We Need A Middle Class For Startups

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

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.
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.

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.
- See: Pipe, Founderpath, Stripe Capital, Tractor Ventures

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

Too many early-stage startups are entirely dependent on VC funding to survive.
- See Default Alive vs. Default Dead by Paul Graham.
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.

These funds tend to buy small businesses and grow them into Mittelstands.
- See: Permanent Equity, Syrus Partners

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.
- See: Tiny Capital, Enduring Ventures

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.
- See my notes from the Becoming Warren Buffett documentary.
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.
- Small and mid market PEs have the highest average returns among PE classes.

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.

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.

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