Embedded Myopias

Some key observations derived from embedding credit over four years.

While these observations are largely embedded lending oriented, some of the takeaways are relevant for embedded finance at large.

Myopia 1: All platforms are equally “embed-worthy”

A few years ago, there was a belief that embedding credit within any software platform was the same—you leverage their distribution, and they gain a new revenue stream through lending. However, not all platforms are equally "embed-worthy." While credit can technically be embedded anywhere, when it comes to delivering the best possible value to both the end borrower and the embedding platform, we’ve had the greatest success with small business-focused vertical SaaS (vSaaS) companies.

These platforms are the center of gravity for small businesses, providing the best context for creating truly tailored credit products to be embedded. Moreover, because they are deeply integrated into the daily operations of small businesses, they not only offer rich data for underwriting but also induce a strong stickiness between the business and the vertical SaaS, reducing the likelihood of default.

However, even within vertical SaaS tools, we’ve seen cases where embedding credit has gone wrong. This typically occurs when companies attach generic credit offerings to specialized software, resulting in a "tissue rejection" effect—where the embedded credit doesn’t align with the platform’s core functions and user experience.

Myopia 2: E’meh’edded Lending

We've seen instances where credit products are embedded in software with a lender-centric approach, focusing on attaching a "one-size-fits-none" credit product to a platform. The goal is often to tap into the platform’s distribution to lower acquisition costs and utilize data for underwriting. However, this approach leads to a poor product experience for the end borrower, causing the embedding to fail. Labeling off-the-shelf credit products as "contextual embedding" simply doesn’t work, and embedding platforms have come to realize this. 

The solution is for embedders to adopt a truly platform-centric view, rather than a lender-centric one. This requires stepping into the shoes of small businesses to understand where and how they would need and use credit within a software platform. Once this perspective is established, the embedded credit product must be adaptable, fitting seamlessly into the context of operational workflows such as procurement, marketing, and payroll. The embedding must extend beyond just attachment to a workflow—it should consider how the credit is spent and utilized within the platform.

Myopia 3: Proactive vs Reactive Lending

In the pre-embedded era, lending was largely a reactive process. Small businesses typically sought out a lender—usually a bank—when they needed capital, whether to expand their operations or to address a cash flow gap. Credit was provided only after the business identified and presented this need.

However, with vertical SaaS tools now deeply embedded in the day-to-day operations of small businesses, we have a unique opportunity. For the first time, we can gain a deeper understanding of a business’s activities, allowing us to anticipate its financial needs before they arise. In this new embedded era, vertical SaaS tools are not just assisting small businesses with operational decisions but can also proactively prompt them to tap into credit as part of their daily workflows.

This shift represents a significant change in how lending is traditionally carried out. Instead of the small business identifying the need for credit, the vertical SaaS company—armed with deep insights into the business—can surface that need. This approach enables small businesses to access credit more promptly and seamlessly, flipping the traditional lending model on its head.

What’s truly exciting is that these credit prompts can be informed by the experiences of similar businesses within the SaaS ecosystem. For example, a business in Florida can benefit from the insights derived from a business in California. This referential learning, which was previously unimaginable, opens up a new paradigm where lending can be more proactive and integrated, significantly expanding the size of the opportunity.

Myopia 4: The Total Addressable Market (TAM)

Given this flipped paradigm of lending, the total addressable market (TAM) is fundamentally larger than previously estimated. Instead of sizing the embedded credit opportunity based on the traditional passive lending model, we can now envision it as a much larger subset of the overall small business lending market. This reimagining of TAM suggests that the potential market size could be significantly bigger than current projections.

Myopia 5: Embedded Lending is a Late-Stage Phenomenon

A common misconception is that embedded lending should be introduced as a late-stage revenue add-on after a vertical SaaS company has fully established its core features. This approach made sense in the past, as we saw with tools like Toast. However, the landscape has changed. Today, there are embedded lending providers that can help SaaS companies launch a lending program quickly, making it feasible to introduce embedded credit much earlier.

Moreover, the value of embedded credit goes beyond additional revenue. It can significantly accelerate the adoption of product features, helping vertical SaaS companies establish a stronger market position earlier in their lifecycle. Once vertical SaaS companies establish a control point, upselling more product features to become multi-product is top of mind for them. Embedded credit is turning out to be really effective in helping vSaaS become multi-product. 

Myopia 6: It's still all about lending

While lending is the foundation for embedded credit, the real opportunity lies in how these credit products are integrated into the vertical SaaS platform. The lending aspect earns the right to embed, but the battle is won in the vSaaS app’s user interface—the pixels, if you will. Here, the focus is on creating seamless, adaptable experiences that enhance how small businesses access and leverage credit.

Though the underlying lending product remains consistent with compliance and regulatory requirements, the way it’s embedded can vary dramatically. This variability presents a massive opportunity to reimagine how small businesses interact with credit and how that interaction can be employed to drive product goals for vertical SaaS companies.

Myopia 7: It's a race to the bottom with the cost of capital

In traditional lending, the low cost of capital typically wins, which is why banks have long been the go-to lenders. However, in the embedded lending space, there are different pockets of value along the value chain. Embedded lending providers can monetize in various ways, such as through wallets, expense management, other financial services and more. This multifaceted approach allows for monetization beyond just interest rates, offering new opportunities for profitability. See this old post from a few years ago.

At Vaya, we’ve expanded monetization avenues beyond just lending in novel ways that we’ll share in the coming days. 

Myopia 8: “Embed and they'll come”

The belief that simply offering embedded credit—like putting a banner on a dashboard—will yield spectacular outcomes is misguided. Real traction requires fine-tuning, which is both an art and a science. Success depends on aligning the incentives of all parties involved. When the incentives for the vertical SaaS are more than just a revenue share add-on, the potential for driving product adoption becomes significantly higher. This alignment is the key to unlocking the true value of embedded credit.

Myopia 9: The False Positives Hiding Beneath Repeat Usage

With certain types of embedded credit products we've seen in the market, the cost of capital for the borrower can be too high, failing to justify their business economics. In such cases, citing their repeat usage of the product as a sign of product satisfaction is misleading.  

One can also expect moral hazard, such as the hiding of revenue, as explained in detail in this paper on revenue-based financing with payment processors.

Myopia 10: Not giving the embedding time to marinate.

A proper contextual embedding is a continuous process, not a one-time effort. It often involves a co-learning dynamic between the embedding platform and the embedded lender, requiring ongoing fine-tuning of both messaging and the product to ensure it resonates and is utilized most effectively by the platform.

As embedded finance accelerates in the coming years and embedding becomes a default modality, the time to value will decrease through incremental learning—ideally, with a diminishing rate of embedding myopia!