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Building a lending business is hard. Here’s why most software companies shouldn’t do it.

Convenience has become table stakes now. In the past few years, especially since the onset of COVID, we’ve come to expect that what we need can be dropped on our doorstep with the click of a button. Those expectations go beyond our personal lives and carry over into how we run businesses, which is why embedded financing is growing so fast. 

For independent software vendors (ISVs), offering capital to their merchants can be a powerful step up in the relationship. Putting capital in their hands when they need it helps ensure merchants stay healthy and operating, and giving them access to that capital through your software platform increases stickiness and loyalty by letting the merchant get everything they need in one place.

Small business owners want quick access to capital where they already spend time in the software they use to run their business day to day. Add to that the declining access to VC money, and there’s an enormous opportunity for software companies. But in addition to the opportunity, it also presents a big challenge.

The challenge of building embedded finance 

To put it simply, building a lending business is incredibly hard. There are a lot of moving parts and hurdles you have to clear to make it sustainable. When you really break it down, there are five crucial requirements:

  1. Access to quality customers at the right point in time, with low customer acquisition costs (CAC) and a frictionless conversion process

  2. Consistent and homogeneous data sets for underwriting risk—a challenge given the inherent complexity and inconsistency of small business data

  3. A proven underwriting history with reliable risk models that deliver consistent results

  4. Efficient operations capable of automating end-to-end processes to keep variable operating costs below about 2% of revenue

  5. And, of course, access to capital, the lifeblood of lending 

The trouble is, access to capital hinges on the successful execution of the previous four requirements. The increasing verticalization of software gives an advantage in two of these areas, but can software companies overcome the others? And when it comes to building in-house, should they even try?

The Verticalization of Payments and Industry-Specific Software 

The verticalization of payments has been an ongoing trend, with comprehensive software tools that help business owners manage their operations seamlessly. A prime example is Toast, a widely recognized platform that helps restaurateurs oversee just about everything. This trend will only continue, leading to more end-to-end operating systems that simplify business management and payment processing.

Industry-specific software holds unique, accurate, real-time transaction data, which can be a solid foundation for building a lending business. It also provides a steady funnel of new customers, already engaged with the software and using it regularly. However, while vertical software can address the first two requirements of low CAC and consistent data, it falls short in underwriting expertise, operational efficiency, and access to capital. 

These are formidable challenges that even many pure-play lenders struggle with, especially during tough economic cycles. Having had the opportunity to play a significant role in the growth of both QuickBooks Capital and Square Banking, I can say two things for sure: these are high hurdles to jump, even for companies with massive resources available to them, and they’re the kind of problems that fintech was born to solve.

To build or not to build?

Seamlessly integrating financial services within industry-specific software can provide tremendous value to business owners. But the greatest strength of these software companies lies in their specialization. They intensely focus on and understand their industry, and building a lending product falls well outside their strike zone. Building a lending product in-house distracts from that focus in a way that would be catastrophic to many software companies. The solution is to partner with someone whose strong suit is connecting businesses to capital through technology. 

Fintech has a significant role to play in making financing more accessible to small business owners, and embedded financial services make perfect sense. With domain expertise across finance and technology, the right fintech partner can automate the underwriting process, getting accurate results from live data with as little as six months of history, whereas banks traditionally need two years of audited financials and tax returns. 

Along with operating efficiency and tech-driven underwriting, they can also build compliance and regulatory solutions into their embedded offerings, creating a turnkey solution for vertical software and minimizing effort on their end. It allows software companies to leverage their deep industry knowledge and data through an embedded solution as simple as an off-the-shelf product.   


The rise of embedded finance presents an exciting opportunity for software companies to expand their offerings and empower small businesses. However, it's crucial to recognize the challenges inherent in building a sustainable lending business. Careful consideration, expertise, and strategic partnerships are essential for success in embedded finance. Vertical software solutions and fintech can work together to create unprecedented value and give small businesses a new level of financial access.




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