Y Combinator for Mittelstands?
neilthanedar.com
neilthanedar.com
The idea of Mittelstand business is to be conservative, low in debt, turn a profit, keep a company private, usually under multi-generational family control and from the very beginning make decisions for the long term, and keep employees around for life.
Software companies that come to mind that are like this are say, IntelliJ or Valve maybe, not startups. There's nothing to IPO, there's usually not that much interest in outside money, so how does this square with the VC industry?
The initial move from talent to profitable business is what we need - not because we can see a runway to 18 months IPO but because what the duck else do you do with money other than create new better wealth for the world.
Previously this has been solved by government taxing rich and giving it to innovators through schools, universities and arms spending (simplifying slightly).
But apparently tax is bad now, and governments don't know how to pick winners to VCs are going to take over. If this is not a great idea we should try some other options - the OP has an idea. It's not bad. Others exist (including that tax one which apparently no one with money likes)
But that's ok. We don't have to stick with the current formula - other options exist in the phase space. We don't want to throw out the fanta aston growth of the past 200 years, but we do want to ... fine tune it to provide similar benefits, at different social costs/benefits.
From a longer term perspective, the VC money is not "theirs" - this is an investment in the future of the species.
I think there are three questions
1. How do we discover fundamental breakthroughs (steam turbines, E=mc2, new drugs). Tax funded edication and universities is mostly the answer (R&D labs at companies so big they look like government departments also help). I think we could double the science budget in every western country every five years for decades before hitting some negative feedbacks
2. How to build out the skeletons of these breakthroughs (ie when we got electricity in the 1900s the question was how to build wires to every house. Yes the initial rush was privately funded but that was about two blocks of NYC. The continent wide rollout was ... tax funded. How will we move from oil and gas to (Inpresume) solar. It will need more wires, different home and industry power plants (gas boilers etc).
3. finally the foam on top - the tech startups etc. How to encourage these - speed them up, have them deliver different social and industry outcomes. my take is to stop doing what we currently do, which give us the current outcomes (oh look another MIT graduate being asked to scale for growth) and find different founders in different places.
I think YC itself is trying to answer many of these questions - they have pushed out to fund startups outside USA, they are choosing outside the SaaS window and are looking at fundamental ideas (fusion startups!). But honestly compared to (effective) government funding they are a drop in the ocean. but it seems they point in the direction Inwoukd too.
I would like to create a small fund to invest in these pre-Mittelstands at the earliest stages and help them go from $0 to $10M faster.
These businesses need much less funding (usually <$1M) to get to this stage, so it's a different model than VC. But if you invest early enough at the right valuation, the returns could be VC-style with a much lower risk profile.
If you invest $100K at <$1M valuation pre-revenue in 100 pre-Mittelstands, 1-5% of those companies are going to get to $100M+, 10-30% will get to $10M+, and 50%+ will get a positive exit.
There is a robust buyout market between PEs and corporates for these companies.
Yes, this is a form of venture capital. But most VCs today would not consider pre-Mittelstands VC-backable startups.
This post and my last one We Need a Middle Class for Startups (https://neilthanedar.com/we-need-a-middle-class-for-startups...) make the argument to VCs that they can get big exits and returns investing in Mittelstands.
You say "pre-Mittelstand", so I guess it's not about investing in companies that are aready Mittelstand (and effectively lifting them out of that) either.
From there, they will have many exit options, including corporates, PE, and even IPO.
I don't believe there's anything in the Mittelstand definition that prohibits exits.
I'd target this Y Combinator for Mittelstands accelerator at the $0 to $1M stage for pre-Mittelstands.
In fact generally Germany was the largest net exporter, up until not long ago, despite China being better known for its trade balance. Losing WW2 was in the purely economic aspect the best thing that ever happened to them, although it's seasonal because sometimes foreigners tell them they should be more into finance and insurance instead of manufacturing.
That makes Germans feel bad, they're really good at feeling bad, ie guilty, it's cultural, but they don't really do things differently. They just stick to analog tech and work like fuck, that's it. Just work, that's how they have fun. Socially? More awkward, much happier working. That's why they drink like they do.
Don't get bored that badly. And that's where the analog magic begins, in the subtle subtle subtleties, which are huge and obvious if you put in the time without getting bored, there's a whole world down there. The digital equivalent is this: What if I just leave this comment written without hitting reply? What if I bookmark it, will the text get saved? Is there a time limit to how soon I can reply, or how late? What if I do it right on a time limit? Where does one thing end and the other begin? In the analog realm: What if superstition is good? What is superstition, what is science? Science means cutting, where to draw the line? At what point do I call out a man in a lab coat as a bullshit artist, or do I let him tell me black is white, 7 equals 12, 60 equals 100? Do I draw a line, or do I use my spine to make decisions better, let my hands do the typing like right now, eye-hand spinal coordination, the spine as the second skull talking without the skull's thoughts?
