Businesses that are shooting for the "middle class" (say, less than $50M in earnings at their peak) are of course possible and healthy and good for the economy. What's missing in this analysis is that those businesses are not going to be "founder-friendly" the way that the prototypical YC-seed-stage startup is. To use the article's definitions:
* "Bootstrapped from zero" is, of course, founder-friendly - no investors and no board means you get to do what you want!
* "Raised $100M+ from VCs" is also pretty founder-friendly, at least in the early days, because you're selling those VCs on the lottery-ticket dream that they could earn 3-5 orders of magnitude ROI. With such an incredibly high upside, VCs and angels are willing to take risks with zero due diligence on unproven founders and small dilution.
If you remove the long tail of upside from the possible outcomes and tell your early investors "the best case for you is 100x return, but zero is still just as possible" then the market will compensate in these ways:
* Less availability of capital
* More dilution
* Less faith in "visionary founder" CEOs and more desire by investors to bring in professional management
* Long and protracted due diligence processes before the check even lands
All of that is fine! There's nothing wrong with building a business this way. But there's no free lunch here - companies that don't chase astronomical outcomes will have a harder path to getting those first few dollars in funding.
The key is that Mittelstand businesses are much less likely to fail. (This is why PEs on average outperform VCs. I go into these economics in my post.)
This can be the Goldilocks deal for founders where you raise <$5M from angels or PEs who are happy with consistent 5x returns and get to $10M+ revenue and $50M+ value with majority ownership. And there are orders of magnitude more of these opportunities available vs. VC-backed unicorns.
And being VC-backed is only great if you're one of the winners. If you're one of the >90% that's written off, you're back to zero.
I hit the wall at Series B with my startup Labdoor. We pivoted to profitability and are now headed to Mittelstand land, but this all would've been way easier if we just headed straight to middle class.
> The key is that Mittelstand businesses are much less likely to fail
I think you're getting at the crux of it here. The question is, how does one of these businesses "prove" to investors that they are less likely to fail? The failure rate for new business starts is famously high, whether that business is a tech startup chasing unicorn status or the corner deli. I think this will manifest itself in the due diligence phase, bringing back a bunch of things that tech founders have eschewed: detailed business plans, fundraising towards specific initiatives (as you point out in your post), and harsh measurement of progress towards those goals in board meetings with rapid consequences if goals are missed.
> I think you're getting at the crux of it here. The question is, how does one of these businesses "prove" to investors that they are less likely to fail?
By having a business plan. That's why banks (at least over here in Germany) ask for one when you ask for a loan. You present a plan, someone reads it, you talk it through, clarify a few things and if everyone is happy they give you a loan and you start (or grow) your business with it.
> You present a plan, someone reads it, you talk it through, clarify a few things and if everyone is happy they give you a loan and you start (or grow) your business with it.
In the US, unless you can put up property like a house or land as collateral, or plan to use the loan to purchase recoverable assets like industrial equipment (I suppose a data center would qualify, but actual computer hardware depreciates faster than banks like), you won't get the loan, even if it's a local bank you're approaching.
In theory a software business could use IP assets as collateral, but that usually doesn't apply to new software businesses.
Getting to the point where a software business could get a business loan from a bank more or less requires bootstrapping.
Yes, they do, if you can provide a security for the loan. More often than not, the founder is the guarantor, which sucks for them if the business fails. This is moderately founder friendly, to say the least.
In Germany, there's the option to have the government secure your loan towards the investment bank. For the founder, that means you get capital into your new company and only the company is legally liable for it, but not you personally.
This seems to be why Germany has a lot of healthy middle / medium sized businesses, if indeed true on face value.
This is what the US should really subsidize, the ability to bootstrap and start a new business, especially first time business owners. I know the SBA does some things around this but it is very much focused on "mom & pop" type stores, I don't know of any software businesses started with an SBA loan (though I imagine due to time and volume, there probably is one).
I think taking the risk out of it in this way would be a huge economic win, but it would definitely not be popular with the incumbent businesses that have the dominate lobby voice in US politics.
That's what I did, and that's not how it works. The Bürgschaftsbank guarantees the loan in case the founder fails to repay. I'm going through that right now.
I don't have a definitive answer, but I'd venture that that's is something that can be addressed by your pitch, how high you are aiming, etc...
