BACKING THE BETTER MOUSETRAP

Man invents mousetrap. Mousetrap works. Inventor beats a path to his nearest Canadian venture capitalist

ALEXANDER ROSS April 1 1972

BACKING THE BETTER MOUSETRAP

Man invents mousetrap. Mousetrap works. Inventor beats a path to his nearest Canadian venture capitalist

ALEXANDER ROSS April 1 1972

BACKING THE BETTER MOUSETRAP

ALEXANDER ROSS

Man invents mousetrap. Mousetrap works. Inventor beats a path to his nearest Canadian venture capitalist

It happened just the way it’s supposed to in all the folklore about Better Mousetraps. Harold Humphrey, a greying, 51-year-old consulting engineer who knows more about plastics and how to use them than almost anyone else in the country, was sitting at the kitchen table of his bungalow outside Toronto early one morning in 1966, sipping coffee and doodling on a scratch pad. He liked to get up before the rest of the family was awake, pad around in his housecoat, fix himself some coffee, and while the house was still quiet . . . think.

For several years now Humphrey had been thinking about the whole problem of pumps. A pump, of course, is a device for using energy to transport liquids from one level to another and it’s one of the most basic machines on earth. There are hundreds of designs for pumps — all of them, in Harold Humphrey’s view, too damned complicated. “They have valves and springs and all kinds of little parts. I simply felt there must be

HICKORY DICKORY DAVIS

Now you take your average better mousetrap; it doesn’t look like much. But when artist Peter Davis (left) builds one, it’s a work of art as well as a functioning machine.

And here’s how it works. The mouse enters the box with the cogs on the side. Inside is a treadmill and hanging from the bars on top is a piece of cheese. Now to get to the cheese the mouse has to get on the treadmill, which sets the whole wonderful contraption in motion.

A pulley attachment pulls a release hook up the pole at left; this releases the car at the top of the track. The car rolls down, as it’s doing in the photo, and hits a lever which is propping open the door at centre; this lets the door swing shut, trapping the mouse. Anything else you’d like to know?

a better way. And that morning, sitting there at the kitchen table, in a flash, I had the whole thing. It just suddenly flashed on me — this is the way to go.”

Humphrey, a professional engineer who designed ammunition containers for the army during the Fifties and the seat belt that is now standard equipment on all General Motors cars, immediately trotted down to his basement workshop and started tinkering. What he’d drawn on his scratch pad was the design for a new kind of pump that was — but of course — revolutionary. Within 24 hours he’d built a prototype. “And it worked,” he says. “I’d found what I was looking for. The simplest possible pump. Only two parts, one made of rubber, the other a flat piece of plastic. That’s got to be the simplest possible pump you could ever hope to get.” It’s called Polypump.

Now according to folklore, that’s the happy ending. Man invents mousetrap. Mousetrap works. World markets beat a path to his door. Inventor gets rich. Retires to the Riviera.

In Humphrey’s case, it’s actually beginning to work out something like that. Polypump Limited is now a public company with three plants in three countries, $10 million in sales last year and about 500,000 pumps in use —mostly on liquid-dispenser bottles, those plastic containers that squirt out hand lotion. Humphrey, as a minority stockholder and technical consultant to the company, is much richer than he was before, though he’s still no millionaire.

But all of this was a lot trickier than folklore. It actually takes at least seven years to turn an idea into a profitable company. It also takes millions of dollars, which somehow must be extracted from a financial community that is skilled, above all else, in thinking up reasons why It Can’t Be Done.

So this isn’t a story about inventors. It’s a story about what happens — or doesn’t happen — after a promising invention has been created. It’s about the most crucial stage in this process: finding the money that must be spent to prove that the mousetrap not only works but can be sold at a profit. And it’s about a new and specialized breed of investor who’s beginning to emerge in this country: the venture capitalist, who uses his money, his technical judgment, his business savvy and his intuition about people to help bridge the vast distance between an inventor’s bright idea and a profitable business.

