Unpacking Embedded Lending: Components, Risk, and Business Models

I break down different types of embedded lending business models with their pros and cons. Choosing the right type of model can make all the difference in your fundraise, valuation, and success.

Embedded lending has made a comeback and gained significant traction in the past few years, especially in consumer fintech.

Auto loans originated at dealerships have been one of the most successful embedded lending products in history. Consumers like convenience, dealerships sell more cars, and lenders get access to borrowers. It was a win-win-win.

During the internet boom, companies like BillMeLater (originally called I4 Commerce) launched to take this concept online and offered simple credit financing for online purchases. BillMeLater was eventually acquired by PayPal in 2008.

There was a lull for a few years when Affirm launched in 2012. Buy Now Pay Later (BNPL) made a comeback around this time.

Fast forward to today, a few top embedded consumer finance companies originate $150+ billion annually and have generated a market cap of $30+ billion.

SMB embedded lending has also gained traction recently. Companies like Lendio, Settle, Parafin, and many others have raised significant capital.

Even with this growth, it seems like embedded lending is not understood that well. It sounds like a monolith but there’s a lot more under the surface.

So I thought I’d unpack embedded lending platforms, their components, and business models for founders.

Categories of embedded lending businesses

All embedded lending companies can be categorized across 3 dimensions:

• Target Market - Consumer, SMB

• Business Model - BNPL, Unsecured Loans, Secured Loans, Credit Cards, Invoice Factoring, Merchant Cash Advance, Working Capital, etc.

• Vertical - General, Healthcare, Retail, Auto, E-commerce, Real estate, SaaS, Services, Wealth Managment, etc.

The below is just a small sample from hundreds of embedded lending companies.

• Consumer/BNPL/Ecommerce: Affirm, Klarna, Afterpay

• SMB/Working Capital/General: Parafin, Kanmon, OatFi

• SMB/Merchant Cash Advance/Ecommerce: Stripe Capital, Shopify Capital

• Consumer/Unsecured Loans/Healthcare: Sunbit, Cherry, PayZen

• SMB/Invoice Factoring/General: Pipe, Wisetack, Slope, Resolve, Mesa

• Consumer/Credit Card/General: Imprint, Synchrony, Marcus by Goldman Sachs

We’ll look under the hood of a few embedded lending companies. We’ll learn about the components of a business, revenue drivers, pros, and cons. Being aware of different business models can help founders focus on the important problems applicable to their company, help them make the right decisions, and avoid going in the wrong direction.

After reading this, you’ll be able to answer questions like:

• How should I think about the right business model when I start?

• Do I need to raise debt capital for my embedded lending company?

• What are the pros and cons of various embedded finance business models?

Components of embedded lending businesses

Every lending company and by extension, embedded lending company has a few core components. We’ll quickly recap those below and then review how different companies make money.

If you are interested in learning about these in detail, feel free to read these posts:

• A brief guide to building your first lending product

• Building large embedded lending businesses

• Lending business equation for your company

Now, let’s list all the components of an embedded lending business. You can break down an embedded lending business into 5 components:

• Platform

  • The website that sells the product or provides a service.

• Originator

  • The embedded lending company.

• Bank

  • The bank sponsor.

• Debt Facility Provider

  • The debt facility provider.

• Loan Product

  • Installment loan, Pay in 4, Invoice Factoring, Line of Credit, etc.

All business models across all categories of embedded lending depend on the choices of these 5 components. Revenue, cost, team, partnerships, etc. are driven by your preference for each of these components.

Business models in embedded lending

I’ve previously written about building your lending business equation.

You solidify your revenue driver and business model based on your category and choice of embedded lending components.

You will see that banks like to earn interest while non-bank lenders prefer to earn fees. Generally, fee revenue is valued higher than interest revenue.

Some companies fight against fees for consumers and pass those costs to merchants, while others charge no fees but higher rates.

There are at least 4 different types of business models based on how you set it up.

• Consumer Embedded Lending

• Embedded Loan Marketplace

• SMB Embedded Lending

• Co-branded Products

There are others like Captive Embedded Lending but we’ll focus only on the 4 most common for this post.

