Embedded lending and financing options can be attractive to your customers while generating robust revenue. Learn what’s involved and how to get started.
In our guides Revenue in Financial Features and The Ultimate Guide to Interchange Revenue, we explore the five potential revenue streams you should consider when making financial features available to your customers. In this guide, we’ll take a deep dive into lending and financing and explain how to think about these opportunities for your company.
In the broadest sense, lending and financing involve giving your customers access to funds they don’t already have. They can be valuable because they help businesses to manage the timing of capital outflows (costs) and inflows (revenues). Common forms include cash advances, invoice factoring, credit + charge cards, term loans, and lines of credit.
If you’re seeking to become more valuable to your business customers while generating robust new revenue streams, this guide is for you. In it, we’ll discuss:
Although we refer to “businesses” in this guide, these products may be available to sole proprietorships and independent contractors as well. (article continues below)
In the past, we’ve highlighted that interchange revenue is a powerful monetization strategy for companies that make financial features available to their customers.
As a complement to interchange, we firmly believe that embedded lending and financing will emerge as another primary source of revenue in coming years. Here’s why:
Shopify is another case in point. Today, more than 60% of their revenue comes from merchant services, the majority of which are loans.
The simplest reason for making lending and financing options available to your business customers is that you’ve already built the flywheel: distribution, software, data, trust. Through software, you’ve become increasingly valuable to your customers; you’ve gotten to know them and earned their trust. Now the infrastructure is finally here that allows you to efficiently meet their lending and financing needs, which spins the flywheel even further and faster.
There are many kinds of business lending and financing; which you choose will depend on your goals, your customers, and their needs.
Say you’re the CEO of Invoicify, a company that helps 100,000 small businesses manage their finances (invoices, payroll, taxes, etc.). Your typical customer has annual revenues of $150K–$1.5M.
You’re excited about white label lending and financing because of how well you know your customers. You can see with clarity their unmet needs, the peaks and valleys of their seasonal cash flow, and their ability to repay. Not to mention, you can offer financing in your customers’ exact moments of need—i.e., on your platform.
Let’s say that one of your customers is a general contractor. In the following section, we’ll discuss the circumstances in which it might make sense to offer them each of the following five types of lending and/or financing: cash advance, invoice factoring, credit + charge cards, term loans, and revolving lines of credit. In practice, you might choose to offer your customers just one, all five, or any number in between. (article continues below)
With cash advances, you purchase a portion of the future revenues of your business customer, typically at a discount, giving them early access to funds they expect to receive in the near future.
Say your customer, the general contractor, needs to access $50K to buy new excavators. Through your platform, you can see that they consistently generate an ample amount of revenue each month and should have no trouble paying you back.
"If your platform has unique or proprietary insights into the ability of your customers to generate future revenues, cash advance could be a good fit for you."
With cash advance, you could offer the general contractor the ability to tap a button, sell you a portion of their future revenues, and access the funds right away. Later, when the revenue lands in their account, the cash advance can automatically be repaid.
Cash advances may be a good fit for businesses that struggle to qualify for traditional bank loans. If your platform has unique or proprietary insights into the ability of your customers to generate future revenues, this may be a good option for you.
A real-world example: because DoorDash has unique insights into the revenue potential of the restaurants on their platform, they are uniquely well-positioned to offer financing to their customers by purchasing a portion of their future revenues.
With invoice factoring, your customer sells you the right to collect the money owed from invoices that are due to be paid by their end-customers.
Say your customer, the general contractor, needs to pay their subcontractors, but they don’t have enough cash on hand. In many industries, including general contracting, large buyers often pay smaller suppliers 30–60 days after the work is performed and the invoice is received.
"Invoice factoring transforms future revenue into funds your customer can use immediately."
Let’s say the general contractor is holding invoices worth $100K over the next three months. With invoice factoring, the general contractor could sell you the right to collect those revenues from the building owners in exchange for a lump sum of $97K. You keep the difference, in this case $3K—as well as the risk of missed or late payment. The general contractor would still be responsible for continuing to provide services to the building owners as usual. Only now, instead of paying the general contractor, the building owners would pay you (for the specific invoices you've purchased).
Invoice factoring can be appealing for customers like the general contractor because it’s a way to transform future revenue into funds they can use immediately—for example, to hire new team members or invest in better infrastructure.
There are two types of business credit cards: revolving cards and charge cards. A revolving card can carry a balance between statement periods, whereas a charge card must be paid off each statement period (typically monthly).
Say your customer, the general contractor, is looking to cover day-to-day expenses—things like gasoline and trips to the hardware store. After processing their application, you decide to offer them a charge card with a limit of $50K.
