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

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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.