We Need A Middle Class For Startups

Problem: There are only two types of businesses on social media:

  1. Bootstrapped from zero.
    • “Sell a product or course online! Sell services locally!”
    • There are millions of different get rich quick schemes floating online now.
    • The goal here is to secure the bag and escape the grind ASAP.
  2. Raised $100M+ from VCs.
    • “Are you a Unicorn yet? Which Y Combinator class were you in?”
    • Startups are now getting $20M+ pre-seed valuations.
    • The goal here is to go public or exit for $1B+ as quickly as possible.

Result: Aspiring entrepreneurs think these are the only two paths to startup success.

  • Founders with access to VCs raise money too early.
    • It’s easy to get stuck on a fundraising treadmill, especially in high-cost markets.
  • Entrepreneurs without these connections use whatever funds they can find.
    • Credit cards, family and friends, loans, and lines of credit are risky and costly ways to fund a business, especially with personal guarantees.

Idea: Make Mittelstands cool in America.

  • Rebrand the US Middle Market ($10M-$1B in annual revenue).
  • Create a studio and fund to build and buy Mittelstands.

Why? Many VC-backed startups would be better as Mittelstands.

  • I learned this lesson the hard way with my startup Labdoor.
    • We raised $7M+ in Seed and Series A funding from investors like Y Combinator, Mark Cuban, and Floodgate, couldn’t raise Series B, had to downsize and rebuild through cash flows, now profitable and growing again.
    • Because we raised money from flexible investors, we were able to pivot to becoming a Mittelstand, but this is rare with VC-backed startups.
  • My first business, Avomeen, is a classic Mittelstand.
    • Founded in 2010 by me and my dad.
    • Now over $10M annual revenues and nearly 100 employees.
    • Acquired in 2016 for $30M+ and again in 2021 for $60M+.

Secret: Mittelstands are already about one-third of our whole economy.

  • This is over $10T in annual revenues.
    • 48 million Americans work for the 200,000 businesses in this sector.

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.

  • Remote work, no code, social media, and ecommerce platforms all make it easier to bootstrap new businesses from zero to revenue.
  • New non-dilutive funding sources are now available for revenue-generating businesses.

Key: Fundraise only for specific purposes, not for general operations.

  • Too many early-stage startups are entirely dependent on VC funding to survive.
  • Seed funding can and should be a path to profitability for most startups.
    • Mittelstands can launch and get profitable for <$1M.
      • This could be the only funding your business ever needs.

Advice for Investors: Fund Mittelstand-focused studios and holding companies.

Opportunity: Recapitalize VC-backed startups and turn them into Mittelstands.

  • Example: There are hundreds of YC-backed startups stuck at ~$1M revenue that can predictably grow to $10M+ revenue with the right team and funding structure.

Key: Mittelstand revenue and profitability is more predictable.

  • Even service businesses can get to this scale with good management.
  • No more asking “is this a product or a company?”
    • One great product is enough to make a Mittelstand.

Opportunity: Create a startup studio that rapidly launches and scales Mittelstands.

  • This is my idea for Utopic Studio.
    • Goal: Build and buy many small businesses with Mittelstand potential.
      • By focusing on optimizing overall portfolio value vs. individual startup value, we can aggressively grow our best businesses and quickly launch new ones.

Secret: Mittelstands can be the foundation for massive conglomerates.

  • Example: Berkshire Hathaway started as one Mittelstand.
  • Mittelstands can be great at generating positive cash flows and float.
    • Holding companies can quickly reinvest profits into new and better businesses.

Economics: Unicorn VCs vs. Mittelstand PEs:

  • The median PE outperforms the median VC most years:
    • The results are even more pronounced when you measure since 2000.
      • Even in the top quartile and top 5%, PEs are still outperforming VCs.
      • (Note: If anyone has this data for 2015-present, please DM or email me.)
  • Focused Mittelstand PE funds can compete with the best VC funds.
Source: Cambridge Associates, via top1000funds.com.

Challenge: Getting liquidity for Mittelstand businesses.

  • Mittelstands have three paths to liquidity:
    • IPOs are increasingly an option for PE-backed companies (2015-2021).
      • 10% of PE-backed exits (by number) were IPOs (TTM).
      • 42% of PE-backed exits (by value) were IPOs (TTM).
    • Acquisitions by Corporates (30%) and other PEs (28%) still made up the majority of PE-backed exit value.
Source: PitchBook

Prediction: Mittelstand holding companies will start going public.

  • The best funds will aggressively raise capital and use it to rapidly acquire and scale more Mittelstands.
    • Smaller/solo Mittelstand founders will have these acquirers as an easy exit.

Idea: Public VC funds should invest more in Mittelstands. 

  • This asset class has higher average returns vs. public and VC markets.
  • These businesses are usually locally owned and labor intensive.
  • Mittelstands can be the foundation for a more stable and fair economy.

Vision: Promote employee stock ownership for American Mittelstands.

  • Employee owned businesses are more common in Europe, especially the UK.
  • Startups, especially in Silicon Valley, have normalized employee ownership.
    • This creates a wider pool of wealth, which has positive second order effects.
      • These people tend to invest a lot in startups, philanthropy, and activism.
    • We should spread this practice to all American businesses.

This idea is a work-in-progress. If you’d like to riff on it, please DM or email me.

Published by Neil Thanedar

Neil Thanedar is an entrepreneur, investor, scientist, altruist, and author. He is the founder & GP of Utopic, a pre-seed biotech VC fund investing in the future of science. He is also the founder & chairman of Air to All, a 501(c)3 nonprofit medical device startup, and Labdoor, a consumer watchdog with $7M+ in funding and 20M+ users. He previously co-founded Avomeen Analytical Services, a product development and testing lab acquired for $30M+ in 2016. He has also served as Executive Director of The Detroit Partnership and Senior Advisor to his father Shri Thanedar in his campaigns for Governor, State Representative, and US Congress in Michigan.