Someone who wants to build niche business software vs "the next Facebook" is a good example. The first case has clients outlined, a good estimation of revenue, competition, etc... The second is more abstract but aims higher. Success (albeit highly unlikely) means billions in revenues.
>The first case has clients outlined, a good estimation of revenue, competition, etc... The second is more abstract but aims higher. Success (albeit highly unlikely) means billions in revenues.
It's a stereotype that startups don't have things like estimates of revenue, a clear business plan, clients, etc... A few crazy outliers get all the attention but the vast majority that get funding have a clear and convincing plan to get to profitability, and often clients or at least partner businesses (in other words clients that aren't paying yet, but are willing to spend their own resources working with you).
The problem is that most new businesses fail, so if you're investing in new businesses the winners can't just make you a little money, they have to pay for multiple losers too.
You also need to convince investors that it's worth putting their money into these risky businesses instead of say Microsoft/Apple/Google/Amazon/etc... which will not go out of businesses anytime soon and produce respectable returns.
Even startups not aiming to be the next FAANG company have trouble estimating revenue, product development time, etc. It's just extremely hard to know all the unknowns when you are starting a new business, especially since it is likely that you are only an expert in one of the required fields (eng, product, marketing, sales) to bring your product to market and will have to learn everything else on the fly. Most business plans for startups are useless.
most new businesses in the US are still bootstrapped, usually through a combination of family (non-)wealth, non-professional investment, (small) bank loans, supplier credit, and plain ol' hard labor. most of those will be small businesses, but many will grow to mid-sized businesses. most will not be software businesses.
software doesn't have an investment problem. in fact, it's a maturing industry where all the big money that investors can squeeze out has mostly been squeezed out. that's where the lack of interest in the sector lies, not some missing middle investment. investors are looking for bigger opportunities because the risks have risen, but there's such a glut of money looking for return that we have risky sideshows like crypto/nft's seeing billions pouring into it irrationally just because it could be big.
what is actually happening in relation to the middle is the hollowing out of the real middle class, where family wealth and non-professional investment is going to zero and becoming untenable for starting a new business, and economic rents overwhelm even those where it's available. the problem is that we're becoming feudal, and fewer people managing bigger pots of money is less efficient and less dynamic.
I had not considered the way crypto/nfts have been commandeered to be a side effect of wealth not being able to be allocated fully anymore. That's an interesting take. I wish there were a way for that kind of wayward money to do some real work improving our communities while it waits for something more profitable to do.
I don't necessarily mind that people are trying to make money with their money, but it is a shame that so much capital is caught up in financial instruments that don't do any real work while it's holding onto it.
that's exactly the crux of the problem: a misallocation of resources due to the increasing distortions caused by increased wealth concentration. it's directly observable in investment markets like software startups or crypto, but it's effects are felt all over the economy.
like most systems, balance is critical to optimality. greed in moderation drives the economy, while greed in excess grinds it to a halt (as does a dearth of greed, à la communistic economies).
at least 50 years of poor financial policy fostered by laissez-faire economic dogma led us to these distortions, so it's no better time than now to start realizing this and digging ourselves out of it, rather than being distracted by outrage du jour.
> I had not considered the way crypto/nfts have been commandeered to be a side effect of wealth not being able to be allocated fully anymore.
If I point out that Marxist economic theory talks about a "crisis of capital accumulation" where capitalists (meaning those with capital to invest) don't have enough places to invest their capital succesfully, and that this is related to "financialization" as a method of opening new places to put capital (also in some circumstances "imperialism"), and that in different periods this can go up and down... in the past I usually get down-voted.
> The key is that Mittelstand businesses are much less likely to fail.
Citation needed.
Around half of new businesses in the US fail after five years[0], and it is reasonable to assume the vast majority are small.
Mom and pop businesses fail all the time, we just don't hear about it very often.
Also, one of the key properties of Mittelstand, as I understand it, is that you don't need, or indeed want, an exit. It's (ideally) a cosy, lifestyle business.
I agree that this is a healthy approach and more people should be aware this is a viable option, but I'm not so sure it can be mixed with PE or VC (for the reasons I mentioned).
I think this would be much more healthy than the multi-phase aim-for-the-moon approach everybody takes today. And quite likely brings better results for both the investor and the founders.
If the business is already on the path to a small profitability, it is much more likely to get into large profitability than something that wasn't even started. And much less likely to get into a total loss.
