Babes in Toyland: Donald Spector's Investors Hoped for an IPO
Instead, they lost money, sued, and pushed his Balzac Inc. into Chapter 11
For much of this decade, toy inventor Donald Spector has had two things
going for him that most entrepreneurs would die for: A nationally known
product. And a wellspring of great press in the person of Mary Rodas, who
as a child marketing prodigy, Spector says, gave him the inside dish on
kids' tastes. Spector even credited her with making a hit of his best-known
toy, the multicolored, cloth-covered Balzac Balloon Ball.
Rodas, whose Salvadoran immigrant father was Spector's apartment building
superintendent in Union City, N.J., became vice-president for marketing
at one of his companies in 1990 -- at age 14. Top U.S. magazines (including
Business Week, in a short 1991 story), newspapers, and TV news programs
have chronicled her career ever since. Such publicity helped attract private
investors to a company that Spector formed in 1995 to produce and market
the ball. He even talked about taking the company, Balzac Inc., public.
The good PR has kept on coming. Rodas hit the pages of Working Woman
and Crain's New York Business last year. She reaped more coverage
in December, when Spector named her president of Catalyst Toys, a division
of one of his five companies. And this February, an Associated Press profile
of Rodas that appeared in the Chicago Tribune and elsewhere recounted
her remarkable story once more.
There's just one aspect of Spector's business that hasn't gotten much
attention: Just over two months ago, a group of disgruntled investors forced
Balzac into bankruptcy. Moreover, court papers and dozens of interviews
suggest that financial problems have plagued Balzac since 1996, even as
press reports portrayed Spector's toy business as thriving. Court documents
also show that Catco Inc. -- the company where the 14-year-old Rodas was
a VP and to which Spector licensed the balloon-ball patent -- has faced
more than a dozen lawsuits over the past five years from suppliers, partners,
and investors, many seeking payment of funds they claim they're due.
That's in stark contrast to the image painted by numerous news stories,
which regularly pegged Catco's annual revenues at $70 million, a figure
mentioned in the 1991 Business Week story and repeated in a 1993 New
York Times article that attributed the figure to Spector. Today, Spector
declines to discuss Catco's revenues. Yet the most recent report by Dun
& Bradstreet, which rates the creditworthiness of private companies,
says that Spector projected annual sales for Catco in 1997 at $20 million.
If there's less gold here than thought, what of Rodas' Midas touch?
Despite her title, her role appears to be limited. Spector has told Business
Week Online that Rodas has no knowledge of the finances or day-to-day operations
of Catalyst Toys or any affiliated ventures. He says she's a sounding board
for ideas and that she makes marketing suggestions. Rodas, who hasn't been
named as a defendant in any of the suits, was unavailable to comment on
INVESTOR RISK. What emerges from the saga of Donald Spector and Mary Rodas is a cautionary
tale for investors who might be tempted to ignore the risks of private-equity
investments at a time when fabulous returns from a few hot startups have
captured public attention. One big lesson: You can't be too careful when
investing in a privately held company, because it is virtually impossible
to know what you're getting into. There's a lesson for small businesses,
too: Disappoint your investors at your peril.
Why have Spector's problems escaped public notice? Partly because his
companies are privately held, and partly because Rodas' rags-to-riches
tale is so charming. There probably was also a natural reluctance to scrutinize
a kid too closely. Spector capitalized on this in 1995 when he pitched
Balzac to prospective investors, 43 of whom put a total of $1.175
million into the company, according to its recent bankruptcy filing. They
bought three-year debentures paying 8% annual interest with warrants attached
to buy Balzac shares. But within three months, the company was insolvent,
a February, 1998, investors' lawsuit alleges. That left the warrants with
no real value. Balzac paid interest on the now-mature debentures until
the end of last year. The principal is another matter: Some investors say
they've gotten a portion of their capital back; others say they're still
Spector's glowing résumé, included in Balzac's private placement memorandum
and now part of the court documents, may have wowed some investors. He
has about 150 registered U.S. patents -- for such devices as a hydraulic
exercise machine, a CD system that emits smells electronically, and a method
for sending gift certificates over the Internet. A self-described child
prodigy, Spector says he studied at Columbia University starting in 1962
at age 13. His résumé says he was a teenage researcher in the division
of neurosurgery at Cornell University Medical "School" (College is the
term Cornell uses), where he spent four years. It also lists a research
job at an institute affiliated with the University of Notre Dame in South
Yet Spector's résumé seems to exaggerate his credentials. Asked to verify
its details, he says that the Columbia course was a Saturday class for
"gifted students." He adds that his research stint at Notre Dame involved
a project overseen by a professor of sociology at New York City's Hunter
College. As for the Cornell connection, Dr. Richard Frazer, the neurosurgery
department chief at Cornell for the past 24 years, says there's no record
that Spector was ever affiliated with the department. Russel Patterson,
Frazer's predecessor, adds he has no recollection of Spector. Asked about
that apparent discrepancy, Spector says he "worked on various research
projects" at Cornell in the neuroanatomy department under Dr. Thomas Meikle,
a dean of Cornell Medical College, who died about two years ago. Patterson,
who knew Meikle, says it's possible that Spector was one of a large number
of student assistants who worked in the labs during summers.
