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Comment by tptacek | Hacker News Reader

I'm a fan of bootstrapped companies and have started and operated a couple of them, sometimes quite successfully. But I don't understand how the economics of funding them are supposed to work. VC is a star-search business. Most businesses fail, and that includes businesses run conservatively with organic growth. In a portfolio like that, the winners have to pay for the losers, or the math just doesn't work.

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I think one thing that can help is many businesses (we read about them on HN all the time) are "successful" and could be $1m, $10m, even $100m/yr - but they have to be pushed to $1b/year or more to satisfy the ICs.

Somehow to allow them to "exit" at 1/10/100 instead of trying for 1b or crash would be nice. But it would need a different type of "VC" partner.

One funding mechanism could be something akin to "guilds" - once you have a group of ten or so of these businesses "together" they could help fund additional ones. A "guild-like" setup (think Union of workers that owns a percentage of the companies, perhaps) could be used to fund new ones starting out.

Again: the winners have to pay for the losers. The unusually large successes are what makes the model work. I'm sure they're pushed past the point where they need to go to be economically viable, but by the time you've reached that scale, you're already out of the "mid-market" bracket.

Sure, but if you're 9/10 on successes it's a lot easier than if you have to deal with 1/100.

If you’re able to pick successes with 90% accuracy at the stage where they’d benefit from this level of investment, I’d like to borrow your crystal ball.

Right, where I think you're seeing pushback is on the idea that you can reasonably get anything resembling 9/10. Think about what that's saying: we're talking about businesses doing 8 figures of annual revenue. If there's a playbook for reliably creating those --- "reliably" meaning "you can build a portfolio of them run by different people serving different markets, and make money" --- what is that playbook? Getting a 10MM/yr company off the ground is not a small achievement.

Bear in mind also that as you scope down the size of the companies you're starting, you necessarily also have to scope down the investment (these companies have, obviously, much smaller valuations, meaning $1MM of equity buys a much bigger chunk of the company). But companies today take A-B-round-scale investments to get to 8 figures ARR. You get those investments by targeting a much, much higher ARR.

This thesis doesn't hold up for me, I feel like I have to be missing something.

Choosing safer paths does not bring you from 1/100 of success to 9/10 - perhaps it brings you to 3/100 or 1/10, but at that level you still have to have the winners making it very big to pay for the losers.

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.

but how will the LPs brag to their friends about their brilliant investments?

sure 13% IRR is amazing, but it is not going to make my neighbor jealous

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.

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