TO UNDERSTAND TIM WAGNER'S feelings -- grief, rage, chagrin, and all the other emotions that bubbled up as his company slipped away -- you have to put yourself in his shoes.
You and two friends, all of you in your mid-twenties, hit on an idea for a business. Not just any idea -- the idea, you feel it in your bones. And bingo, you're right. Capital is there for the asking. Sales rise so quickly your plant can't keep up. In the first six months of production you do $3 million, with profitability just around the corner.
But somehow, in that same six months, everything begins to go horribly awry: the dream that is right there, in your grasp, turns bit by bit into a nightmare. Relations with your investors sour. You and your partners are stripped of control. You stay on as an employee, only to be rudely dismissed less than two months later. Desperate, you try to figure out some way of capitalizing on your interest in the business, though you have no way of knowing, just then, what it's worth. When you run out of possibilities you settle for $63,800 -- with the very people who booted you out.
And then, within a month, they have organized a private placement, selling a hefty chunk of stock to outside investors. By the terms of the offering, the company is worth nearly $6 million.
Once, 20% of that was to be yours. Now you have no company, no equity -- and no job.
In retrospect, the high point of Timothy Wagner's roller coaster had to be that wonderful June evening in 1985. It was party time, that night, at VMG Products, a wingding thrown to celebrate the beginning of production. And look at all those people. Bill Prater, the jovial money man from Seattle, along with Ken Breiland and most of the other investors Prater had helped line up. Several people from the food brokerage that had helped VMG's sales get off to such a stunning start. And everyone else -- suppliers, customers, employees, family, friends, so many that traffic was backed up for blocks outside the company's Vancouver, Wash., plant. Sometime that night, after the speeches and before the dancing, the new diaper production line would be christened, then ceremonially turned on. A few of VMG's Baby's Choice brand of disposable diapers would roll off the line, and the company Wagner and his partners started would be formally, officially, on its way.
Though he was happy, Wagner wasn't really surprised at VMG's bright prospects. He was only 25, but his business ventures had always turned out well. In high school, he and friend David Pitassi had sold more stuff on behalf of the band than anyone in recent memory. In college -- Wagner went to the University of Portland (Oregon), Pitassi to nearby Lewis and Clark College -- the pair had cleared nearly $50,000 on their "Pet Volcanoes," a novelty inspired by the 1980 eruption of Mount St. Helens. And though disposable diapers might seem an unlikely product for a startup, Wagner knew better. Soon after college he had worked as a salesman for National Starch & Chemical Corp., an industrial-adhesives maker. When the disposable-diaper people who bought their glue from him talked about their industry, he heard opportunity.
Two companies, Procter & Gamble Co. and Kimberly-Clark Corp., dominated the diaper marketplace, their three nationally advertised brands accounting for roughly 80% of sales. But that left 20% or so of a $2.5-billion market for a handful of private-label manufacturers. A diaper company producing and selling in the Pacific Northwest, Wagner figured, could compete handily in this segment by being a low-cost manufacturer. It could take advantage of new, efficient production machinery -- diaper lines, as they're called -- available from European manufacturers. It would be close to its raw materials, and it would have lower shipping costs to its market than any other manufacturer, none of which had plants any closer than California.
Concept in mind, Wagner got in touch with Pitassi and a college buddy of Pitassi's named Walter Klemp, then working as an accountant with Coopers & Lybrand in Portland. The three hit it off, and by April 1984 had come up with a 60-page business plan. VMG -- the name was derived from their middle initials -- would manufacture private-label diapers for supermarkets primarily in Oregon and Washington. It would start slowly, but would grow to sales of $15 million by its fifth year of operation. At Klemp's suggestion, they took the plan to William N. Prater Jr., head of Weatherly Private Capital, an investment firm in Seattle.
Prater liked what he saw -- the three eager young men, their persuasive plan, the money they convinced him was there to be made. To be sure, he cut back their proposal: instead of the roughly $1.4 million they wanted, Prater suggested a figure closer to $900,000. The rest could come from the bank, he said, secured by the diaper line they planned to buy. His proposal for structuring the deal was a little unusual. Instead of raising capital by selling stock in a corporation, he said, we'll set up a limited partnership. That will be quick and easy, and we'll structure it so you can work your way into a majority position.
To Wagner and his friends, it was exciting -- so exciting that they decided to go with Prater right away. Hell, how could they lose? Prater, an experienced investment packager, had promised to raise nearly a million dollars, just like that. Why bother taking the proposal elsewhere? They'd get a lawyer, of course, but only to check over the documents Prater was drawing up -- no need to involve one at this stage. By August, Weatherly had lined up the investors, the lawyers had given the paperwork the once-over, and the deal closed. VMG got $310,000 in cash and another $573,500 in promissory notes and loan guarantees.
Over the next several months, the trio's carefully worked-out business plan proved dead wrong on two significant counts. One, no supermarket chain was about to commit itself to a hefty private-label contract with an unknown supplier, let alone one run by three kids in their twenties. If something went wrong, the chain would be left with a black eye, a lot of hassles, and possibly no diapers. But two, the market for nonnational-brand disposables was suddenly much, much bigger than even Tim Wagner had thought. In January 1985, P&G had repositioned Pampers upward, and was now selling them for the same premium price as the company's own Luvs and Kimberly-Clark's Huggies. So far, no one had moved to fill the gap between cheap private-label diapers and these premium brands.
It was a niche, Wagner realized, made to order for VMG. Suppose the company produced its own brand? Because of its low costs it could undercut the national brands' wholesale price by about 12%. That would allow retailers to sell VMG's Baby's Choice for less than Pampers, yet make a higher profit. Unlike the original private-label plan, there was no risk to the supermarket. If Baby's Choice didn't sell, the retailer could just discontinue the order.