"Credit and charge cards generate robust interchange revenue—typically between 2–3% of the total transaction value for each purchase."
Or say you offered a revolving credit card and decided to offer one to the general contractor. As long as they don’t carry a balance (i.e., as long as they pay down their card in full every month), they won’t pay any interest. If they do carry a balance, they’ll typically pay 12%–23% interest on it.
Credit and charge cards can be a great addition to your product offering because they generate robust interchange fees (revenues you earn when your customers make card purchases). The amount of interchange you earn will vary based on your card network (e.g., Visa, Mastercard) and your partner bank. But it’s generally between 2–3% of the total transaction value for each purchase—often 50 basis percentage points more than a business debit card.
A real-world example: Ramp offers a suite of embedded financial products that gives them unique insights into the creditworthiness of their business customers. By providing their customers with business charge cards (both physical and virtual), Ramp turns these insights from its software product into incremental revenues in the form of interchange fees while also adding value to Ramp’s customers by helping their customers manage monthly cash flows. (article continues below)
With term loans, the lender sends the borrower a lump sum which is repaid over a fixed schedule, usually with the addition of interest and/or fees.
Say your customer, the general contractor, plans to open an office in a nearby suburb. They need to purchase equipment and construction materials at a cost of $100K. After processing their application, you decide to offer them an unsecured loan of $100K with a five-year term (60 installments) and an annual interest rate of 10%.
"Term loans can be appealing because they are easy to understand—and when it comes to how the funds are deployed, there are few strings attached."
Significantly, a term loan can be either secured or unsecured. “Secured” means that the loan is backed up by something the borrower owns—referred to as “collateral.” In the event of nonrepayment, the lender is legally entitled to seize it. “Unsecured” means that the borrower doesn’t collateralize the loan; that is, they don’t “secure” it with one of their assets.
Because they’re less risky, secured loans typically feature lower interest rates and are less stringent in terms of the criteria for credit approval. Returning to our example: the general contractor might collateralize the loan with a pair of concrete mixer trucks (value: $100K) and thereby qualify for a lower interest rate (perhaps 5%, rather than 10%).
Term loans can be appealing to businesses because they are straightforward and easy to understand—and when it comes to how the funds are deployed, there are few strings attached. (article continues below)
With revolving lines of credit, a lender provides funds up to a specified limit that a borrower can withdraw, spend, and repay over time.
Let’s return to the example of the general contractor. As a business, they’re likely to earn more revenue in summer—when days are longer and the weather is more conducive to construction—and experience a corresponding slump in winter. But regardless of how busy they are, they still need to pay their full-time employees.
"Unlike credit cards, funds accessed using revolving lines of credit can be used to pay by ACH, check, cash, or wire transfer."
After processing their application, you approve them for a line of credit with a revolving limit of $100K. That means they can withdraw $10K today, $50K tomorrow, $35K next week—as long as they stay within their $100K limit. Once they’ve repaid what they’ve borrowed, their credit limit may be replenished.
Another productive way that businesses use revolving lines of credit is to fund inventory purchases. Once the inventory is sold, they repay the amount they’ve withdrawn plus interest. Unlike credit cards, revolving lines of credit aren’t limited to card purchases; the funds can be accessed directly and used to pay by ACH, check, cash, or wire transfer.
Revolving lines of credit are typically used by businesses to smooth out uneven cash flow and fund inventory purchases ahead of sales. Interest is typically paid only on the amount withdrawn, and only for as long as the borrower holds it. (article continues below)
How you choose to set up your lending and/or financing program will significantly impact your time to market, setup costs, and hiring needs.
There are a number of ways to launch a fintech lending or financing program, including those in the table above, with a great deal of ongoing market innovation. Regardless of which approach you choose, there are a number of potential factors to consider:
In all five of these areas, working directly with a bank can take years and millions of dollars. Fortunately, over the last few years, banking-as-a-service platforms have emerged that make the process much easier. The result is that it’s finally possible to launch financial products in a matter of months, without hiring a large full-time team, and without sacrificing your other priorities.
If you’re interested in learning more about how launching a lending and/or financing program can make you more valuable to your customers while building your bottom line, contact us to book a demo or sign up for sandbox.
November 4, 2022
Frequently asked questions
Over the last ten years, hundreds of tech companies have started offering embedded lending and financing options. They include leading brands like Uber, DoorDash, Amazon, Flexport, and Shopify.
To understand who’s doing it and why, let’s consider the different types of embedded lending and financing. In each case, we’ll provide a couple of well-known examples.