Executive Summary

The most dangerous competitor is the one you don’t see coming. For SMB direct lenders, that competitor isn’t another lender - it’s the software your borrowers already use every day. This is the embedded lending shift, and it’s not a future trend. It’s happening now, and it’s replacing traditional deal flow with something faster, smarter, and more convenient.

While you’re competing on rates and relationships, a new channel is quietly absorbing your market share. This isn’t about working harder; it’s about recognizing that the game has fundamentally changed. The fastest-growing companies aren’t just making loans; they’re embedding them directly into the workflows of their customers. This article breaks down the three channels of modern lending, reveals the data behind the shift, and provides a clear framework for what separates the winners from the rest.

The Common Struggle: Vanishing Deal Flow and Squeezed Margins

If you’re a direct lender in the small and medium-sized business (SMB) space, you’re likely feeling the pressure. Deal flow feels less predictable, broker loyalty is eroding, and margins are being relentlessly compressed. You’re fighting for every deal, only to see borrowers get funded by competitors you’ve never even heard of. This isn’t a perception; it’s a reality backed by data.

The market has become brutally competitive. In the third quarter of 2025, a staggering 56% of direct loans were priced below S+500, a sharp increase from 37% in the second quarter and just 28% in the same period last year. This race to the bottom on pricing is a direct consequence of a saturated market where lenders are forced to compete on the only lever they think they have: cost.

This margin compression is happening because the traditional model of relying on a network of brokers is breaking down. While it once provided a steady stream of deals, it now creates immense risk, unpredictable volume, and a direct hit to your profitability. You are paying 10-15 points for deals that are being shopped to multiple lenders, turning your origination process into a commodity auction.

The Contrarian Insight: Your Real Competitor Isn’t a Lender

The prevailing wisdom is to fight back by building a better broker network or a more aggressive sales team. This is a losing strategy. The real threat isn’t another direct lender who offers a slightly better rate. The real threat is the accounting software, the payment processor, or the vertical SaaS platform that your borrower uses to run their business.

This is the core of the embedded lending shift. Instead of a borrower actively seeking out a loan, the loan is offered to them at the precise moment of need, directly within the software they are already using. It’s frictionless, contextual, and incredibly convenient. The borrower isn’t applying for a loan; they’re clicking a button that says “Get funding for this invoice” or “Finance this inventory purchase.”

This shift is powered by a massive data advantage. Embedded lenders have access to high-frequency, real-time transaction data, giving them an unparalleled ability to underwrite risk and make instant credit decisions. While you are analyzing stale bank statements, they are analyzing live cash flow. This allows them to offer capital faster, more conveniently, and often with more confidence than a traditional lender ever could.

The Framework: The Three Channels of Modern Lending

To survive and thrive, you must understand that the lending landscape is no longer a single-channel game. It has permanently fractured into three distinct channels. Most direct lenders are still operating exclusively in the first, and most vulnerable, channel.

Channel 1: Traditional Direct Lending is the world you know. It’s relationship-driven, reliant on brokers, and increasingly commoditized. Its market share is actively being eroded by the other two channels.

Channel 2: Marketplace Lending platforms like Fundera or Lendio aggregate multiple lenders, creating a competitive environment that further drives down margins. While they offer borrowers convenience, they turn lenders into interchangeable commodities.

Channel 3: Embedded Lending is the disruptive force. It’s where lending becomes a feature, not a product. It’s growing at an explosive rate because it aligns perfectly with borrower expectations for speed and convenience. A staggering 90% of SMBs now consider embedded finance essential to their operations.

The Proof: A Regional Direct Lender’s Wake-Up Call

Consider the case of a mid-market direct lender with an annual loan volume of $25 million. For years, they operated a successful business relying on a network of brokers for 70% of their deal flow. In late 2024, they noticed a disturbing trend: despite offering competitive rates, their deal volume was declining. They were losing deals, and they didn’t know why.

After a deep analysis, they discovered the culprit. Their borrowers weren’t going to other lenders; they were accessing capital through the vertical software platforms they used to manage their businesses. A local contractor was getting instant financing for materials directly from their project management software. A restaurant was accessing working capital through its point-of-sale system. These were deals that never even made it to a broker.

The lender had lost nearly 20% of its potential deal flow to competitors it didn’t even know it had. This realization was a wake-up call. They had to adapt or become obsolete.

Their transformation was strategic. They didn’t abandon their direct channel; they augmented it. They partnered with a vertical SaaS platform in a niche they understood, becoming the embedded lender for that platform’s customers. The results were dramatic.

Before & After: The Embedded Lending Shift

By adding an embedded channel, they not only recovered their lost deal flow but also significantly improved their margins by reducing their dependence on expensive broker commissions. They were no longer just competing; they were building a durable, defensible business.

The Implication: Adapt or Be Replaced

The embedded lending market is projected to grow from $9.2 billion in 2025 to $35.8 billion by 2035. This isn’t a niche market; it’s the future of SMB lending. For traditional direct lenders, the implication is clear: you can no longer afford to operate in a single channel. Relying solely on brokers and direct outreach is a strategy for survival, not for growth.

The winners in this new landscape will be the lenders who adopt a three-channel strategy. They will maintain a strong direct lending presence, selectively participate in marketplaces, and aggressively pursue embedded lending partnerships. They will understand that the goal is not just to provide capital, but to deliver it at the point of need, with the least amount of friction possible.

Your Next Move: What Separates Winners from the Rest

To compete in this new era, you must ask yourself a critical question: Is your lending business built for a three-channel market, or are you still playing a one-channel game?

Here’s what the fastest-growing companies are doing right now:

1. They are auditing their deal flow. They are identifying exactly where their deals are coming from and, more importantly, where they are losing deals.

2. They are asking their lost prospects: “How did you end up getting funded?”

3. They are exploring embedded partnerships. They are identifying the software platforms that their ideal customers use every day and exploring what it would take to become the embedded lender for those platforms.

4. They are building a direct-to-borrower channel. They are investing in their own marketing and brand to reduce their dependence on brokers and build a direct relationship with their borrowers.

   
   

The embedded lending shift is a threat, but it is also an immense opportunity. For those willing to adapt, it offers a path to higher margins, more predictable deal flow, and a more defensible business. The time to act is now. While your competitors are focused on the next deal, you can be focused on building the next generation of your business.

References

[1] Bloomberg. “Private Credit Profits Come Under Threat as Loan Margins Narrow.” December 4, 2025.

[2] World Bank Blogs. “How embedded finance is reshaping credit access for MSMEs and in.” July 18, 2025.

[3] Future Market Insights. “Embedded Lending Market | Global Market Analysis Report.” October 27, 2025.

[4] PYMNTS. “90% of SMBs Say Embedded Finance Is Now Essential.” September 19, 2025.