The analog world is infinite. And there might be a Mittelstand for you too somewhere in that little world of subtleties.
Aren't there a fair number of startups that could achieve that, but get blown up because the VC model only allows for abject failures or unicorns.
For the "Mittelstand" path you have to look for growth paths with the aim of sustainability.
Find a niche and fullfil the needs there.
Walking away with $50 mil is a lot better than with liquidation value.
As for the larger scale: every startup is expected to settle into some size with little further growth at some point. The "unicorn" is a rather new trend, and it's only a small fraction of even VC-funded startups (although it's a larger fraction by funding or attention).
Or is this a case where the German word has been co-opted for a different meaning in English? (Though other words like Kindergarten or Zeitgeist are very close to their original meaning, now that I look them up.)
I find the English usage of “Angst” really confusing, as it really just means anxiety or anxious.
USA: While angst and anxiety come from similar roots, angst is not just anxiety but a dread or anguish. Often angst is focused in a certain way, such as towards a particular condition one person has or a group of people have. Anxiety is more general.
There may also be differences between the two words in certain fields, such as with professional definitions.
There are also other derivative uses, such as teenage angst, that are more akin to feeling overwhelmed but not necessarily anxious.
I want to split SMB in American terminology into two categories - small businesses ($0-10M) and Mittelstands ($10M-$1B). My focus is the latter.
SpaceX is $2B+ in revenue in 2019, so they're a little out of this range, but many of their suppliers are definitely Mittelstands.
Yes, this is a reaction to "unicorns" for sure. I'm arguing that there's great value for founders and investors in Mittelstands.
TIL that my current and previous employer are both (more or less) Mittlestand businesses.
I must say, I really do prefer working for these kinds of companies. The lack of outside influence, the robustness in the face of economic uncertainty, the long-term focus, etc. all I think contribute to a more responsible leadership than I've come to expect from any other type of enterprise.
I think they are not the ones employing recruiters to sing their praises and send zillions of emails.
That doesn't mean it's all roses. My last company brought in a terrible middle-manager who was at least part of the reason I left.
If I were searching in the market right now, I'd probably apply to a bunch of different companies and ask some variation of the following questions:
1. Are you privately-owned (and plan to stay that way)?
2. Are you profitable?
There's obviously a bunch of other questions that are important to job satisfaction (is the work relevant to the companies revenue goals, work/life balance, etc.) but those two questions determine whether the company has at least the economic independence to make the right decisions over the long-term.
But having gone through YC in W15, they're definitely not built for Mittelstands. YC pushes you to keep iterating and changing your pitch and product until you're targeting a multi-billion dollar market.
I do believe there's room for a YC for Mittelstands:
Be like Paul Graham circa 2005 – find people who others didn’t think could be founders and coach them from the very beginning to control their companies.
Both of these ideas are on my list of solutions to The World’s Biggest Problems.
I want to raise a $1M+ per year rolling fund to build this accelerator.
Who would be ideal investors for this fund? I'm thinking angels to start and family offices and PE as we scale.
Perhaps I'm forgetting another type of acquisition, but these are the two that I can think of off the top of my head.
Let's say the deal is $100K for 10-20% of pre-revenue/pre-product pre-Mittelstands.
You will get 100+ out of 200 businesses that are >1X+, 20+ that are 10X+, and 2+ that are 100x+.
So I'd do diligence like YC - wide open applications, largely focused on the team, one or two interviews max, global focus.
I very strongly suspect that if investors could be getting returns of '20 that 10x+ and 2+ that are 100x+' as you say, they would already be doing so, and we wouldn't have to be theorizing about it. The fact that VC has for decades only existed for software & pharma and not, like, a new type of cable harness or industrial process or anything else in the physical/manufacturing world should probably tell us something
I dig into the data here: https://neilthanedar.com/we-need-a-middle-class-for-startups...
Mittelstands are allowed to partially or fully exit.
PEs do invest in Mittelstands at $10M+ revenue. But there's not a great market yet for pre-Mittelstands, which is where I'm focusing here.
This seems implausible.
1) the business, like many new businesses, will probably fail within 10 years
2) when the business fails, I won’t be able to recoup my losses because bond holders will be first in line for the liquidation money
However, it’s even worse because:
3) the business isn’t even trying to become large enough for a buyout or IPO, so it will be very hard for me to sell my equity.
Logically, which is easier: trying to earn 10 million a year in revenue, or 1 million? We can simplify that even more: which is easier, trying to earn 1 million or $100,000? Trying to earn $100,000 or $10,000 a year?
At every level, for every step down, the answer is: much, much easier. Given two numbers for revenue, the smaller one is easier to achieve, every time. As a rough approximation, for each comparison given above, one value is about 10x easier to achieve than the other.
The problem is that VC's exclude, and filter out, the easiest class of money to make, that in the $1-$10 million range.
