Fintech

Consumer fintech is out. Embedded finance is in.

Part distribution strategy, part product design, embedded finance is drawing the attention of investors who want to fund next-generation financial infrastructure.

Dollar bills in cubes

Embedded finance includes lending, payments, open banking, banking-as-a-service, data aggregation and data transfer services.

Photo illustration: Paper Boat Creative/DigitalVision/Getty Images; Protocol

The lower fintech multiples tumble, the harder VC funding is for founders to find. But savvy investors are betting on a less-flashy type of fintech that’s been overlooked in recent years: startups they believe will form the infrastructure for the next wave of financial services innovation.

And funders have coalesced around a label for these companies, one that startups are only now starting to adopt: embedded finance.

The picks and shovels on offer include lending, payments, open banking, banking-as-a-service, data aggregation and data transfer services. The offerings are typically API-driven and deeply integrated into another product rather than redirecting consumers to a third-party site.

Companies like Stripe and Plaid are considered early exemplars of embedded finance, joined by newer ventures like Apiture and Yapily. And embedded plays are emerging in both traditional fintech and crypto.

“The next phase is not going to be in the next consumer-facing digital bank or consumer-facing crypto wallet,” said Martin Tantow, a partner at Pegasus Tech Ventures. His firm’s portfolio shows how the tide is shifting, with Pegasus backing early consumer plays like Robinhood and SoFi, which both went public in 2021. But infrastructure is what appeals to him now: “Embedded finance — now, that’s what’s getting interesting for us.”

Tantow is not the only VC shifting focus. Bain Capital Ventures is one of the firms that set the trend, as partner Matt Harris has long encouraged companies to consider embedded finance as a strategy.

“It’s easier now, because of innovation in financial infrastructure, to get fintech products up and running faster and more easily. They take some of the legwork out of legal compliance, regulatory complexity that companies don’t want to take on,” said Christina Melas-Kyriazi, a partner at Bain. “I’m really interested in that.”

Melas-Kyriazi says companies that pitch her with a clear distribution strategy are best aligned with Bain’s investment thesis. “If you’re solving a consumer-facing problem, you want to go direct-to-consumer,” she explained. “But a better way to access that person, at times, can be via software, where they’re doing their work.”

Startups serving up software to financial services companies and other business customers are also earning more investor dollars than other fintech sectors, giving them some buoyancy amid sinking valuations. According to Dealroom, embedded finance investing roughly tripled between 2020 and 2021, and investment in payments startups — a key sector within embedded finance — appears to have held steady in the first three months of 2022.

Melas-Kyriazi said the best embedded-finance companies either leverage data collection or network effects so that “once someone starts using your product, they're going to use it again and again, and it's going to be harder for them to switch.”

Catherine Birkett, CFO at GoCardless, said integrating financial services, like putting payments and accounting together, simplifies business operations in obvious ways. The open-banking company secured $312 million in late-stage funding in February. “This is easy to explain to investors, and from there it’s logical that fintechs that offer convenience and ease of use to merchants are more likely to acquire customers than those that don’t,” she said.

That’s part of the embedded finance pitch: It’s a more efficient and consumer-friendly route to reach other companies’ loyal customers as opposed to branding and launching a new financial product into often-crowded markets. Like other business-to-business models, that makes it dependent on other companies as a channel for growth, but embedded finance’s supporters argue that’s a feature, not a bug.

It’s not enough to just declare yourself an embedded finance company and start pitching investors. Tantow emphasized that in the current environment, companies must have strong financials to back up their pitch — preferably enough revenue to survive a looming downturn. “I want to see what their distribution model is [and] which channels and strategic partnerships they are pursuing,” he added.

For investors now, the most exciting fintechs are ones with low overhead, a clearly defined strategy of marketing to businesses and a promise of infrastructure that will accelerate the transition to a fully digital financial ecosystem.

PitchBook recently warned of a “bifurcation of the market” in fintech: Those serving consumers and small businesses, the firm’s analysts wrote, “will be negatively impacted while enterprise and infrastructure companies will remain at strength.”

Or as “Saturday Night Live’s” trend forecasters might put it: Get embedded, or go to bed.

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