Your points also seem a bit odd:
> Less availability of capital
There's no reason for that. If the investments are less risky, there should be more capital, not less.
> More dilution
Yep, at least more dilution per round. Companies doing that shouldn't do multi-round or have a very small first round followed by a second one.
> Less faith in "visionary founder" CEOs and more desire by investors to bring in professional management
Hum... Bringing management is a VC only thing. Their desire to bring management is clearly one of the forces stopping them form investing on less risky ventures. It's a non-performing choice for risky startups, and it's a non-performing choice for less risky ones. I'll just not call it stupid because there are handful of contexts where it's not, but doing it by default is clearly stupid. The good thing is that it's not viable for less risky bets.
> Long and protracted due diligence processes before the check even lands
>If the investments are less risky, there should be more capital, not less.
That's not the right metric. An investment balances risk and reward. If the reward of the less risky business is too low, then there will be less capital. If I guarantee your money back, and also zero growth (I'll just hold the money then return it), no one would invest - not enough reward.
Next, you have to outperform other risk/reward outcomes, such as bond or stocks or real estate, etc. Otherwise investors should (and likely will) put their money elsewhere.
For some market to get significant investment, it has to do well on the risk/reward frontier compared to alternatives.
Those reasons are why there is not massive VC type funds investing in companies like these. It's not that VCs are stupid, or investors are stupid. It's that the risk/reward for such companies has to compete against all other options for that capital.
Concerning "And quite likely brings better results for both the investor and the founders.":
That "[it] brings better results" for some groups does not imply that it more healthy for this group. Also the other way round: "more healthy for some group" does not necessarily imply "better results for this group".
In this sense I did not think that this phrase was to be considered an answer to my point.
Hum, ok. You are interpreting "better results" in a strict monetary sense, without accounting for second-order problems from bad deals.
It looks more healthy for both groups. I do expect it to bring better both first-order and second-order results. (Those two are always correlated, and on investment relationships they are very strongly correlated.)
FWIW the German "Institute for Mittelstand Research" defines Mittelstand companies as being fully owned by a family who is able to operate economically independently. This by definition excludes most forms of VC funding (having a board with seats held by people outside the family would defy that definition).
Even without this restriction the common definition in Germany is the equivalent of SME, i.e. less than 500 employees and less than €50M annual revenue. This includes some 95% of companies in Germany.
So unless he's asking VCs to invest without demanding equity or any amount of control that would interfere with the will of the family owners of the business and for the goal to be capped at €50M annual revenue, I don't see how "Mittelstand" is the right concept to use.
FWIW the resilience of (traditional, i.e. older) Mittelstand companies is likely more related to the same factors as the resilience of worker co-ops (which likewise tend to be growth-limited but stable across economical crises): the owners have a personal (often generational) stake in the company and the workers are assumed to be in it for the long run rather than being laid off at the next opportunity. Plus of course the owners' fortunes being so tightly coupled to the well-being of the company means that they're able and willing to inject their own capital as necessary to weather crises.
These deals work for smaller funds with fewer staff. The current situation stems from the giant funds. Not so long ago most A rounds were a couple of million or less.
> What's missing in this analysis is that those businesses are not going to be "founder-friendly" the way that the prototypical YC-seed-stage startup is.
I don't understand your definition of "founder-friendly." I want to build a business that delivers real value to customer and I want to do that from day one. I don't mind working harder or working on boring problems (if necessary) to do that.
* "Bootstrapped from zero" is, of course, founder-friendly - no investors and no board means you get to do what you want!
* "Raised $100M+ from VCs" is also pretty founder-friendly, at least in the early days, because you're selling those VCs on the lottery-ticket dream that they could earn 3-5 orders of magnitude ROI. With such an incredibly high upside, VCs and angels are willing to take risks with zero due diligence on unproven founders and small dilution.
If you remove the long tail of upside from the possible outcomes and tell your early investors "the best case for you is 100x return, but zero is still just as possible" then the market will compensate in these ways:
* Less availability of capital
* More dilution
* Less faith in "visionary founder" CEOs and more desire by investors to bring in professional management
* Long and protracted due diligence processes before the check even lands
All of that is fine! There's nothing wrong with building a business this way. But there's no free lunch here - companies that don't chase astronomical outcomes will have a harder path to getting those first few dollars in funding.