Whatever his academic credentials, Spector began his career as an inventor
at least two decades ago. By 1989, he had started Catalyst Applied Technologies
Inc., a patent holding company around which he labored to build a toy empire.
His other companies, including Catco, exist to commercialize his patents.
Rodas and Spector say their business relationship started when four-year-old
Rodas accompanied her father to Spector's apartment. Rodas told Spector
he was laying his kitchen tiles incorrectly, and her critique so impressed
him that he began showing her toys he invented. "Ever since then," says
Rodas, "I have been working one-on-one with Don on many different products
-- over 300 or 400 products."
"GUT FEELING." Rodas first became a media darling in her Catco post, which she filled
part-time while being chauffeured back and forth from the Professional
Children's School in New York City. Her job was to apply her mysterious
marketing acumen to Spector's creations -- suggesting design changes or
rejecting some concepts outright. Rodas' method? "It is just sort of things
I know from observing and watching TV and from looking at kids," she explains.
"It is just a gut feeling and gut reaction."
Rodas' most touted accomplishment has been a splashier look for the
Balzac Balloon Ball, a toy Spector patented in 1989. Balzac is a shell
of dense, colored fabric that fits around an empty balloon. Filled with
air, water, or even rice, the balloon becomes a sturdy ball. Rodas' primary
suggestion was to liven up the shell with neon colors and patterns. She
and Spector then promoted the toy nationally.
The ball, which sells for $5 to $200 depending on size, ranges from
about five inches to five feet in diameter. It has been sold mostly at
specialty retailers, such as those at Universal Studios and Disney World,
and at New York's F.A.O. Schwarz, where it's a popular item. Spector claims
that Balzac was a top-selling U.S. toy in 1990. About 10 million Balzacs
have sold since then, generating between $70 million and $80 million in
sales, he claims. The industry trend-watcher, Toy Retail Sales Tracking
Service Report, has never listed the Balzac in its top 100 toys. However,
TRSTS doesn't count sales from F.A.O. Schwartz, Universal Studios, and
Because the Balzac ball never really caught on in the mass market, Spector
formed Balzac Inc. to develop the brand, with the help of Maryland attorney
Bernard Kraft, who recruited investors, some of whom say they were his
acquaintances. In a related-company transaction, Balzac acquired the right
from Catco to market and sell the ball. Catco had managed the test marketing
of the toy from 1990 to 1995, according to the private-placement memorandum.
Kraft, who, according to court documents, lent Catco money to finance the
creation of the new company, became Balzac's chief financial officer and
a 9% shareholder. Spector and Kraft sought to raise $2.5 million to fund
Balzac, holding out the possibility of an initial public offering within
12 months. Kraft ultimately left the company, though, and sued Catco in
1997 to recover his money. The two sides have since settled out of court.
PR. Spector's pitch to investors stressed Rodas' talents, though at 19 she
was no longer a child prodigy. "Ms. Rodas had a recognition factor sufficient
to attract regional television news and press coverage," the placement
memorandum said. When American Appraisal Associates Inc., a New York City-based
business appraiser, valued the company at $63 million, it took the "public
relations benefit attributable to Mary Rodas" into account.
Stephen Marcus, president of real estate development company Stev-Ren
Associates in Aspen, Colo., was intrigued enough to kick in $125,000 on
the advice of a friend. At a presentation to investors, "they must have
had four or five pictures of [Rodas], showing her on TV or whatever," he
recalls. "They kept showing this girl -- like she was supposed to know
something at 12." Marcus also invested without knowing much about Balzac.
"I don't even know what they do. They make toys and sell them in some mall,"
he says. "I relied on a friend who said it was going to be terrific."
But Balzac Inc. was unable to raise more than $1.175 million of the
$2.5 million it figured it needed to start operations. Two Baltimore-area
partnerships, Toyzac and B.I.G., representing 36 people who had bought
a total of $550,000 of Balzac debentures, became alarmed when Kraft unexpectedly
left the company in spring 1996. (Kraft has not returned phone calls seeking
comment.) Fearing the worst, the investors soon confronted Spector, who
told them the company was insolvent, according to the February, 1998, suit
they filed in U.S. District Court in New York. The investors asked for
their money back, but Spector and other Catco representatives calmed them
by telling them that a licensing deal was imminent, the court filings claim.
