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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.

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.

thanedar 4y ago
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.
- bradleybuda 4y ago
  > 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.
  - belval 4y ago
    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.
    - spaced-out 4y ago
      >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.
deleted 4y ago
[deleted]
marcosdumay 4y ago
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 Hell yes. That's the largest difference.
- ChrisLomont 4y ago
  >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.
- q-big 4y ago
  > I think this would be much more healthy than the multi-phase aim-for-the-moon approach everybody takes today. Healthy for whom? - startups founders? - angel investors? - VCs? - national economy? - financial markets? - ...
gumby 4y ago
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.
hodgesrm 4y ago
> 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.
hnbad 4y ago
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.

thanedar 4y ago

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.

bradleybuda 4y ago
> 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.
- belval 4y ago
  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.
  - spaced-out 4y ago
    >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.

deleted 4y ago

[deleted]

marcosdumay 4y ago

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 Hell yes. That's the largest difference.

ChrisLomont 4y ago
>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.
q-big 4y ago
> I think this would be much more healthy than the multi-phase aim-for-the-moon approach everybody takes today. Healthy for whom? - startups founders? - angel investors? - VCs? - national economy? - financial markets? - ...

gumby 4y ago

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.

hodgesrm 4y ago

> 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.

hnbad 4y ago

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.