But there's always been a follow up question here which I've thought a lot about: which is easier - going from $0 to $100 million in revenue, or going from $1 million to $100 million?
The easy rebuttal to "the $1 million business may not be able to go to $100 million" is "then they can pivot and still be far ahead of the person or team starting from $0." They already know how to run a business, how to do idea validation, how to be ramen profitable - they've done all that. It's going to be easier. They've done it before. Yet right now no one targets them as the safest bet, as in fact where the smart money should go.
So a mittelstand, by one treating these smaller amounts of worthy of pursuit (amounts which are also easier to achieve), and two leaving the door open to going beyond those amounts when the time comes, might even be able to outcompete many VC's, over time.
The presence of "underutilized potential" doesn't mean that there's a triage opportunity. Free cash flow (and liquidity thereof) still needs to pencil out. If exits are mostly a no-go into perpetuity, then the only way to realize actual cash-on-cash returns (e.g. for a net present value calculation) is ultimately dividends -- that, or creating a marketplace for private stock transactions in such companies.
It's at least conceivable that there is a spot on the risk/reward tradeoff this kind of thing could address quite distinct from VC or PE backed companies. Not at all clear, and liquidity would have to be contracted around.
If we take [Valuation = Next 12 Month Revenue * EV/Revenue * Marketability Discount], we arrive barely at 15M/20M USD (if you are even profitable!), and still, the majority of these companies will not reach this state and just disappear :/
The fact we are talking about Mittelstand is notice that the German approach (arch enemy of UK/US culture through 19C) might suggest a wider phase space than is feared.
We should try something. While the benefits of steam/oil/electricity/silicon/pharmacy are great there are downsides to how we have arranged our societies - and it would be good to explore some of those options rather than say "the solution is always to copy USA, see Meijei for details".
(no this is not some anti-USA rant)
I personally think taking the SoftBank fund and attempting to launch a million startups globally is just as likely to get us results the OP is talking about (even if that's because kicking off 500,000 new companies between Chennai and Jakarta is going to do something, and it cannot be a worse ROI than WeWork
But whatever, there is a phase space outside the standard approach here.
VC is going to be good for taking fundamental tech breakthroughs and pushing them into the public - but the fundamental tech break thoughts have almost always come from government funded programs (transistors, pharmacy (mid-19C chemistry) etc) - so we should not forget that just more VC is unlikely to solve the big problems (sorry people who want to fix fusion on VC money.
Weirdly Turbine engines might be the best privately funded example. But that basically was a rich guy funding his own itch. That's not a good bet (or as a UK citizen a good way to run a country)
Anyway I am rambling so - yeah go for it. spread the money around as best we can - give it not to the rich or those with success behind them but find other indicators (phd might be one, just lucky is another, old and still passionate if you can measure that or helll just helicopter money in.
Try goddammit because none of us are taking it with us.
If you had the metrics, and could give up no equity, isn't that a better deal?
TinySeed is probably the best example of a YC for Mittelstands now. I love what Einar is doing there and am trying to refine a model that works here.
Getting to enough revenue where they can be Pipe funded isn't trivial. We can be a bridge to those funding sources.
Not sure how many are growing at >40% CAGR with minimal capital requirements...
Fine if you wanted to fund HVAC, plumbing, construction, etc. businesses that are generally ignored by YC. Wouldn't count on startupy growth from companies YC screens against
And public or not, who is going to buy those shares if their prospect is now down to a 2.7x return: invest $10M for a $27M return ($27m revenue in 5 years, x5 revenue multiple, 20% ownership), and an even less likely exit?
The whole VC pipeline is based on growth.
> Advice for Founders: Stay indie as long as possible.
> Take advantage of new bootstrapping tools and non-dilutive funding sources. Raising VC funding increases growth potential but reduces optionality. Startups can always raise money later.
>It’s near impossible to return money raised and get your equity back.
> Trend: It’s easier now to fund businesses without giving up equity.
1. https://neilthanedar.com/we-need-a-middle-class-for-startups...
I hope I'm wrong, but I'm a cynic here.
Ideas are cheap.
If you have a good idea, and not even access to $100k in debt, then that's a decent proxy that you either don't believe enough to take the debt yourself or that you maybe aren't qualified to run the business.
Especially when you consider a huge majority of successful businesses are founded by more than one person...
But even besides, there’s plenty of third world-ish countries with lots of talent and no easy money.
It's a lot harder to make $10M per year in Zimbabwe than it is in the US.
It also just isn’t smart to start a startup with personally-guaranteed debt if you aren’t wealthy to begin with. Of course you need to believe in yourself, your idea, and your business, but that doesn’t mean pretending that there’s zero chance of failure—that’s just hubris.
(Yes, this is Taleb's barbell strategy.)
that would almost certainly mean instant success or a quick death, no? If the author is targeting the "middle class" of startups, why hasn't their expectations adjusted with that? I'm very confused.
It reads like an outline, not an article.