Model 1: Consumer Embedded Lending

Consumer lenders acquire customers only by embedding their loan products in other websites. They have $0 CAC. These financial services companies generally originate a loan using a bank sponsor or lending licenses. They raise debt facilities (from banks or non-bank lenders) and perform all servicing/collection activities (sometimes they pass it on to third-party servicers).

Company: Affirm

• Platform

  • Peloton

• Originator

  • Affirm

• Bank

  • Celtic, Webbank, Cross River Bank

• Debt Facility Provider

  • Multiple large debt facility providers like Ares, Goldman Sachs, etc.

• Loan Product

  • Installment Loans

Peloton sells products (bikes) and wants to increase sales by offering credit to purchase their bikes. Affirm integrates with Peloton to allow customers to buy products using a BNPL product (close end unsecured personal loan).

Peloton launched with Affirm back in 2015. By 2020, 30% of Affirm’s originations were from Peloton.

Here’s how it works:

• Affirm integrates with Peloton to verify the delivery of the product, honor return policies, and process refunds.

• Affirm uses multiple bank sponsors like Celtic, Cross River, and Webbank for loan origination.

• This means that the credit policy is owned by the bank, but developed in partnership with Affirm. It’s Affirm’s credit policy approved by the bank.

• The originated loans are sold 3 days later back to Affirm. The originating banks may or may not participate in the originated loans. Generally, they keep 5% of the originated pool on their books.

• Affirm buys those loans using debt facilities from third party lenders.

• These are asset backed facilities and the lenders take most of the economics.

Affirm earns merchant discount rate and residual interest but also bears the risk of defaults.

In this model, Affirm is a lending company with $0 CAC. Once they are integrated with the store or service provider, acquiring each incremental customer costs $0.

Pros:

• Control over approval rates and credit policy.

• Can continue to scale with a few large debt investors.

• Can securitize and make good economics if loans perform.

Cons:

• Managing credit risk, cost of capital, servicing/collection teams, etc.

• Increasing interest rates could negatively impact unit economics.

• Manage bank sponsorships and slow iteration (everything has to be approved by the bank).

Model 2: Embedded Loan Marketplace

Loan marketplaces don’t take credit risk or build their credit policy. They don’t have bank sponsors, they don’t raise debt capital, or service the loans. They implement the lender’s credit policy in their system. Then they securely get the applicant’s information and either send that as a lead to multiple lenders (based on high level policy cut offs) or apply the credit policy to show pre-approved offers (similar to loan comparison websites).

Company: Lendio

• Platform

  • Lendio

• Originator

  • N/A

• Bank

  • 75+ lenders on the marketplace

• Debt Facility Provider

  • Banks or non-bank lenders

• Loan Product

  • Multiple products like Working Capital Loans, Term Loans, Credit Lines, ec.

Let’s take an example of a partnership between Staples and Lendio. Staples has tens of thousands of small businesses and they want to provide financial products to those SMBs. So, they partner with Lendio to offer these products.

• When a small business on Staples needs a loan, they can apply for a loan through Staples.

• The application flow and loan processing are from Lendio.

• As Lendio receives the application, they apply the credit policy of 75+ lenders on the other side and show offers to the small business.

• The business moves forward with one of the offers.

• The bank or non-bank lender whose offer was accepted processes the completed application.

• Lendio’s customer service helps the business throughout the process.

• Once the loan is finalized, it is “originated” and “funded” by the lender (bank or non-bank).

• Lendio earns a fee and doesn’t take any credit risk.

• The lender also continues to service the loan.

Affiliate fee is the primary revenue source in a marketplace business model.

You may have to share this fee with the Platform (Staples in this case).

Your net fee should be high enough to pay for: setting up partnerships (both sides), credit policy management, compliance, and customer support.

Different lenders pay different fees based on the quality of applicants and lending products.

Pros:

• Originator “marketplace” doesn’t take any credit risk.

• Needs a small team - primarily for partnerships, compliance, and customer service.

• No post origination responsibilities like servicing, collections, etc.

Cons:

• You don’t control the credit policy. Lenders may frequently update credit policies and rates.

• You have to manage policy updates which impacts approval rates.

• Generally doesn’t work for high risk populations (unless there’s also a turndown program).

