E658 | Martin Scherrer, Redstone VC: CVC Secondaries Without Burning Bridges

0:00Welcome back, everyone, to the European VC podcast. Today, I have my dear friend and co-host of the podcast and our in-house expert on everything CVC, Jape Hoyer. And we are talking to Martin Sierra, partner and head of managed funds at Redstone, a firm playing a dual role as a classic VC and VC as a service for corporates and family offices as well. Martin brings deep roots in insurtech, fintech and corporate venture. And today we'll focus on CVC secondaries, how to wind down without burning bridges. And as a side note, of course, given this topic, the recent closure of Munich Rees' CVC efforts is very much on our radar and the backdrop of today's conversation.

0:57This show is not investment advice and the hosts of this episode may be invested in the funds and companies featured. So welcome to the podcast, guys. Thank you. Hi, Andreas. Hi, Jeppe. So, Jeppe, you know so many in this corporate venture landscape, and Martin was one of the guys you really wanted to get on the podcast. So first, maybe you'd say a few words while you think that Martin is the great guest to talk about this today. I do. It's not the first time we have Redstone on the show. We've had some movie here before. Redstone is one of the funds that I really look up to. I engaged with Redstone for the first time at my time at Merce Growth back in 2018, where they did assist us.

1:36So this VC as a service thing came in, and that is really interesting for me. The topic for today is one that I have thought a lot about, when to bring in. Martin and I, we have been discussing when is the right time to bring this topic in, that is secondaries of CVCs, because I'm here to talk about, you know, everything good about corporate venturing and how to extend the 3.7 year average lifetime. But right now with the closure of Munich Re, we don't, you know, we cannot avoid this. Now we need to have the talk. We have an expert here, Martin, and I'm really, really looking forward to what Martin will bring to all the corporates out there that are listening in.

2:18Martin, I gave a very short intro to Rattstone, But to those that don't know Redstone, maybe you can just expand on it a little bit. So Redstone is a VC asset management platform. I would call it today. We run own funds, but we also run managed funds from corporates, from family offices. But I would say the roots really, I mean, my personal roots are coming from CDC. So I started my career at Swiss Re, who winded down, actually wound down. its CVC activities already 23 years ago for several reasons. But also Redstone actually merged as a CVC as a service provider in its early days, 10 or 11 years ago, and only much later on evolved into a classic VC.

3:03So we have worked with more than 80 corporates over the past 10 years. I think we know pretty well how to navigate their world to understand how they operate, how they take decisions, how they define innovation and how they look at strategic benefits. So we bring, I would say, the CVC and the VC perspective in, but also the founder perspective as many amongst us, including myself, I had an insurtech here in Switzerland that I founded or co-founded and then exited. So a lot of us amongst us have founder experience, which I think this threefold of VC, corporate VC and founder background, you know, puts us in a pretty nice position to work with corporates and help them present themselves towards startups and co-investors in a way that they are being welcomed on the stage.

3:59Can you share a little bit about the benefit of being in both worlds, you know, behaving as a VC, but then also have these managed funds? You know, in the end, it's both about investing into innovation, you know, seeing some disruptions happening out there, supporting those. You do it with a different approach. Since, you know, when you work with a corporate, the original idea is, you know, we don't want to make financial returns. Sometimes they explicitly say we don't want to have any financial KPIs and we first need to persuade them that this is actually really important. But they do it because they want to have strategic benefits.

4:40Of course, that's not the case when you have an LP just investing in your VC fund. In the end, what do you do is the same things. Because I think you just source the capital from a different source and you have a different filter when you look at potential investment opportunities. I think you make a very good point when you talk about the importance of this setup and the fact that corporates need to understand that VCs have optimized startup investing over decades and there's a lot to be learned from that. Could you just talk about the importance there and what that means specifically when it comes to the setup and the processes that you run?