Venture capital is probably the sexiest branch of the whole money business. In Canada, it’s a relatively new field; there are only about two dozen firms, most of them based in Toronto and Montreal, that specialize full time in providing “seed money” to promising young companies. Typically, these vc firms consist of no more than half-a-dozen bright young men who spend their days evaluating the proposals of people who come to them seeking financial backing.

The whole idea, as the brochure of one firm expresses it, is “not to invest in blue chips but to assist in the creation of the blue chips of tomorrow.” If you find the right man with the right idea, and if you back him early enough — sometimes even before a company has been formed — and if you’re prepared to nursemaid the venture for as long as 10 years, you might wind up with a large profit. Venture-capital people are always dreaming about finding “another Xerox,” some tiny company, whose stock is worth pennies, that has the potential to become an industrial giant.

The fact that Canada now has the beginnings of a venture-capital industry is something to feel hopeful about. Seed money now means corpo-

rate control

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later on; and if Canada is an economic colony today, it’s because we’ve always lacked the mechanisms that can mate homegrown ideas with domestic money.

The venture-capital business, then, is much more than an interesting subculture within the financial industry. If Canada is to regain control of its economy, the intelligent use of venture capital has to be a major ingredient of our strategy. It’s obvious that we can’t afford to “buy back” our economy from outsiders. What we can afford, though, is to provide the seed money that will give Canadians control of tomorrow’s big industries.

It was venture capital from somewhere else, remember, that made us what we are today — a country that makes a very good living by exporting our natural resources. But unless we start providing our own venture capital, there’s no way we’re going to develop the kind of economy that depends on ingenuity and innovation. Foreign-risk money might create another International Nickel, because the resources are here and the world needs them. But there will never be a “Canadian Xerox” unless we take the risks ourselves.

The granddaddy of all venture capital firms, American Research and Development Corporation, has “found a Xerox” not once but several times. Founded in Boston in 1946 by a visionary named Georges Doriot, ARD made early investments in several high-technology companies that later became major beneficiaries of the aerospace and computer boom of the 1960s. ARD’s $61,400 investment in a company called Digital Equipment Corporation, which makes computer accessories, is now worth $354.6 million. Another early ARD investment, Teledyne Inc., cost $581,339; that stock is now worth $5.4 million. In 25 years, ARD has sunk $23.6 million into young companies. This stock is now worth $313.5 million, which is a lot better than bank interest.

Teledyne and Digital Equipment are legends in the trade. They’ve helped to give the venture-capital business an impossibly glamorous image. At some point in their careers, most venture capitalists have tried to live up to it, usually to their sorrow. Canadian Corporate Management, a holding company (of which Walter Gordon is chairman), once sank $500,000 or so into a revolutionary new type of motor that was nothing but a bunch of ball bearings rolling around inside a metal casing; the prototype of the Baldrive motor, as it was called, worked beautifully. But

the device bombed out in the later stages of development. These days, Walter Gordon sticks to investing in decidedly unsexy things, like shopping centres. Charterhouse Canada Limited, one of the oldest Canadian venture firms, a few years ago backed a couple of young promoters who were trying to market a carbonated cider called Apple Brau. “At that time,” says Charterhouse President Sandy Sinclair, “everybody thought we were great guys, investing in native enterprise and all. Well, the short answer is that we took a $30,000 fling that cost us $30,000.” The basic problem with Apple Brau was that nobody wanted to drink the stuff.

The real mystique of the venturing business, you see, is that you’re not gambling on Revolutionary New Mousetraps so much as you’re gambling on people. “After looking at a hell of a lot of inventions,” says

Charterhouse president Sandy Sinclair: “We took a $30,000 fling that cost us $30,000.’’

George Montague of UNAS Investments Ltd., “my conclusion is that there just isn't anything that human ingenuity can’t devise. But the real issue is, who needs it? Is there a market? And if there is, can this guy put it over?”