Model 3: SMB Embedded Lending

Similar to consumer, embedded SMB lenders provide financing to businesses through a partner. Embedded lenders develop a credit policy, use bank sponsors, raise debt facilities, and perform servicing/collections. SMB lenders generally offer multiple products and more leeway in pricing (due to limited SMB regulations). Based on pricing, they may earn an origination fee and net interest margin.

Company: Parafin

• Platform

  • Doordash

• Originator

  • Parafin

• Bank

  • N/A

• Debt Facility Provider

  • Multiple large debt facility providers like SVB, Jeffries, Trinity Capital, etc.

• Loan Product

  • Merchant Cash Advance, Working Capital Loans

Parafin launched with Doordash as its first partner on Feb 9, 2022. Doordash announced “Doordash Capital” as their first financial product powered by Parafin. It’s important that Doordash retains the branding because Parafin could be replaced in the future. The first product is “revenue based financing.”

• DoorDash has a ton of suppliers, restaurants, and other small businesses. Parafin integrates with DoorDash and offers loans to those SMBs.

• Parafin controls the credit policy, probably with DoorDash’s inputs.

• DoorDash doesn’t take any credit risk and likely controls the customer experience.

• To the SMB, it seems like they are taking a loan from DoorDash.

• Behind the scenes, Parafin provides “merchant cash advance” financing i.e. Parafin gets paid as a % of sales and uses the debt facilities to fund the loans. Parafin then services and collects the loan.

• Doordash may earn a commission based on the loans originated through its platform.

Pros:

• Control over credit policy to only originate loans that meet profitability standards.

• Potentially high margin given the effectively high interest rate of the product.

Cons:

• Have to balance credit risk, approval rates, and net interest margins. High cost of capital may impact unit economics negatively.

• Need to constantly raise capital for first loss positions and grow teams to service the loans.

Model 4: Co-branded Products

Credit cards are the most common co-branded fintech products. Both for consumers and businesses. In a co-branded relationship, the brand provides distribution and the embedded finance company handles everything else - credit risk, debt facilities, card products, fraud, servicing, collections, etc. Co-branded relationships could be extremely valuable both for the brand and the embedded player. American Express and Delta is one of the most successful co-branded relationships (all large airlines have similar relationships). Even Apple built a co-branded card with Goldman Sachs (which wasn’t as successful).

Company: Imprint

• Platform

  • Brooks Brothers

• Originator

  • Imprint

• Bank

  • First Electronic Bank

• Debt Facility Provider

  • Citibank, Atalaya, SVB, etc.

• Loan Product

  • Credit Card

Brooks Brothers launched its first co-branded credit card with Imprint in July 2024. This partnership reflects the growing interest in monetizing through embedded fintech products.

• Brooks Brothers is a 200+ year old popular high-end brand.

• They have millions of customers and they want to offer products to increase loyalty. They partnered with Imprint to launch a co-branded card.

• The card is operated and managed by Imprint *in partnership with Brooks Brothers*. Imprint manages the credit policy, pricing, approval rates, line management, servicing, collections, etc.

• Co-branded cards have to offer strong incentives for customers to use branded cards as their primary card over bank cards like Chase.

• That’s why co-branded cards have competitive rewards with special rewards for usage at the brand’s stores. Imprint has to closely manage profitability because of these incentives (in addition to overall credit risk).

Imprint’s revenue driver is the interchange and interest earned. It has to balance that with the commission paid to Brook’s Brothers, default rates, and the rest of the operations.

Pros:

• Strong loyalty because of brand affiliation

• High LTV

• Zero CAC

Cons:

• Managing credit lines, interest rates, rewards, cost of capital, and risk.

• Need bigger teams for customer support and servicing.

• Complex accounting and compliance management across multiple partners.

Examples of additional embedded lending models:

Stripe Capital, Shopify Capital, Square Capital, and Toast Capital are examples of business models like captive embedded lending. In this case, the platform is the originator and lender (with or without a bank sponsor). But lending is a different product than their core product. They use lending as a monetization product.

Car manufacturers drive sales with 0% APR financing offers for new car purchases.

New home developers offer interest rates and cash discounts when taking mortgages with their preferred lenders.

Hope this post helped you understand the details of embedded lending.