5:22I mean, one myth out there is, and we also hear that, you know, ever again from corporates that, you know, investing in startups is not so difficult. You know, everyone knows an angel who invests in startups. Maybe, you know, someone is investing himself. The magic behind it in the end is not only to make an investment. as we all know it's about you know working with the with the portrait setting up a portfolio working with the portfolio companies making great exits and that takes a lot you know in order to get into that position you need to think about a portfolio that's something that corporates you know usually don't really want to think about they rather say like let's start with one or two or three investments and then let's see then where that takes us and you know when you revise you know your strategy after three years you know we we all know that about the j curve and we know it's probably the worst moment in time to you know to think about is this a good thing what we're doing so you really need to commit to an investment strategy to the build up of a portfolio at the very beginning you need to to have financial returns as your goal on top of your strategic goals that you have because otherwise you are in the market immediately being viewed as someone who's not really caring about valuations and that's not someone a coin investor you know wants to you know be in on the same cap table with what is really interesting here right because also when And I refer back to the book called The Venture Mindset by Yostrebulev.

7:01One of the things in corporate life is this portfolio thinking. They don't have it. So it's like if you have already invested$100 million into an initiative, you're not going to be willing to close it down. Venture capitalists knows the high risk of building a portfolio and closing down things that do not work. Right. So it's just a pure mindset thing here that is a challenge when we go through this. And regarding the financial, you know, aspect of investing, we are always the ones, you know, sometimes saying, you know, this is an investment that is really interesting from a financial perspective.

7:39And we have many situations where a corporate said, yeah, but you know, it's not strategic enough for us. So we'd rather pass on this. there's one fund you know health fund that we will build up we're you know in the meantime one of those financial investments that was not so close to the core of the insurer it looks like this is now going to be the fund returner for them and what that means is that you know the expectations on all the other investments are not as high anymore because you already have your your capital paid back and you're not being questioned year by year, what are you doing?

8:18Why are you burning so much capital? I'd love for us to go because we all know runoff processes are super delicate and super important to get right. And you've helped the SCORE team and have a very important case study there on how you at Radstone managed a full portfolio transition after SCORE decided to stop their new investments. I'd love to hear more about the key steps that you took in that process and what lessons can be learned by other corporates. After SCORE took the decision to exit this, there's always the question, how do you close this down? How do you wind it up? And obviously, there's the opportunity to sell the portfolio as a whole or in pieces to a secondary buyer.

9:02That's the quick and dirty solution. So you can get it quickly off your table. the thing is that a secondary buyer it you know himself wants to get a two to four x on his fund so therefore you will have to take a really painful cut on your net asset value which you know comes typically at a 50 to 80 percent discount and so first you need to think you know do you want to go that route or as score decided uh you know before we were involved they said you know we want to get as much out of it as possible we don't have any rush in getting back liquidity we want to maximize value we want to gradually reduce risk and generate liquidity i think unless you have a you know a meaningless or a bad portfolio is definitely the best decision and then the first question you know who who does the runoff you know do you want to do that with an internal team do you want to go with an external team the existing team is typically a bit of a stretch because you know if you put yourself in their shoes you know they they're very surprised about the decision they're obviously not very excited about that decision when investments all of a sudden come to a halt i think there's also you know for natural reasons some frustration in in there some particularly insurers they have their asset management function where you typically have people focused on private equity investments having said that they typically invest in funds and they're not used to deal with individual companies and also they have different priorities so in this case and and and score was advised by by a big four you know they took the decision to go with an external specialist who's experienced in managing such situations who knows how to create value on boards how to work with co-investors and and we actually have another case which is helen energy portfolio we also took over the helen ventures portfolio we also took over this year after very similar situations and there we actually took over you know three members of their team which for them was actually you know a pretty good move because otherwise you know what would have they be doing that probably would have been laid off now they are with us They're in an organization where even after Helen Ventures is being divested completely, they have new career opportunities within our VC operation.

11:33And Martin, there's one thing that comes into mind as you go through all the corporates you have been in dialogue with. Some of them are your customers today and so forth, right? And also tying back to your CVC background. there's a lot of CVCs that dream about spinning out anyway that that is kind of the future and what they need to do because they they see the VC world and and what that also has of positive elements but but as you go through this is that a is that a why aren't they spinning it out right when they want to close it down well what what comes to mind in these processes what are what What are the learnings from your side?

