Why Software Startups Should Sell Their Product But Not Their Company to German Mittelstand Companies

Or

There Are Buyers of Products, And There Are Buyers of Companies And They Are Different.

A recent article detailed two well-known Berlin startups which had just been acquired by Mittelstand companies.

This begs the question why there aren’t more of these types of exits. Can the German Mittelstand companies be startup acquirers at a larger scale?

The majority of startups are building Software as a Service (SaaS) companies with high gross margins. In a SaaS world where growth is directly correlated with enterprise value a founder’s is to grow as quickly as possible to build an important and material software company and to maximize the company value. The highest valued SaaS companies have annual growth rates in excess of 75 per cent.

As a reminder, Mittelstand companies are "highly focused medium sized companies, achieving unprecedented efficiencies by designing a business model with a razor-thin focus and learning to do the one thing really well. They are typically privately, family owned". Many of them are in the automotive and mechanical engineering sectors and are focused on hardware and systems integration. Medium size Mittelstand companies have revenues on the order of a hundred million Euros with relatively narrow margins. They tend to grow with the GDP of their major export markets. In the past years of low interest rates they have been significantly credit financed.

Will these companies be able to pay the expected acquisition prices? Does their balance sheet provide enough room to pay cash? Do they understand the mechanics of a software business? Does their ownership structure allow them to agree on a deal ? Are they willing to take significant risk?

The answer to these questions is obvious and seems like bad news: The majority of Mittelstand companies are unlikely to be potential acquirers.

The good news is that the Mittelstand companies can be great customers and fantastic early adopters: They have fewer hierarchy levels and can make decisions quickly. They want to co- develop the Minimum Viable Product to get results. They tend to be very international and they will want to deploy products globally right from the start. In contrast, big industrials and automotive OEMs are much slower moving, and their many hierarchies and lack of true urgency will likely kill a startup. Many of their innovation outposts and labs are clueless and powerless.

For successful exits, SaaS startups need to understand the software ecosystem. The same companies that are competitors can be potential buyers. In the manufacturing and Industrial Internet of Things (IIoT) spaces, CAD and PLM companies like Dassault, Autodesk, Siemens, PTC, SAP, Oracle, Infor, and Ansys are some of the key  players. These companies make acquisitions routinely using their cash and stock, and their investors understand the need for growth.

The German Mittelstand companies can be great customers, but they are an unlikely buyer of startups. In fact, they are not really an exit option unless a startup is willing to sell very early or has essentially failed.

Angel Investing in 2017 - Looking For Value in New Places

I did not make any predictions for 2017, following Winston Churchill’s quip about the politician ‘who needs the ability to foretell what is going to happen tomorrow, next week, next month, and next year. And to have the ability afterwards to explain why it didn't happen.’ Here is what was noteworthy in my eyes.

Picture credit: Nasdaq

Public markets and private tech startups

Who could have imagined that the value of the DJII would increase a whopping 25% and go from 19762.60 to 24719.22, and that the Bessemer Venture Partner Cloud index would increase by 49.9% in the same period?

There were only 14 Tech IPOs, and the majority were in the consumer/retail space. The Stitch Fix IPO was noteworthy for delivering massive returns to investors. Meal kit providers Blue Apron and Hello Fresh both managed to go public but then followed two very separate trajectories, illustrating the importance of understanding the unit economics and LTV, but also the difference between the investors in their respective markets.

In the venture capital space, 109 mega rounds of $100+ million were evidence of the massive amounts of capital wanting to be invested. 22 new unicorns were minted while this was more than in 2016, it was only about half of 2014 and 2015 numbers.The pipeline of unicorns was still growing, yet many of the unicorn valuations took significant hits. The most prominent and public example was Softbank’s investment in Uber.

Seed investing activity in the U.S. declined to reach a two year low, and yet a median seed stage deal size of $2.0 million remained astonishingly high. International investments were strong: In Germany alone, €4.3 billion were invested in 507 deals with Berlin leading the way by a wide margin. The number of deals and the investment volume in Germany could be best compared to New England, but was significantly smaller than in San Francisco, Silicon Valley, or New York.  

It would have been easy to speculate about how technology trends like Blockchain, the Internet of Things and Artificial Intelligence will to disrupt everything. And yet, as Peter Thiel reminded us a few years ago, the biggest secrets are about people and not about nature. Susan Fowler’s courageous reflections in February about her very, very strange year at Uber surfaced biases of the worst kind. And subsequent revelations forced us to examine our daily interactions and whether we treat others like we wanted to be treated ourselves, with dignity and respect. A few years back I had penned a somewhat admiring post about Harvey Weinstein, and in hindsight it became clear his professional and personal behavior were inseparably intertwined.

At the same time, I met Tammy and Grace from BetterBrave, and they deserve a big shoutout for tackling a topic that defies easy answers and yet is so crucial for society.

My existing portfolio

I entered 2017 with thirteen active angel investments. Compared to 2016, the value of my portfolio stayed flat: Four companies raised additional funding, and I participated in two of these. There was one significant markup, one down round to half the value, and one recap that effectively wiped out the existing investors. There were no exits and no final death notices.

Special shout out to 3ten8.ai for getting the first large telco PoC, and to 3DprinterOS on closing the first OEM deal with Dremel.

New investments

It turned out to be the year of investing in Industrial IoT (IIoT) and in German startups; the result of 18 months of research in and search for enterprise software startups in Germany. Much of it was self sourced by attending pitch events all over the country, founder networking and mentoring, and outreach to VCs.

• I met Simon of Kreatize and invested in the first round together with Atlantic Labs and with other angel investors. Simon and Daniel are building a SaaS network to order custom manufactured parts and allow for seamless collaboration between manufacturers and suppliers. They are headquartered in Berlin with strong roots in the industrial southwest of Germany.
• I mentored Akshat and the Amper team through the Alchemist Accelerator program. Amper is helping manufacturers increase efficiency and productivity through real-time machine and factory monitoring, and they are based in Chicago. My initial investment was followed by Slow Ventures.
  
• Kemal, the CEO of Relimetrics, was referred to me in December 2016. Kemal and Juergen have developed a low-cost imaging technology to inspect and monitor material shape, deformation and reliability across different phases of the engineering lifecycle. Relimetrics went on to raise a seed round from Silicon Valley, German and French investors in December 2017, and they are based in Berlin and in Silicon Valley.

• Atlantic Labs graciously referred me to Wandelbots. Christian and the team have built software and hardware to teach industrial robots with wearables, making programming robots available for everyone. They are based in Dresden.

There also were five startups that I spent significant time working with but did not invest in. The number of blog posts collapsed from 11 to 2 as deal sourcing and founder mentoring took precedence.

2018 resolutions

Organizations and experts who are ostensibly more qualified than I regularly fail at making predictions, Instead, I will rather focus on a few key resolutions: Continue to look for differentiated opportunities in enterprise SW in Europe - and in Germany in particular- , bet on contrarian outliers in Silicon Valley, and dive deeper into the Blockchain and tokens.