Y Combinator for Mittelstands

This is a follow-up to my most popular post We Need a Middle Class for Startups.

I want to raise a $1M+ per year rolling fund to build this accelerator.

  • DM or email me if you want to invest!


Idea: Raise two funds to help founders launch and scale middle class startups:

  1. Accelerator: Invest the first $100K+ to help new pre-Mittelstands launch and grow.
  2. Ventures: Invest $1M+ to help pre-Mittelstands go from $1M to $10M+ revenue.

Problem: It’s hard to fund pre-Mittelstand startups.

  • Most VCs won’t fund niche services and SaaS businesses.
    • VCs expect SaaS startups to 3x+ for two years, then 2x+ for three years, after hitting $2M ARR.
    • A pre-Mittelstand’s growth trajectory looks more like $2M, $4M, $6M, $9M, $12M.
      • That’s “only” $2M to $12M ARR in five years.
  • Most PEs wait until $5M-10M+ in annual revenue before investing.
    • PEs typically target 3-5x returns through safe flips and rollups.
      • Example: PE buys three businesses with a combined $20M in revenue and $4M EBITDA for 8X EBITDA ($32M). They combine operations and increase sales and marketing spend and get the company to $30M revenue and $10M EBITDA. They convince a “strategic” corporate or larger PE to buy it at 12x EBITDA ($120M).
    • Micro-PEs are starting to move earlier with holding companies (see Trend below)
      • But these funds are just starting to invest in $1-10M revenue pre-Mittelstands, and no PE is investing in $0-1M pre-Mittelstands.
  • Most banks won’t fund new pre-Mittelstands with no revenue history.
    • These founders are expected to bootstrap to $1M+ revenue and profitability.
      • This isn’t possible for most new and aspiring Mittelstand founders.

Solution: Fund pre-Mittelstand startups from $0-10M+ in revenue.

  • Accelerator: $100K for 20%.
    • Help new Mittelstands go from $0 to $1M+ annual revenue fast.
      • Founders are currently expected to perform amazing feats of bootstrapping to get through this stage, raising money from friends and family and shows like Shark Tank when possible.
    • For new ($0-500K annual revenue) SMBs.
      • For many aspiring Mittelstand founders, $100K and one investor is enough for them to quit their job and go all-in on their business.
    • Be the first investor and believer in new pre-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.
        • The brilliance of Y Combinator is that it built a front door that is easy to find (YC) in front of a front door that is hard to find (VC).
          • Y Combinator for Mittelstands can do this for PE.
  • Ventures: $1M+ for 20%.
    • Help established Mittelstands go from $1M to $10M+ annual revenue faster.
      • Targeting $1M to $10M in six years or less.
        • 6 years to $10M revenue = 48.6% CAGR
        • 10 years to $10M revenue = 25.9% CAGR.
    • For established ($500K+ annual revenue) SMBs.
      • These startups are still way too small for even small cap PEs.
      • This category is starting to be called Micro PE.
    • Targeting 5-10x revenue multiples.
      • We can’t do the 10-20x+ revenue multiples VCs are giving SaaS startups now.
      • We can create a sliding scale where larger pre-Mittelstands get more money for 20% (max valuation = 10x revenue).

Mittelstands vs. VCs:

Thesis: It’s possible to get VC-style 10x+ returns with a much lower risk profile.

  • Startups must grow at >100% CAGR to generate 10x+ returns for VCs.
    • $2M to $72M in five years is 104.8% CAGR.
  • Mittelstands can generate equivalent returns with <50% CAGR.
    • $2M to $12M in five years is 43.1% CAGR.
It’s possible to get VC-style 100x+ returns with <$1B exits.

Key: All US businesses, not just tech startups, follow a power-law distribution.

  • That means there are 10x+ as many $100M companies vs. $1B startups.
    • The entire VC model only works when funds get these $1B+ exits.
      • That’s why we’re seeing the proliferation of $1B+ VC funds and 100+ company portfolios.
    • Mittelstand funds can consistently generate 10x+ returns with 8 and 9 figure exits.
      • This 10x+ increases the pool of investable startups.
    • The probability of $1B+ startups actually drops below the power-law distribution.
      • This suggests there’s a ceiling to startup size that inhibits growth past $1B.
  • By building our model to get 100x+ returns with <$1B exits, we can get top-tier VC results investing exclusively in Mittelstands.
    • This pre-Mittelstand zone is currently underrated as an investment sector.
      • Prediction: Mittelstand investing will get hyped in the next downturn.
From: Zipf Distribution of U.S. Firm Sizes by Robert Axtell, Science, 2001

Trend: A funding ecosystem is starting to form for pre-Mittelstand startups.

Timing: PE and VC returns oscillate based on market sentiment.

  • VC has a higher ceiling during booms, but also a lower floor during busts.
  • Prediction: PE will outperform VC by +10% IRR over the next 10 years.
    • And you can get better than PE returns by investing in pre-Mittelstands.
  • PE and Mittelstands are counter-cyclical.
    • They do best in down markets because they’re largely valued on cashflow and assets, not growth.
      • This is the perfect time to start a pre-Mittelstand fund.
Source: vcwithme

Challenge: Can you get YC-level returns with a Mittelstand strategy?