12:15You know, spinning out a fund at an early stage is something that can work or when you put up a second generation fund before you start investing. So you basically commit the corporate's own capital and you onboard third-party capital from other, you know, potentially also strategic investors from the same sector or purely financial investors. But once you have filled up, you know, a huge portfolio, that becomes pretty challenging, you know, if you only think about how to value, you know, that portfolio for the new investor joining the round. It is definitely a good strategy, I believe. Swisscom Ventures, for instance, Switzerland has shown that, you know, in their recent fund, they have onboarded external capital.

13:05And that obviously makes it, is a very strong resilient strategy to protect your CVC from being shut down. And maybe one example, we have a first advised Berliner Volksbank to set up their first fintech CDC about eight years ago, I think it was. And we worked with them as a VC, as a service provider. then the second fund generation they opened up to other volksbanken and reifheisenbanken there was also an insurer investing into it so it was now a a open lp structure still with uh you know with strategic benefits for for the lps and now the third generation is redstone fintech three fund the team again here from berliner volksbank or has has moved to redstone and now it's a it's a typical VC fund, still with some strategic benefits for those banks as LPs.

14:03Now they have decided to close it down, right? So let's imagine that situation, right? What is the divestment strategy that you then go in with, right? Because they want to get out, you know, how do you handle that? We first obviously had to onboard the portfolios. In Scor's case, it took us about three weeks to onboard 25 portfolio companies. So we had no interaction with the previous team. So we had to read through everything we had. We were shared, you know, by score. That was a pretty challenge. And then, of course, once you speak to those 25 founders, you know, many of them have, you know, big topics, big requests, you know, things that have been waiting, new financing rounds they want to work on.

14:47So you have to get your arms around which are the big exposures, where are the critical topics at the moment, which of the cases, you know, maybe can you just put aside for the moment. Obviously, where are the board positions that you need to take over? Who within Redstone is the best suited person with a background that can support that company? Then we typically do a scenario analysis. So we identify for each and every portfolio company three scenarios. A, what would happen if we would try to sell that company ASAP? What's the value we could get out of that? Second scenario is what could we expect if we sell the stake, you know, at the next financing round as part of a secondary?

15:36That's typical scenario B. and scenario C is you know what can we expect if we hold until the company itself exits and then that's basically the starting point and then obviously you know there are different options that arise all of a sudden you have a co-investor who asks whether he can increase you know buy some shares from you in order to increase the stake and and then obviously that that also plays a role you In what you said, right? So if we imagine option C, right, that you hold it, right? So in a downsizing and letting everything go scenario, do these corporates actually also give you more capital for follow-on investments or how does it go?

16:19Yeah, that's a very good point. And it is very important, I think. So yes, actually, in all the cases where we manage funds from corporates that are phasing out, we have the opportunity to make follow on investments. Why is that so important? Because it sounds a bit contrary to it if, you know, someone corporate says we want to stop investing in VC. there are two typical scenarios one is a company and we just recently had such a situation a company hanging between seed and series a they lacked behind their plan they were not able to raise from external investors that corporate was their only institutional investor so they would they all of the founders eyes were just looking into the direction of that corporate you know please we need more capital otherwise you know no one's going to give us more money you know we persuaded the corporate to put in a fairly it was a very small amount so um you know a few hundred thousand and that led to some angels follow on to that round that make it made it bigger it gave them a longer runway and after that longer runway at the end of that runway They managed also with our support to get on board two really great new VCs.

17:42And that made them pretty independent now of the corporate. That's a beautiful situation, I think, to get there. But I also know how hard it is to get money out from a big corporate. Could you talk a little bit about what does a successful partnership look like between Redstone and a corporate client? You have to set clear expectations or at the core, I mean, you have to talk with the corporate, what are your expectations? What are your goals? You have to define competencies, you know, that we have decision rights. You have to define an interaction model. You have to define, you know, what are their expectations with respect to reporting and score, for instance, publicly listed company needs to report based on IFRS 9 standards.