Spector didn't respond to requests for comment on Balzac's alleged insolvency.
In December, 1997, Spector agreed to sell San Francisco toy manufacturer
Wham-O Inc. a license to produce, market, and sell the Balzac ball over
the life of the patent -- for $2.5 million, plus royalties. Under a previous*
agreement, the Toyzac and B.I.G. investors were to get a portion of the
proceeds. But two months later, these debenture holders sued, accusing
Spector, Michael Deutsch -- a vice-president and director at Catco and
Balzac -- Balzac, Catco, Catalyst Applied Technologies, and Wham-O of violating
the mediated agreement. Bret Hadley, Wham-O's senior marketing vice-president,
says the dispute hasn't affected either the licensing deal or his company.
According to one Toyzac/B.I.G. investor, among the groups' main complaints
was that Balzac pledged company inventory to buy a significant interest
in a publicly traded company, First Entertainment Holding Corp., whose
ventures include low-budget films, Internet gaming sites based in Dominica,
and adult-entertainment Web sites. "That's the entertainment business.
We had invested in the toy business," objects the investor,
who contends that Spector and Kraft wanted to bring Balzac public quickly
by merging it into First Entertainment. The private-placement memorandum
made no mention of any merger strategy. Spector says Balzac now owns about
12% of Englewood (Co.)-based First Entertainment, whose shares NASDAQ delisted
last year for failing to meet minimum price requirements of $1 a
share. Spector says none of the investors' money was used to buy First
CREATIVITY. Then last December*, the Toyzac and B.I.G. investors settled their federal
court suit against Spector, Deutsch, and the other Balzac defendants. Under
the deal, the two partnerships were to get $550,000 from the Wham-O licensing
contract, to be put into escrow. The deal also promised them a portion
of the Wham-O royalties -- which total at least $250,000 a year, according
to the Chapter 11 filing -- until all their members are repaid their principal
and interest. "Our impression is that Mr. Spector is a very creative guy,
but our people formed the conclusion that there was a lot less substance
in Balzac than they were led to believe," says Peter Gunst, partner at
Astrachan, Gunst, Goldman & Thomas, the Baltimore law firm that represents
Toyzac and B.I.G. Spector says he does not wish to comment on that.
It was Balzac's deal with Toyzac and B.I.G. that led to its bankruptcy
filing. Angry at being left out of the settlement, seven other investors
who held $600,000 in Balzac debentures tried to force Balzac into Chapter
7 liquidation, according to one of their attorneys. Balzac, which shows
$4 million in liabilities against $8.1 million in assets -- and $755,000
in gross revenues in 1998 -- successfully converted the proceedings to
Chapter 11, which may give the company a chance to reorganize. The
attorney says his clients are seeking repayment of their $600,000 principal
plus interest, and a judge has yet to determine whether Chapter 11 is a
Where does all this leave those who believed in the Spector-Rodas-Balzac
magic? "The Balzac spin-off from Catco was an unfortunate episode," says
Spector, who nonetheless contends that the investors' suits were unjustified.
"I think that the situation did not go well in the first six months. We,
I think, made an extraordinary effort to keep the company going so that
the product could be licensed and everyone could realize a return on their
Spector remains convinced that the Balzac Balloon Ball has a bright
future, especially with Wham-O's mass-market muscle behind it. "It does
tremendous business at locations where it is demonstrated and promoted,"
Indeed, on a recent day, the Balzac display at F.A.O. Schwarz's flagship
store in New York was packed with delighted children. Two adults, noticing
the fun, slipped Balzacs into their shopping baskets. Wham-O, meanwhile,
believes that the product has more potential than its early sales showed.
Wham-O Vice-President Hadley says his company, which created the Frisbee
and Hula Hoop, has spent several million dollars marketing the balls and
has sold about a million of them since 1997. "It is good, but we think
it could be a lot bigger," he adds.
Spector, meanwhile, has obstacles to overcome. Catco still has to fend
off suits, and Balzac is deeply troubled. Yet Spector says he plans to
reorganize the company. That sounds like a tall order. Amid flat sales,
the toy industry is consolidating: Wholesale toy sales declined 0.3%, to
$15.2 billion last year, according to the Toy Manufacturers of America,
a trade group. Nevertheless, Spector says he and Rodas plan to continue
developing and licensing products.
And what of Mary Rodas, now 23? From now on, her gifts as a marketer
will really be put to the test.
By Jeremy Quittner in New York
*This story was updated April 29, 1999 to clarify that the
court-mediated agreement was in December 1998. A September 1997 agreement wasn't court-mediated.