360 views on tech #45: How to build a unicorn: Lessons from venture capitalists and start-ups

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8 min readNov 21, 2022

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How to build a unicorn: Lessons from venture capitalists and start-ups

By Markus Berger-de León, Jerome Königsfeld, Leo Leypoldt, and Kai Vollhardt — McKinsey Digital

A mythology often grows up around unicorns that burst onto the scene, with stories of bold action, “crazy” bets, quirky personalities, and luck. While these myths may make for great storytelling, underneath them lies a set of facts that helps to explain unicorns’ success.
New data highlights five things incumbent businesses could learn from venture capitalists and unicorns.

Five Ts for finding unicorns

VCs looking for companies that have unicorn potential ask five key questions as they evaluate prospective investments. Executives at companies seeking VC support for their new businesses should ask them, too.

1. Teams: Do they have sufficient experience and networks?

A common mantra among VCs, particularly about early-stage funding, is “Invest in people, not in businesses.” But what kinds of people and in what kind of teams? Our analysis yielded four facts:

· Mavericks are the exception. The vast majority of successful scale-ups were started by two or more people.

· Diverse founding teams are best. Top founding teams bring complementary skill sets to the table.

· University education still matters — a lot. A large majority of founders of the top 100 unicorns have completed an academic degree, and more than 70 percent have advanced degrees such as a master’s, an MBA, or a PhD. Where the degrees came from mattered less.

· Track records and experience are essential. More than 80 percent of founders gained work experience prior to building their successful venture, and more than half had founded start-ups before.

2. Total addressable market (TAM): Is it big enough to be worth it?

VC investor wants to know if the investment can become big enough to be worth it. Assessing the potential comes down to two things:

· Size matters. The biggest sectors have the greatest number of successful scale-ups. Similarly, significant trends have an impact on TAM volumes and, in some cases, even open up a “blue ocean” — entirely new, large market spaces (e.g. sustainability). Smaller markets or sectors can also be the homes of successful start-ups as long as the potential for market disruption is significant.

· There’s a clear market opportunity. A large enough market is table stakes. It is essential that the market also offers significant growth potential for new entrants. To determine whether a market is “crackable,” VCs typically assess whether there is an opportunity for a product or service to take advantage of a market weakness. Strong fragmentation is one example of such a weakness. A young market without dominant companies and with relatively low barriers to entry also can offer an attractive opportunity.

3. Timing: Too late, too early, or just right?

In comedy, they say timing is everything. That’s equally true of investing in start-ups:

· Leaders recognize trends first and benefit from early moves. Correctly identifying new trends and their impact early on allows first movers to enter uncontested spaces and build a strong position — which typically results in higher margins and faster growth. For this reason, ventures at the forefront of trends benefit from greater capital availability and more-attractive valuations.

· The start-up operates in a two-to-three-year window.VCs look for that “Goldilocks” spot where a business isn’t so far ahead of the market that it will die before it has enough customers or so far behind that its market opportunity is lost to competitors. They look to invest in start-ups where the product or service not only works but also has early indicators of market interest.

4. Technology: Does it work at scale?

VCs evaluate whether a business can go from selling and supporting a hundred products to a million without breaking. Technology is often at the heart of a company’s ability to scale:

· Software drives the scale. VC investors typically want to confirm a company’s ability to operate efficiently and stably with millions of customers and thousands of employees, often while growing at a rapid pace. For this reason, they favor software over hardware, as it can scale almost instantaneously, if it is well built and supported.

· Tech foundations can support scale. Some VCs have dedicated technology teams to review and assess a start-up’s tech profile to ensure it is scalable. They are on the lookout for high degrees of automation so costs don’t escalate as revenues grow. Having a tech foundation that’s ready to scale requires developing a modular tech stack built around microservices and APIs that create simple and well-defined interfaces to data, algorithms, and processes.

