Right now, the SEC is considering raising the accredited investor definition from $1M+ net worth to $10M+.
As is, just 10% of Americans qualify as accredited. This increase would make startup investing the exclusive domain of the 1%.
We should be going in the other direction, ending accredited investor restrictions so 100% of Americans are allowed to invest in startups!
This doesn't mean that 100% of Americans can or should invest their money in startups. But at least it will be legal for them to do so.
Using income or wealth to restrict accreditation causes biases in the funding market. Less than 1% of 18-34 year olds are accredited. Only 1.3% of African Americans are accredited. These biases affect which founders get funded.
Open access to startup funding enables truly open crowdfunding. This will lead to more startups being created, and more types of founders getting funded. This is all a huge positive gain for society, and can build wealth for Americans who never had access to this asset class.
If we really believe in the power of founding and investing in startups, we should let everyone do it!
Hi Trevor. Thanks for this reply. I agree that we need different politicians, not just more of them.
My hypothesis is "altruists can win elections", and I'll test it by helping many of them get elected. (Inspired by YC's hypothesis [1] "young hackers can start viable companies.")
YC creates more startups in a specific way - by empowering hackers to keep control of their startups. Similarly, I want to empower altruists to be effective politicians while maintaining their independence.
The network effect concern is real, as is the lack of financial incentives for backers. I haven't solved these issues yet and am open to ideas here.
Politics can be a force for good, and while not everyone shares this value, I will work with altruists that do. I believe this shared mission can bring altruists together across parties.
If I were starting a Mittelstand today, yes one great option would be to take YC's funding, take little to no additional capital, and exit as a Mittelstand with most of your equity.
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.
Mittelstands (defined as $10M-$1B in annual revenue) are very stable, profitable companies once they get to that stage. But there are very few funding options for pre-Mittelstand businesses.
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.
But then you are VC-funded. As Barrin92 hinted at, VCs tend to want to see returns and consequentially optimize for growth. Or is the idea for VC to pull out and realize profits once the company got to Mittelstand?
I mentioned this in another comment - pre-Mittelstand investing is also driven by power-law 100x+ returns.
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.
It's very well possible that I either did not understand how your answer relates to my question, or that my definition of "exit" (namely, that a company gets sold, usually to a larger entity, and is not held by founders anymore) is incorrect or too narrow, but, again, how is an exit compatible with a company being part of the Mittelstand?
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.
But by definition if a company grows for decades it doesn't 'exit' (=it isn't sold or renamed or repurposed). So I think that the Mittelstand definition should prohibit an exit, maybe not for the individual (=founder/owner) but for the company as a whole. In my opinion this is why in german you don't really use the term for companies anyway except when econonomists look back and analyze your company history.
I begin to think that OP just took the word "Mittelstand" to mean "$10M-$1B", which at least to several other people in the thread is rather confusing.
Generally another Mittelstand family can provide funding, that's how it goes in Chile. It's not like they've never met in eg Swiss ski slopes, parties, that sort of thing. And they have capital, not only are they high net worth individuals, they are also high absolute worth individuals, because they don't really get into debt. The German economy is a macrocosm (you can think of it as a constellation if you don't like "macrocosm") of the Mittelstand, there's actual profits and defensible business, and the money piles up year after year, spending less, saving more, investing the savings, export the savings, repeat.
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.
How do you plan to do due diligence? With YC, the strategy seems to be to throw a bunch of money at a bunch of early startups and hope one of them has a $1B+ exit. For arguments sake, let's say they are putting down 200 investments knowing 1 or 2 will provide (basically) all their returns. So 99% can fail and they are fine. But if I'm investing in a Mittelstand, I'm not looking for unicorns. It's more like I want 100 out of 200 businesses to return 10x and boom, I've got a great overall return. The problem is that I'd imagine you need a lot more due diligence for this, since you need more consistent (but smaller) winners. I would think it's hard to consistently find great businesses, particularly if you are investing at the 0 revenue stage, which your posts says you want to do.
But how would you exit? VCs exit via an IPO or an acquisition. The whole point of the Mittelstand is that they do neither. Do you somehow force the owner to buy you out? What if they don't have the liquidity, how does this work?
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
These $10M-$1B revenue businesses are great buyout targets for corporate and private equity firms, and these companies are increasingly going public at the higher range. (About 1/3 of PE exits last year were via IPO).
Since exits are limited and risk is still high, your accelerator for "Mittelstands" will end up looking like a traditional financing vehicle, providing loan funds in return for profit or revenue share, or some other earnings distribution. In which case it will look like a high-interest loan. You'll find yourself competing with all the alternative financing and "fintech" companies ranging from Stripe Capital to Paypal financing to local bank financing. I'm not sure the accelerator model really works here given the exits and risk.
It would seem so, although there's a distinction between (1) being acquired for the product/team vs. (2) being acquired by a private equity firm. For case (1), you would want to build a mittelstand product that is strategically aligned with the acquirer. For case (2), you would want to build a mittelstand business that with consistent and reliable earnings/dividends.
Perhaps I'm forgetting another type of acquisition, but these are the two that I can think of off the top of my head.
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 dig into the economics in the post. The data shows the median VC would get better net IRR returns with a Mittelstand PE strategy.
It works because Mittelstand revenue and profitability is much more predictable.
If you're on the Midas List, VC is still a better business. But many investors, especially solo GPs, should consider building a portfolio of middle class startups.
I wonder if the numbers you're giving are tripping up a mismatch between what you mean by "Mittelstand" or "mid-market startup" and what HN generally thinks of. You're saying the numbers are attractive given a "mid-market" definition that spans all the way to 9 figures of annual revenue. It's true that there's much less risk in quickly getting a company to 6 figures of annual revenue and growing organically from there. But there's a lot of risk --- risk equivalent I think to the typical VC-funded startup --- trying to get it to 10MM/yr within the time horizon of a typical VC investment.
Another sticking point with me is that claim that even services companies can get to this level of profitability with good management. Well, yeah, they can. But they don't exit at the same valuation as product companies, because they tend to fall apart when their founders leave.
The biotech revolution has consistently been ~25 years behind the internet revolution.
Both revolutions started with major government projects (ARPANET in 1966 and the Human Genome Project in 1990).
This led to decades of cost and performance improvements, initially mostly by large companies.
But we needed new platforms and funds to go from Web 1.0 to Web. 2.0.
We need breakthroughs like this in biotech now to get to Biotech 2.0!
It's been 24 years since Web 2.0 was created. It's now time for Biotech 2.0!