  • 90%+ of YC’s projected returns now come from the <1% of their startups that IPO.
    • But this only started in 2018, 13 years after YC’s first class.
  • YC’s model is especially hits-dependent because they own <10% of their startups.
    • To get a 100x return on their $125K standard deal, YC needs a $300M+ M&A exit or an $600M+ IPO.
      • This analysis assumes YC owns 2-4% of companies at M&A or 1-2% at IPO:
  • Our Accelerator model can get a 100x return on an exit as low as $50M.
Source: Crunchbase

YC for Mittelstands:

Strategy: Be the first (and often only) investor in pre-Mittelstand businesses.

  • If one of our Accelerator founders gets a $1M exit, we get a 2x return.
    • This aligns us with founders at the earliest stages, unlike both VC and PE.
  • If one of our Accelerator + Ventures founders gets a $10M exit, we get a 3.3x return.
    • If a Mittelstand founder only takes our two rounds, they keep 64% ownership at exit.

Opportunity: Help founders keep control of their Mittelstands for longer.

  • Y Combinator did this for startup founders.
    1. YC was predicated on the idea that “Young hackers can start viable companies.”
      • This seems trivial now, but when YC was founded in 2005, the conventional wisdom still dictated that VCs should replace founders with professional CEOs.
        • YC’s funding, education, and spotlight gives founders leverage over investors.
          • More funding options means better terms and more founder control.
  • We can do this for Mittelstand founders:
    1. Invest long before private equity gets interested.
    2. Founders get to $10M+ revenue with majority ownership.
    3. This gives them leverage to turn down PE/corporate buyout offers.

Why: These businesses can be way better for founders.

  • Majority Ownership: Mittelstand founders keep full control of their businesses with us as their investors.
    • They can choose to exit quickly (we share upside) or slowly (we share profits).
  • Higher Win Rate: VCs can rely on their portfolio to cover losses, but startup founders are all in on one business, win or lose.
    • Mittelstands are more likely to win, which makes life easier for their founders.
  • More Opportunities: There are many more Mittelstand business opportunities available in every region and any market condition.
  • You don’t even have to have a new idea to start a Mittelstand.

Simulation: What are the expected returns for a Mittelstand accelerator?

  • Assumptions: Mittelstands grow slower but are more likely to exit.
    • Structure: 100-company portfolio, 2% and 20% fees.
    • Growth: 40% average YoY growth, 6 years to exit.
      • This shows that we can get great returns with sub-50% annual ARR growth.
    • Outcomes: 25% go to 0, 25% return <1x, 50% return >1x.
  • Results: 50th percentile – 30.3% IRR, 90th – 67% IRR, 99th – 133.1% IRR.
    • Prediction: Y Combinator for Mittelstands will have 100%+ IRR in 10 years.
Data generated using VC Simulator by Wes De Silvestro

Key: Be the whole round each time.

  • Mittelstands can get profitable with $1M funding or less.
    • These companies can use non-dilutive funding sources to keep majority ownership forever.
  • Mittelstand accelerators should get a right of first refusal to fund any future rounds.
    • This will be key to keeping our ownership at or above 20% at exit.

Advantages: Be fast, fair, and open to all.

  • Faster than VCs.
    • Close a $100K Studio deal in 1 week with 1 application.
      • Question: Is it possible to make these investments on metrics alone?
        • This should make our investment selection process fairer.
  • Better terms than PEs.
    • Founders can keep majority ownership as long as they want.
    • We’re aligned with founders on pursuing non-dilutive funding sources for these businesses.
  • Easier than banks.
    • Get a $1M Ventures deal in 1 month with no personal guarantee.
      • Problem: Banks require Mittelstand founders to personally guarantee their debt.
        • Our deals never require personal guarantees.
      • Problem: Banks take 3-6+ months to process a commercial loan.
        • That includes 100+ hours of collecting, creating, and submitting documents and financial records.
      • Question: How much due diligence/auditing do we need to do to avoid fraud?
        • This is easier if we can connect into their analytics and payment platforms.

The Future of Mittelstands:

Market: What is the limiting factor to how many deals we can do in a year?

  • There are 200,000 Mittelstands in America now.
    • 340 new unicorns were created in 2021. (296 combined in the previous five years.)
      • Let’s say there are ~100 new unicorns per year on average.
    • There should already be 1,000+ new $100M+ Mittelstands created per year.
      • How many of these businesses can we fund at the $0-10M stage?

Potential: How can we inspire many more founders to create Mittelstands?

  • YC expanded the pool of potential startup founders by age and origin.
    •  VC used to be more biased towards older founders and executives already based in US tech hubs.
  • YC for Mittelstands can expand access to lower income founders.
    • Mittelstands are usually self-funded by middle or upper class founders.
      • This is the classic “family” business.
    • $100K can be a life-changing investment for these founders.

Vision: Lead a movement to create and grow more middle class startups.

  • Mittelstands are great for founders, investors, employees, and the economy.
    • The higher likelihood of successful exits better aligns incentives between Mittelstand founders and investors.
    • The lower failure rate of these businesses provide stability for employees and the economy.

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.