How Embedded Finance is Enabling Companies to Become FinTechs
Angela Strange, general partner at Andreesen Horowitz (and fellow Canadian!), proclaimed that in the not-too-distant future, “every company will be a FinTech company.” The spirit of her statement is correct! Embedded finance is one of the most disruptive themes in FinTech as it is redefining how we collectively interact with financial services.
Embedded finance is the concept where nonfinancial companies offer financial products without requiring their customers to separately access a traditional financial institution. The financial product or service – such as payments, lending, banking, insurance, or investment management – is ancillary to the underlying sale and is only purchased by the consumer at the time of need. The nonfinancial company still retains control over the customer journey and experience, while the FinTech or financial institution distributes its products through the nonfinancial company’s platform. For consumers and companies, acquiring or selling financial services becomes a natural extension of the buying or selling experience. Examples include:
Jobber – Jobber is a platform that helps home service professionals manage their business operations. Since managing cash flow is essential for small businesses, Jobber partnered with Stripe to offer its customers access to funding directly from Jobber’s dashboard and receive the money in a few seconds. By embedding Stripe’s financial product into its platform, Jobber solved a challenge for its customers, grew its revenue from its customer base, and made its product stickier.
Air Canada – When you visit Air Canada’s website to purchase a flight, you can buy travel insurance from Allianz or Manulife and also pay for your purchase online within the same purchase journey.
Embedded finance is a win-win for both consumers and companies. Consumers benefit from an enhanced, seamless buying experience that is convenient and personalized, all at their fingertips at the time of purchase. Consumers also benefit from increased financial accessibility and better pricing since businesses can offer personalized products as a result of having access to customer insights and data that allow them to refine their risk assessment.
Nonfinancial companies benefit by increasing the lifetime value of their customers. Companies can offer an ancillary service that is connected to the consumer in a manner that reduces friction, simplifies transactions, lowers customer acquisition costs, and gathers customer data. Companies can help differentiate their product offerings and build stronger customer relationships, which in turn generates additional sales in their core business and increases customer retention. Furthermore, as the distributor, the nonfinancial company also creates an additional revenue stream without the overhead of operating a financial institution. Eric Sager, COO of Plaid, put it best when he said, “An underlying benefit of embedded finance is that it offers ways to monetize without charging customers more, and therefore enables companies to eliminate barriers to adoption of their core offerings.” Per McKinsey, the businesses that are best placed to offer embedded finance offerings include retailers, online marketplaces, software companies, telecoms, and original equipment manufacturers (OEMs).
What makes embedded finance an attractive investment theme is the large and growing addressable market. Lightyear Capital forecasts that the embedded finance market will grow from $22.5 billion in 2020 to $230 billion by 2025 (on a revenue basis), a tenfold increase in 5 years! Bain & Company believes that embedded finance accounted for $2.6 trillion of total US financial transactions in 2021 and it will exceed $7 trillion by 2026. This provides a significant market opportunity for incumbents, new entrants, and investors.
So, which types of financial products can a nonfinancial company offer its customers as an extension of its core offering? The most common embedded finance offerings include:
Embedded payments – Payments was the initial use-case for embedded finance and will continue to be the largest segment of the market. Companies incorporate payment functionality directly into their platforms so consumers do not have to leave it to complete their transactions. For example, VoPay provides an application programming interface (API) for businesses to embed its payment functionality into their websites to manage their customers’ entire financial interactions.
Embedded lending – This is where FinTechs provide retailers and e-commerce sites with the ability to offer credit financing during the checkout process from their own platforms, thereby allowing customers to apply for and obtain approvals for financing at the time of purchase. An offshoot of embedded lending is Buy Now, Pay Later (BNPL), which enables consumers to purchase products immediately but pay for them in installments. For example, Financeit focuses on point-of-sale financing, while Affirm and Klarna are leaders in the BNPL space.
Embedded insurance – Companies embed insurance options into the checkout experience allowing consumers to select insurance as an add-on to their purchase. It is useful to consumers because it is offered at the time of purchase with no need to connect with an insurance company. Companies such as APOLLO Insurance, Walnut Insurance, and Foxquilt are examples of embedded insurance providers tackling different verticals.
