A strategy to get the most out of a private placement

Meet F.R.O.Y.D., the product with perfect prospects. Sure, he's a homely guy, bright yellow with a big nose and a sheepish grin. Here's a list of folks who say this 13-inch toy looks like a winner: Hasbro, Coleco Industries, Fisher-Price, Tyco Toys, and Kenner Products.

And here's a list of folks who have turned down the chance to launch F.R.O.Y.D.: Hasbro, Coleco Industries, Fisher-Price, Tyco Toys, and Kenner Products.

So Carolyne Greene, F.R.O.Y.D.'s creator, and her partner, Jeffrey Greene, found themselves learning the very lesson that their little yellow fellow espouses. F.R.O.Y.D., which signifies "for reality of your dreams," is supposed to remind children that they can be anything they want to be, if they work at it. To get F.R.O.Y.D. into toy stores in three cities last spring, the Greenes had to raise $600,000 by themselves, through a private placement of stock. Simply put, a private placement is the sale of securities (either debt or stock) to investors without registering them with the Securities and Exchange Commission. To sell securities this way, both the issuer and the investors must meet a number of federal and state regulations.

But this is more than a do-it-yourself financing tale. The Greenes' story illustrates how a grand plan for a new business can be reshaped into small, feasible steps. That, in turn, is what ultimately made F.R.O.Y.D. financeable.

The Greenes also learned the difference between regular money and intelligent money. They found the latter -- money from people who can help them in other, nonfinancial ways. It was pure luck, Jeffrey Greene confesses. But if he were to start another company, he'd target such investors from the outset.

Back in 1979, Carolyne Fischer (she hadn't yet met Jeffrey), a designer of fine jewelry, doodled the first F.R.O.Y.D. on her sketch pad. It wasn't until 1984 that she began seriously to develop the character and the I Believe in You theme. This is when she began talking to anyone who would listen about F.R.O.Y.D. Naturally, toy makers were at the top of her list of potential buyers. They said two things: "We think you've got a nifty new toy here" and "We're not investing in it."

Of course, it took years for Carolyne to meet them all and hear this. For a long time she figured it was only a matter of connecting with the right manufacturer. By the time she met Jeff Greene in 1984, she had gotten a time-consuming but first-class seminar on the toy industry. The key piece of knowledge: toy retailers were starved for fresh ideas because manufacturers were being overly cautious in bringing out new products.

Rejection by prospective investors and his own skepticism spurred Jeff, a venture capitalist, to take a hard line with F.R.O.Y.D. The doll got a good reaction, he thought, but what did that amount to? He wanted proof that it would sell. Greene decided the market research done on the Cabbage Patch Kids would be his litmus test. He had the same team Coleco Industries used, R. M. Manko Associates, test F.R.O.Y.D. using the same sets of assumptions and hypotheses and comparable groups of mothers and children.

The test results were great. In the focus groups they were able to determine that F.R.O.Y.D. has a much broader appeal than Cabbage Patch Kids.

But by the beginning of 1989 the Greenes realized that the toy industry wasn't going to buy their character. Disillusioned, they decided they would make F.R.O.Y.D. themselves and began talking to retailers and contract manufacturers.

With his experience in the venture industry and a smashing business plan in hand, Jeff Greene thought finding the money would be a piece of cake. He mailed 100 business plans and had serious discussions with 10 investment groups but came up empty-handed.

Most venture capitalists aren't interested in consumer-oriented or marketing-driven companies, explains Lee Chaden, general partner of MarketCorp Ventures, a Westport, Conn., firm that focuses on such start-ups. "If you don't like consumer and marketing deals," he adds, "you're going to hate toy deals. There's so much risk involved." Indeed, all venture capitalists had to do was look at the industry's casualty list: Worlds of Wonder and Coleco had both filed for Chapter 11 protection. MarketCorp was interested in F.R.O.Y.D. but too busy to take on a new investment.

Round two of rejections forced the Greenes to further refine their strategy. By now they knew they had a winner, thanks to their market research. They knew how to get F.R.O.Y.D. made, thanks to their manufacturing contacts. And they believed that such retailers as Toys "R" Us had high regard for the manufacturer they had chosen.

They still needed financing, but not for a full-fledged company, the partners realized. They used to imagine having a company big enough to launch the doll, develop a television show, and strike licensing agreements simultaneously. Now, as they thought about their discussions with toy retailers, they recognized that all they needed was enough cash to conduct a live test of F.R.O.Y.D.'s appeal in toy stores. Hungry for a big hit, the retailers were obliging.

The Greenes figured $450,000 to $600,000 would be enough to cover advertising and production in three major cities. With their financing needs pared down, they realized, the money didn't have to come from companies or institutions. It could come from individuals. But not just any individuals. They would go back to the people they had met along the way -- everyone who had said "great idea" -- and ask them to buy stock in the company.

It worked like a charm. Walter Stursberg, a partner at Olshan Grundman & Frome who drew up the private placement for F.R.O.Y.D. Inc., was flabbergasted. After 16 people subscribed for the full $600,000, the Greenes had to turn away investors.

The key was approaching individuals whose business expertise gave them a special appreciation for marketing or the character-development business. Thus, the company's backers include senior executives in an advertising agency, a consumer products company, and a direct-mail business. Because of their specialized knowledge, these people had the confidence to invest their own funds and make the decision quickly.

More important, says Jeffrey, such investors will be able to help F.R.O.Y.D. later on, either individually or through their companies. For example, every F.R.O.Y.D. doll will "invite" its new owner to register through a Dream Team postcard that is part of the package. F.R.O.Y.D.'s shareholder in the direct-mail business will be able to provide valuable guidance in using the resulting database.

Right now, those are just dreams. While the Greenes may not succeed in making them all come true, their first-stage financing worked beautifully. Of course, if it doesn't work, it won't be for lack of inspiration. In his autobiography, F.R.O.Y.D. takes credit for giving Mikhail Gorbachev courage to turn the Soviet Union in a new direction. After perestroika, how difficult can selling a few dolls be?


Whetting investors' appetites

Rejection made F.R.O.Y.D. Inc. grow stronger -- and ultimately more financeable. Here's what Carolyne and Jeffrey Greene had going for them by the time they finally found capital:

* Appealing concept. Who doesn't want to see their kids encouraged to succeed at their dreams?

* Vivid research. Talks with toy makers and retailers reshaped the Greene's strategy, provided manufacturing expertise, and gave investors confidence.

* Star appeal. Replicating the Cabbage Patch Kids market research gave F.R.O.Y.D. instant credibility.

* Bare-bones organization. It's a luxury to think about having the staff and money to build the company you want at the outset. The Greenes whittled down their ideas about their company and its financing needs to the bare minimum.