18:31and we need to be able to provide that. And for all of that, you know, you should have, it should formalize that in an operating manual, you know, so it's clear to everyone who can and is allowed to do what and how do we interact. Second thing, I believe it is important to have a financial alignment, you know, also, you know, a performance-based structure where both sides win when the portfolio performs and when we can do great exits. and when you think about the investment strategy yeah when it comes to building up a portfolio you know you need to have alignment and buy-in from the corporate that you're allowed to do financial bets as i explained before and when it's about phasing out the portfolio so that then we call it the divestment strategy you know if you talk about we want to maximize value you need to knowledge that you cannot sell quickly.

19:30Or you may even need to invest further, or when you want to reduce big exposure, it means you cannot sell at the best price. So it's important to talk about that and to have a common understanding, a balance about reducing risk, generating liquidity, keeping an upside, and then strictly adhere to that. And Radstone both does corporate venturing slash corporate clienting, however, sorry, not corporate clienting, but the CVC as a service model. But you're at the same time also have corporate LPs. And there's a bunch of VCs that have corporate LPs or want corporate LPs. Maybe you can talk a bit about when is it right to have a corporate LP?

20:16When should you as a VC think twice about whether you can actually service them as they expect as an LP? And to put it differently also, when should you realize that this is almost a corporate CVC as a service model? Well, I mean, as long as you have a corporate as an LP on a standard VC fund, you know, where you have many LPs, you don't really have to you know think about because they enter a same limited partnership agreement than all the other investors yeah and and i mean obviously you can service them with additional you can provide them additional services that are you know that help them you know take strategic benefit uh out of out of this investment but based on that limited partnership agreement you would never be allowed to invest into startups that are only strategic relevant to that LP.

21:17The issue is only, you know, as soon as you have a single LP, a corporate being a single LP, then obviously that's a completely different game. And that's when we call it, it's a, you know, it's a CVC structure because obviously the corporate can at any point in time, you know, decide to stop this. What we try to do there is, you know, to make sure that we have a balanced IC, not only purely people from the business side, from the corporate, but only some, maybe someone, a partner from Redstone that brings in the pure VC perspective. Maybe an industry expert who is independent, but with maybe with also some VC background.

21:57Yeah. And then it's a different way to serve them because in the end, you know, they're also a client, you know, they're investor, but they are also a client that they expect some output on top of the financial performance. I ask you the question because I'm sure that you, with the reputation Redstone has in the ecosystem, are asked by many peers in the venture ecosystem, how do you manage corporate? So how do you make sure that the relationship is truly good and beneficial for both sides that you don't over promise? And maybe you could talk a bit about the red flags and the things you tend to say to VCs that are thinking of corporate SLPs.

22:36I think oftentimes when a corporate, they decide to do a fund-to-fund investment, it's setting up, you know, what is the expectations? What does a corporate expect to get out of it, right? Because they expect more than just putting money in and get a financial return, right? Otherwise, they wouldn't do it. So I think for me, it's setting expectations around, you know, will they participate in deal sourcing? can the corporate get access to invest into portfolio companies should the startup decide so and so forth right so i think it's those elements and going back to what what martin also put on on on the plate before right it's it's goal and mindset alignment like what is this right one important point and this is also something we you know we discussed with the corporate at the very beginning is, you know, what's your expectation with respect to strategic benefit?

23:39And once someone says, well, you know, for instance, we have an issue with our, you know, CRM or whatever, any technical, you know, pain point they have. And this is, for instance, something where we would, you know, like to get a solution. And we think we could get that through VC investing, through a startup. and as I know VC is not about working on pain points yeah if you have a specific technical challenge that you need to solve there may be 10 startups out there that can solve that issue for you and we might potentially be able to find it through CVC but there may be you know huge huge companies the SAPs oracles of this world Microsoft whomever who might be the better fit for you so don't use cvc to work on your pain points use cvc to get an outside in view you know to see what what's happening out there where does the money flow to where are the best serial founders putting their time and resources into which might potentially you know even disrupt your business or help you you know move into a new business line or make your business more more efficient.