5. Traction: Is there a clear path to profit?

The start-up needs time to grow, but VCs want evidence that it’s on the right track:

· The business is uniquely positioned to solve a real need. Successful ventures provide unique solutions that change an unacceptable status quo. While it is common for successful start-ups to develop completely new technologies, they can also develop a novel combination of existing technologies, market existing technologies with new ones, radically improve user experiences, or simply operate far more efficiently than competitors.

· Revenues indicate traction in the market. VC investors expect revenues of new businesses to grow rapidly. A rule of thumb is the T2D3 pattern to demonstrate good traction — revenues should roughly triple each year in the first two years after founding and then double for at least three years after that. Successful start-ups at least doubled their revenues every year for eight years. More important than total revenue is the type of revenue. VCs favor annual recurring revenues (ARR) over one-off sales and look for customers who buy more than one product and whether per-customer revenue increases over time.

· The path to profit is clear. While it is typical for start-ups to show significant net losses in early years, a clear path to profit is essential. VC investors generally look at customer acquisition costs (CAC) and customer lifetime value (CLV) as key indicators. While the CAC are often steep for new businesses, trend lines should clearly show improvement.

Implications for incumbents

What can incumbents learn from unicorns and VCs? Two elements stand out.

1. Set up an innovation board with a mix of experience

An innovation board prioritizes investments in new ventures based on a business’s strategic growth agenda. These are active organizations that go well beyond basic reviews and approvals. They are most effective when acting as true coaches who can bring to bear the breadth of their experience.

The innovation board needs representatives from three separate interests and areas of expertise:

· The incumbent/business unit representative, who can best judge if the company has unique advantages to offer to the new business and provides the new business with access to them.

· The VC, who brings an unbiased perspective in evaluating the start-up and provides access to capital, talent, and experience.

· Experts that the incumbent lacks.

2. Understand what VCs are looking for as part of a joint venture

VCs can provide significant advantages to an incumbent. But for any kind of collaboration to work, VCs will insist on an important set of requirements. For one thing, they want to be involved from the start so they can ensure, for example, that the run rate stays within reason. They will also insist that the founders have equity in the new business. In most cases, incumbents reward and incentivize their start-up people with bonuses, but VCs know that you will get the best talent only if you offer them shares. On the flip side, the VC will also look to ensure that no single investor has a dominant share in the new business and could potentially block it later for whatever reason.

Beyond the initial phase, VCs have a clear eye on future growth and will eventually want to see a stock-option pool for key hires and will look for an explicit willingness from the incumbent to potentially bring in other investors after two to three years. VCs are looking to protect and maximize the chances for a large payout from their investment, and unless incumbents can adapt to this reality, they will not collaborate effectively with VCs.

A unicorn is, by definition, unique and hard to build. But by understanding what success factors to look for and how VCs think and operate, incumbents launching new businesses can increase their chances of hitting it big.

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💸 Money matters

🔴🟠🟡 Synergy Flow, the startup developing a redox flow battery able to store electricity for more than 20 hours, raised €1.8M, the round was led by 360 Capital followed by CDP Venture Capital.
Waat, fast charging stations, raised €30M, from Raise.
Sympower, the climate tech startup helping balancing the supply and demand of electricity across networks, raised €25M, from Activate Capital alongside Rubio Impact Ventures, PDENH, Expon Capital and Rockstart.
Pelico, industrial operations management solution, raised €18.5M, from 83North, Serena, Isai and La Famiglia.
MadKudu, PLG platform of choice for B2B companies, raised €18M, from Alven, Techstars, Felicis Ventures, Benhamou Global Ventures, Darius Contractor, Sahil Mansuri and Elena Verna.
Dema.ai, the tech startup has developed a no-code tool to provide smaller e-commerce brands with data insights, raised €4M, J12 Ventures and other high-profile angel investors.

New Funds

Index Ventures announces Index Origin II, a €290M Seed Fund designed for extraordinary entrepreneurs
VSquared Ventures unveils new €165M fund for early-stage deeptech
Round2 Capital makes first close of €100M fund for B2B software SMEs