The technology market appears to be following economic trends downward, but companies focused on embedded finance — payments and other digital finance products that can be inserted into third-party platforms — are drawing strong interest from investors.
"Embedded finance providers are the building blocks for the next generation of fintechs," said Adrian Mendoza, founder and general partner of the venture capital firm Mendoza Ventures.
Embedded payments or embedded finance companies are holding up relatively well compared to other VC-funded businesses, prompting investors to seek firms that streamline the user experience for payments, or help build financial super apps. Two-thirds of adults have used embedded-finance services during online checkout in the past year, according to
Embedded finance vs. build-it-yourself tech
"There is often a real business case to partner with a market-leading embedded finance infrastructure provider that has strong [application programming interfaces], rather than building the capabilities in-house and having to navigate any regulatory requirements that may exist," said Spencer Hurst, vice president at the private equity firm Lovell Minnick.
Lovell Minnick invests in embedded finance in two ways. One strategy is to spot software platforms that embed finance and payment tools for their customers, such as Billhighway, which sells software and payment products for nonprofits. Another approach is investing in infrastructure providers that enable the software to offer embedded finance, such as Fortis and LSQ.
An embedded payment strategy enables a software company to monetize additional customer spending, glean more data on customers, drive enhanced loyalty and provide a strong user experience, according to Hurst.
"When done right, these embedded finance cross sales have a negligible customer acquisition cost and increase the lifetime value of the customer," Hurst said.
Firms that distribute their products through embedded payment providers tend to see better retention than firms that rely on distribution rails that are not directly connected to their customers' core technology, according to Hurst.
"One of the keys to success in embedded finance is enabling a frictionless customer experience," Hurst said.
LSQ recently announced a partnership with Esker, a procurement and accounts payable software platform that embeds LSQ's supply chain finance offering into Esker's core software platform, Hurst noted.
Mendoza Ventures' recent investments include Finaeo, which is building rails for digital life insurance firms that integrate the buying and quoting of life insurance and other complex insurance products directly to fintechs through API connections. Another investment, in Senso.ai, embeds mortgage purchasing and pre-approval directly into the software of banks and other fintechs.
Increasing numbers of banks are now letting business customers do their banking within their existing accounting and workplace software.
"We have seen banks and credit unions use embedded financial solutions from startups, rather than trying to build these services themselves," Mendoza said.
There is an opportunity in embedded finance for startups that can streamline payment and financial processes, creating new competition for existing firms in such as Synapse, Stripe and Dwolla, according to Mendoza. "That's especially true in the current market, where fintech startups are being asked not just to extend their own
And any slowdown in IT spending within the financial services industry could create opportunities for new companies that can demonstrate an ability to cut processing friction while trimming costs, as outlined by Mendoza and Hurst.
“In the current economic climate, I think you are going to see many big fintech players clamp down on spending towards innovation and this will leave space for others to break through,” said Ralph Dangelmaier, CEO of BlueSnap, a digital payments company.
An overall drop in fintech startup funding
While 2022's total investments in embedded finance companies are on pace to be at or just below 2021's total, the trend comes against a backdrop of much larger declines in investments in relatively new technology companies.
Fintech funding fell 18% during the first quarter compared with 2021's first quarter, according to
“For the last 18 months we’ve scratched our heads at the money grab for companies that received crazy valuations and funds from VCs for making enough market noise without actually providing real value to customers," said Isaac Gurary, CEO of NoFraud, a digital security company. "There was a major disconnect between inflated valuations and real life. VCs were seemingly throwing cash at anyone who asked for it."
The recent slump has been marked by dramatic declines in the funding or valuation of buy now/pay later and crypto companies. Global crypto VC funding fell from $6.8 billion in April to $4.2 billion in May as the digital-asset sector spiraled downward, according to
In the buy now/pay later sector,
"There have been multiple compressions in valuations. For businesses that were 'high growth' the current market environment has made it difficult for these companies," said Philip Belamant, chief executive of Zilch, a BNPL lender.
Zilch recently announced a $50 million extension of its Series C funding that kept its valuation at $2 billion. Beyond BNPL, the firm offers a virtual Mastercard for digital payments, with an option to pay in full in exchange for cash back rewards or four-installment loan. Zilch plans to offer debt consolidation and FICO score building in an attempt to increase utilization of the site and boost its rate of fee generation, which is part of the fintech's strategy to maintain its valuation, Belamant said.
The decline in fintech investments comes as overall VC funding fell from about $200 billion globally in the fourth quarter of 2021 to about $100 billion in the second quarter of 2022, according to
The reason for the drop-off depends on the sector — BNPL investors are worried about
The need for payments and financial services innovation remains, given the rapid shift to digital that sprung from the pandemic and has continued. That means there's still a demand for fintech startups and for investment, though focused more on providing needed services than those that project marketing or hype, according to Gurary.
"Any company in the fintech industry that has added value to merchants and/or consumers, even if the company was overvalued or margins were inflated, will likely stand the test of time," Gurary said.