24:56And in corporate venturing, Martin also, we need to cover, to have the full strategy for me, the build partner invest framework, because it's all elements that you need. There's no corporate that should just take the one or the other. Also ties a little bit back to portfolio thinking. Martin, I would like to ask you, so when you then take Omer, how does these startup founders and your co-investors react right when when you come in there and say you know now it's me martin sitting on the board assisting you on the on the future it's very different i think first of all there's disappointment when they hear about the decision of the corporate to you know to reduce our weight wind down it's in cvc investment activities you know we have this investor on our cap table probably will not get any support for follow-on rounds there's that capital on the cap table we will probably not get any support on the board anymore you know what what's happening who do who's our contact person and as soon as we have taken over you know their reaction is probably usually a very different one very positive one because they realize oh it's actually someone with a vc background which is you know great for us someone with experience on working on boards providing value to the companies maybe even someone with a specific sector expertise and with a co-investor network that's pretty important particularly when you have a you know someone on the cap table leaving you want to make sure you know maybe you need you know the backing of new investors where we can make interest to and as soon as they hear you know that there's still the option to make follow-on investments they're actually pretty pretty relaxed and happy and it's also the chance for them you know to have a new and fresh set of eyes on the board giving them you know new new inputs but also expect to have some you know some co-investors some founders who want to test your limits and see whether you know you may be interested to still sell quickly at a cheaper price and for them to take the option to profit from that.

27:15I just realized we spoke about the topic, the title of today's episode is CBC Secondaries, and we've spoken about a bunch of the processes of doing so and how to manage it and so on. If we just should touch a small second on how are these deals structured? Normally, we think of secondaries as you buy a portfolio at some value and then you own it afterwards. Here, we've also talked about, well, sometimes it's a consulting agreement, so to say, because you take over the management, but you don't necessarily take over the ownership portfolio. So can you talk a bit about that? When do you go on the one side?

27:50What are the usual deal terms? What makes it clear that one is the right decision versus the other? Up to now, we're not a secondary buyer. There are many specialist secondary VCs who buy entire portfolios in such situations what we do here is we take over the management from the portfolio from the existing team the only difference is that we are external and the difference is that we now have a different goal which you know sometimes not is not even that much different I mean yes you make no new investments into new companies and you accelerate the exit a bit based on that yeah yes it's it's in it I mean every situation is different it obviously the fears whether a fund is pretty early in its lifetime or already pretty late in its lifetime you know obviously out there there's a management fee component for the costs involved on our end.

28:56And then also, you know, typically we get a carry or we agree on a carry with the corporate just to make sure we have full alignment on the outcome. Even so, Martin, I'm sure that the corporate will have made the decision. Do we try and go out and sell or do we try and go out and get it managed? And I'm sure that you've been propositioned also with the opportunity to buy portfolios outright. And so far you've decided not to run that model. Can you talk a bit about typically what you say to a corporate when their proposition that you buy their portfolio and also why you yourselves so far have decided not to run that model.

29:35I think it's just a very different focus. And I'm not saying we as Redstone are not considering this in the future. I mean, in the cases that we described or we talked about, like Score, like Hell and Energy and others, it's basically that was the decision from the corporate to go. that route and you know based on recommendation of you know of their consultants because they didn't want to give away that big part of the of the upside yeah and I think that absolutely makes sense for the corporate and from our end I mean for us you know I've I've been working with with corporates over many, many years.

30:20I know how they function. I think we can offer the tools for the entire value chain of CVC from setting up structures, making investments, running portfolios and exiting entire portfolios. And that's what this is based on and what we're specialized to do. Also, for me, reflecting on it, right? So when you as a corporate decide that it's time to leave the venture space, does it then make sense to sell it all in one of these 60%, 70%, 80 % discounts on the whole portfolio? Of course, you then get rid of the problem. You're gone with all your OPEX and everything is nice and bad. But what I really think you should consider as a corporate is that in this situation where you were to hand it over to Redstone, what you actually hand it over to is a group of specialist investors that are used to handling startups.

31:19Because if you hand it over to a consultant with the only mindset of winding down, then I actually think you get less value out of your assets. so so in in that whole perspective i think for me it makes sense to go to to partners like redstone in in such situations you know also for us you know being you know working with corporates on cvc i mean obviously you know we built our services based on the fact that we want to set up new help corporate set up new cvcs and help them manage them and bring them to a success from a financial and a strategic point of view. But, you know, it's not negligible, you know, looking out there, what's happening out there in the market that you have corporates leaving the stage.

