most fertile. That would point towards the following platforms as the most appropriate for lending fintechs to focus on embedding their solutions with, as this would mean that the end user is managing the solution to a cashflow problem at source without having to leave the platform:
This all makes a tonne of sense from the perspective of lenders and platforms, but what about the end user, those businesses who are in the market for funding? What’s in it for them?
By being able to access tailored lending solutions within existing financial management systems, businesses can unlock their true potential, enhance cash flow management, and thrive in an increasingly competitive marketplace.
Naturally time is of the essence, cashflow shortages can arise suddenly and with little warning. The fact that this form of lending is embedded into an existing platform and connected to both their financial and banking software means funding decisions can be made far faster.
Lengthening credit terms are a feature of modern trading in business-to-business, especially with larger multi-national debtors. It can be part of the price of securing continuous contracts with these blue-chip debtors. Embedded receivables financing can remove this issue instantly. Platform Users can trade their outstanding invoices and secure up to 90% of the value of the invoice instantly. Have access to on-platform track record and performance means embedded finance providers can turn this form of finance around in as little as 24 hours!
Certainty of Funding
Having a continuous ‘360 view’ of how a business is performing, overlaid with AI capability and dynamic credit scoring allows funders to introduce innovative funding options like for example, a rolling ‘Line of Credit’ solution with confidence. Line of credit is a pre-approved ‘always on’ form of finance designed to replace overdrafts & business loans that businesses can draw down whenever they need it. Precisely the kind of innovation only made possible through financial technology.
One of the bug bears of business financing is the level of friction that exists in the process. Long legal process, due diligence, anti-fraud, slow approval processes all make applying for finance something of a drudgery for business owners and a serious interruption and distraction from day-to-day operations, where their focus should be. Access to continuous real-time data on the businesses performance, plus an existing profile of the legal entity means most of these frictions are removed.
The sheer scale of the B2B lending market means it is inevitable that digital disruption in the form of Embedded Finance will in fact be the next wave in the Fintech Revolution.
But which Lending Fintechs are best placed to win? I believe these are the critical characteristics required to truly emerge as a market leader in this new world order:
Clearly automation is the key to scaling any business and B2B funding in an era of Embedded Finance is no different. Creating a credit engine focussed on building a more robust 360 profile of companies and allowing for a quantum leap increase in the volume of credit reviews that can be safely processed is the key characteristic, but this is no mean feat.
This vastly enhanced data rich profile requires the ingestion of data from multiple sources into a common view so that the credit decision making process – and advancing of funds to customers – could be accelerated, without compromising the safety of funders funds and avoiding potential credit events.
Existing – and successful – accounting & banking software and B2B platform providers are not going to work with any finance partner who does not have best in class, API driven technology that adheres to the highest standards in terms of security and data protection. Not so much a differentiator but a basic ‘ticket to the game’.
Potential partners while they will see the obvious benefits of embedded finance, will not want to be subjected to significant levels of disruption to their core operations. Embedded Finance Lenders will need to demonstrate that they can provide a seamless, pain-free integration.
There is an argument that Embedded Finance is a technology opportunity. While that is certainly part of the story, a strong background in the ‘Fin’ aspect of Fintech is also vital. Experience in understanding risk, analytical prowess in evaluating multiple sources of data that lead to making good credit decisions are still necessary, if only to continually improve the data driven engines required to drive the sector forward.
Using the parlance of venture capital and scaling models, will Embedded Finance solve a real life problem?
The short answer is yes.
Lending fintechs are solving cashflow or working capital issues, typically caused by things like extended debtor payment terms, large one-off payments like an insurance bill or a Revenue payment; or unexpected payments which can be as a result of growth for example, having to fund a newly won contract.
Making funding available to them integrated into platforms and software they already use has the potential to revolutionise how businesses manage their cashflow in the not-too-distant future!
At Financefair, we believe that there is a systemic failure in traditional funding. Businesses struggle to find unrestrictive funding to accelerate their growth. Our goal is to give growing businesses ‘the freedom to fund their own future’, giving them back control of their financial destiny. We do this by removing friction from the funding process, reduce restrictions and create a faster, fairer and more convenient and unfragmented funding journey.
By making our range of innovative funding solutions like Line of Credit and Revenue Based Finance, available to be embedded in 3rd Party Partner Platforms, we are giving ambitious and growing businesses ‘the right funding at the right time and, more importantly, in the right place’.
This article was written by
Head of Trading & Partnerships