Embedded financing is where financial products like loans or lines of credit are included in non-financial platforms, stores, or other places businesses operate. It is a part of the purchase flow where someone doesn’t need to leave or wait for the financing to be approved. There are two popular benefits to embedded financing in that it:
- Helps small businesses increase conversion rates and total order values
- Provides access to business funding where approvals can be faster and applications simpler versus going to a traditional or alternative lender.
It’s called embedded because the business getting funding doesn’t have to go to another site, another store, or anywhere else to get the financing.
- Consumers apply for and get approved for the financial product as part of the checkout process.
- Businesses get embedded financing through one of the platforms they use to operate their business.
Embedded financing is different from a discount, loyalty points, or other rewards program because the financing is a government regulated financial product that is offered by a third party, not the company that you’re buying something from or the platform you’re using to run your business. A store brand financing solution where the consumer can purchase now and pay someone else later is embedded financing, but a discount card that gives a loyal customer a percentage off each time they come in is not.
Whether you need to improve sales or fund operations, here’s how embedded financing can benefit your small business.
Offering to Consumers
Offering embedded financing to consumers helps grow your business by increasing conversion rates and average order size. Examples used by consumers include:
- Buy now pay later (BNPL) services where consumers apply for credit as part of the purchase process and get an instant approval decision without needing to leave the online store’s checkout flow or go to another site to apply.
- Store brand credit cards where consumers apply at the register while checking out.
- Travel insurance when booking flights or hotels.
- Auto loans and insurance when buying a car online.
- Extended warranty plans for electronics.
Building embedded financing into your online or physical retail checkout process helps convert more consumers by providing credit to customers that would otherwise abandon their cart because they didn’t have enough in their bank account. Or it could be because they didn’t want the hassle of going somewhere else to apply for and then wait for approval on credit.
Complementary products like extended warranties or emergency insurance also lower the perceived risk for consumers making big-ticket purchases and can help prevent returns from buyer’s remorse.
Embedded financing also helps conversion rates for larger order values by dividing a large cart total into smaller payment chunks and preventing a customer from pruning items from their cart right before checkout to get the total order amount lower.
Pro-tip: Test embedded finance products before offering them to all customers to make sure you get enough extra business to offset the higher fees you pay on BNPL or other products.
Operations Funding Through Embedded Financing
Funding operations through embedded financing (also called embedded lending) gives you quick access to cash within the platforms you use to run your business without needing to pull all the documents together for a traditional small business loan application.
Embedded financing examples you might use instead of short-term business loans are:
- A cash advance for inventory tied to future sales on your e-commerce platform with approval based on your historical sales on the platform.
- A line of credit from your accounting software provider based on the historical knowledge of the company’s books.
Because this type of embedded funding uses data straight from your store or accounting software, applications and approvals are fast and you normally don’t have to offer collateral beyond a personal guarantee. This makes it a great option for new businesses without a business credit score since the sales data is right there to prove your ability to repay.
The downside is that embedded lending may come with higher interest rates and won’t work for all business needs, so here’s when to choose it versus a regular small business loan.
Choosing Embedded Financing or a Traditional Business Loan
The choice between embedded financing and a small business loan from traditional or alternative lenders comes down to how much cash you need, how long you need it for, how quickly you need it, and whether your financial situation makes you a low-risk borrower.
Traditional business loans will be your only choice for major equipment purchases or other capital expenditures with large costs for two reasons:
- Embedded financing is tied to your platform data, meaning your store sales, accounting software history, or similar data, which often isn’t enough information for embedded lenders to manage their risk and offer larger sums for longer terms.
- Funding options from embedded financing don’t offer enough for most major purchases, or if they do, the payback period would be too short to make the monthly payments affordable. Purchasing a $200,000 piece of machinery is possible through embedded financing from your accounting software, but a long term in embedded financing is 24 months and that would be more than $8K per month even with 0% interest.
Embedded funding works well though in situations where you need immediate cash and you’re willing to pay more for speed and convenience. Your account will receive funds in a day or two and the application process can be as easy as allowing access to your store or accounting software data (with some guardrails in place). The process is also speedy because instead of waiting days to value and appraise collateral, it takes minutes to check your personal credit for a personal guarantee.
Pro-tip: Don’t compare embedded loans to standard loans using only interest rates because this ignores the fees. Instead, use an online financial calculator to get the annual percentage rate (APR) which will give you an apples-to-apples comparison by wrapping interest rate plus all fees into a single figure per loan.
The interest rates and fees may be higher on embedded financing loans though, so you may only use them if you can’t wait for a small business loan. Chasing inventory on the season’s hottest gift because you sold out a week before the holidays is a perfect example because you have to have the inventory to sell it now and can’t wait for underwriters to get back from a holiday break for approval.
Embedded financing might also be your only choice if you have a young business or are recovering from a few bad years because a low credit score makes you a high-risk borrower for many traditional lenders, but your platform sales trends will show embedded lenders enough to approve funding.
Embedded financing can work both to grow your business and to get you quick access to funds for time-sensitive situations. But these solutions are not always the right ones. Be sure to evaluate your situation to determine the best financing option for your needs.
SmallBusinessLoans does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