32:07And this will never change. There's a big discrepancy between, you know, the short-term goals of managers and the long-term horizon you need to be able to look at when you invest into startups. it's natural they come and go they make up for such a big part of startup investments that we just need to make sure that corporates when they invest and when they leave the stage again that this is handled in the most professional way possible both for the financial benefit and the reputation of the corporate but also for the startups and the entire ecosystem Marcin, one of the things that I'm eager, the question that I'm eager to pop to you is also, you know, what is it that we're lacking?

33:00Why is it that corporates get to the decision of a close down, right? So I think my dream, I have this 3.7 year average lifetime. It really hurts my soul. That's the cancer I'm fighting. Then I'm up against two things, or we in the ecosystem are up against two things. People and strategy change in corporate life. So we have new decision makers coming in. And in EUVC corporate, one of the things that I dream of is to bring the VC and the CVC space closer together so we will not have this discussion in 15 years right why that happened could i could i get your perspective on why is it that senior leaders when they take over or whatever and do this decisions what what is it that that that is missing in the equation there are so many different reasons for corporates to to leave vc i mean back to my own experience 23 years ago, Swiss Re, why did they, we had a team of more than 60 people, it was huge.

34:10The closure of the VC unit happened two years after the internet bubble burst, so performance was an issue. And it happened one year after 9-11, after which, you know, Swiss Re completely, you know, focused on the, you know, emerging opportunities in their core business. So these are, I think those are two typical situations. Having said that, you know, poor performance, you know, is typically an issue early stage in a fund, you know, unless, you know, the investments have really been made in another very, very professional way, or you don't have built, haven't built up a proper portfolio. And if you then have a new CEO coming into the company or you have, or a new, you know, president of the board of directors you have other issues that are on top of their minds in combination with a lack of mindset for vc then it doesn't take much you know to just close that down i mean helvetia recently munich re you mentioned it i think munich re is far away from struggling in their core i think it's quite the opposite i really i i struggle a bit to understand they also brought parts of the portfolio right in huge exits right yeah yeah so i'm really curious to understand the the reasoning there but it happens and uh i mean the big question really is you know i'm at this point in time you know for for a ceo to pop up and say well we're starting is a new cvc unit it takes quite a bit when you see all those other big players you know leaving the stage why should i be you know exposing myself now and there are new players which is you know fantastic i also ask myself the question you know what what needs to change that in a in a next cvc upswing cycle we get to a stage which is you know more resilient you know do we have more are we able to set up more structures that are more resilient towards our situations.

36:31I think it's interesting, right? Because one of my own kind of, you know, pinpoints that I see is around this, you know, is C-suite in Europe well enough educated to understand what is corporate venturing? When you look at our US counterparts, right? A lot of the big companies, they used to be startups, right? We don't have that in Europe, right? In Denmark, we have not had a company coming in on the major stock exchange for almost 25 years, right? It's legacy, all of it. Yeah. Yeah. And I think it's also really the time horizon that a manager has. You know, it's just, it's not seven years. It's not 10 years or 12 years.

37:15You know, we've recently seen a situation where a pretty strategic investment from a corporate where it was, clear that that you know company will not make it further down further and they entered into a huge merger with another company it cost another you know some more money gave that that that investment more runway seems like that whole thing is now collapsing and you know how could that corporate had agreed to such a merger. And it ended up like, you know, that the CEO had to leave anyway, but like that, you know, was able to not to get a setback on his bonus before he leaves. You know, it's a reality.

38:02It's a reality that you have different incentives, different time horizons. And it's difficult to get that, you know, laid across. Gentlemen, we only have five minutes left. I almost want to go back to an opening question we could have asked as well and something that we spoke about off the air before starting as well, which was how do you best avoid a wind down when you set up a CVC? What are the steps that you need to take? We all know alignment. We all know the importance of making sure that the corporate executive team understands the dynamics of venture and so on and so forth. But are there specific things you can do in an LPA or you can do from a setup perspective that allow you to protect the entity?