Embedded banking – This entails integrating core banking services into a platform’s customer journey. For example, companies can offer their customers a branded checking account to hold funds and make payments. The purpose is to increase platform loyalty through a convenient user experience. Neo Financial is known as an embedded banking provider that is also moving into other segments of embedded finance such as insurance and investment management.
Embedded investment and wealth management – Investment and wealth management services are embedded into larger platforms or channels, thereby providing consumers access to financial planning and investment management tools. For example, OneVest works with FinTechs, traditional banks, and credit unions to embed its platform via APIs in consumer-facing products.
Other – Additional use cases are emerging in the areas of HR tech, tax, and accounting. ZayZoon and DailyPay offer an emerging use-case called earned wage access where employees gain on-demand access to their earned pay before the official payday. Although mainly an embedded payments provider, Trolley also provides an embedded tax compliance offering to its customers.
An interesting trend in embedded finance is that the lines between a nonfinancial and a financial company are blurring. Embedded finance is enabling companies to look more like FinTech companies as a greater portion of their revenues come from selling financial products. For example, Clio, a provider of practice management software to small and medium sized law firms, launched Clio Payments as a built-in online payments solution. Clio previously provided payment processing by embedding an outside vendor’s offering but then decided to build its own platform to offer a more streamlined user experience and capture more of the economics for itself. As a result, Clio expanded its addressable market and created a significant additional revenue stream. In fact, CEO Jack Newton said in an interview that he “sees payments and financial services expanding to a significant share of our revenue.” Shopify is another example of a nonfinancial company blurring the lines and taking on characteristics of a FinTech. Shopify is known as a provider of e-commerce software solutions, but the majority of its revenue comes from “merchant solutions” which are mainly value-added, ancillary financial services (payments, lending, banking) to merchants to increase their use of the Shopify platform.
Another trend to keep a close eye on is the emergence of the Big Tech companies in embedded finance. Companies such as Apple, Amazon, Google, and Meta are well positioned to leverage their large customer bases and technological infrastructure to disrupt traditional finance. Their motivations stem from obtaining access to varying data sources and expanding their revenue streams by tapping large markets. For example, Apple expanded into financial services with Apple Pay and then came out with Apple Card (credit card issued in partnership with Goldman Sachs) and Apple Pay Later (BNPL). Although the Big Tech companies are formidable potential disruptors in financial services, they will need to navigate regulatory challenges, privacy concerns, and anti-trust issues.
The opportunities in embedded finance are vast, but they also come with potential risks and challenges. Embedded finance companies still need to navigate complex and changing regulatory environments and comply with financial regulations (ex. anti-money laundering), or risk reputational damage and severe penalties. Given that they handle sensitive personal financial data, embedded finance companies require robust data security and privacy frameworks, or risk legal issues and a loss of trust from customers and partners. They also need to develop technology that integrates seamlessly into nonfinancial platforms without technical challenges. Finally, given the reliance on nonfinancial platforms, embedded finance companies need to actively choose and manage their partners, since the partners remain the face of the customer interaction and ultimately own the customer relationship.
So, who will be the winners? Although there are frontrunners in each embedded finance segment, there is still significant whitespace for new entrants and industry players given the size and growth of the market over the next decade. We believe the winners will be a mix of FinTechs, established financial institutions, and big tech giants without a winner-take-all. As in other industries, we will see players approach the market with product breadth or product depth, with technology, partnerships, and regulatory compliance becoming table stakes. Nonfinancial companies with the wherewithal to develop and build their own in-house financial products can also win big by turbocharging their growth and expanding their addressable markets, thereby enabling them to essentially become FinTechs themselves.
We at Maverix are excited about embedded finance and are actively seeking investment opportunities that play on this theme, so if you’re active in the space, we would love to connect.
About Maverix Private Equity
Maverix Private Equity seeks to make significant minority investments in disruptive companies with proven business models that have potential for rapid growth. We seek investments primarily in Canada and the US with a focus on the Financial Services, Healthcare & Wellness, Consumer/Retail, Transportation & Logistics, and Work, Live, Play & Learn sectors. Our investment size ranges from US$20M to US$100M+.