Well, what would you say about Rudy Haering, a physics professor at Simon Fraser University who holds a string of patents and patent applications on some truly remarkable inventions? One of them is something called a Super-Conducting Quantum Interference Detector, which Dr. Haering calls “the world’s most sensitive magnetometer”; it’s keen enough to detect the presence of metal from several miles away. Another Haering invention is called a phonon maser — a tiny chip of cadmium sulphide, about the size of a flake of SenSen, which functions as a microphone, an FM transmitter and as a photoelectric cell. You can imagine endless applications: super-min-

iature microphones for bugging the olives in diplomats’ martinis; heartbeat monitors that could be taped to a patient’s chest, with the signals fed into a computer that’s been programmed to flash a warning signal to the on-duty nurse at the slightest telltale flutter; extension speakers for your stereo set that are triggered by beams of light.

In a perfect world, you would suppose, Dr. Haering’s main financial problem would be to choose between huge, lustful offers from Philips Electronics, General Electric and the CIA. In reality it’s not that easy, because (a) for any invention, no matter how super, there are enormous obstacles between the drawing board and the marketplace, and (b) this is Canada, and Canadians only invest in sure things.

Dr. Haering formed a little company called Canadian Thin Films Limited, and spent several thousand dollars of his own money on patent applications. Then he started looking for money in all the old, familiar places — his friends, the banks, giant electronics corporations and, finally, from the venture-capital firms of Toronto and Montreal. But nobody so far has put money in the deal. How come? Are Canadian investors really that cautious?

Yes, they are. But at the same time, the potential pitfalls are truly daunting. To produce a batch of phonon masers, you have to polish the crystal absolutely flat, to incredibly fine tolerances. This process is akin to cutting diamonds — a highly skilled handcraft, and one that might not be readily adaptable to high-volume production.

That’s one pitfall. Another is that it might take several years, and several hundred thousand dollars, to figure out which of the hundreds of potential applications is most likely to produce a profit, and then develop the product. And at the end of all that hassle, your decision on which application to pursue might turn out to be wrong.

But the most daunting pitfall is the inventor himself. Rudy Haering is a brilliant physicist, but he’s just not the kind of guy you can readily imagine running a multimillion-dollar company. There are some people who, when they walk into a room, give off a whiff of the jungle. Venture capitalists are finely attuned to this scent, and apparently they do not detect it when Rudy Haering walks into their offices. “There’s almost a 'C u 11 u r a 1 mismatch,” he says, “between people like myself and the people you have to raise funds from. They always

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keep talking about a track record. What that means is, ‘How many million dollars did you make last year?’ Well, hell, if I had a ‘track record’ I wouldn’t be running around looking for money, now would I?”

There is still another difficulty: Haering wants to keep it Canadian — which, when you’re trying to raise money, can be an inconvenient form of patriotism. Although they didn’t offer to invest directly in Canadian Thin Films, two U.S. firms offered H a e r i n g jobs in their research laboratories, with carte blanche to work on the development of his inventions. “I’ve had several offers like that,” says Dr. Haering. “One of them would have paid me 1.6 times my salary here at SFU. Another offer would have meant twice the salary, and allowed me to stay in Vancouver. But I’ve turned down all these offers, because the whole idea is to try to do this in Canada.”

Dr. Haering’s experience points up one of the less-appreciated disadvantages of being a U.S. colony. There are dozens of large U.S. corporations that can afford to gamble on ideas like Rudy Haering’s. Their research facilities, understandably, are highly centralized — which means that laboratory work gets done by the American parent company and not by its Canadian subsidiary. The end result is that a lot of bright Canadian ideas eventually become profitable American products. “I’ll give you a great example of that,” says Dr. Haering. “On the same day, the very same day, I heard from one Canadian subsidiary that they weren’t interested in putting money into product development, I got a call from the same company’s American parent. They wanted me and two of my students to move to the States to head up a research group to develop our invention. Now that’s a bit thick!”

Raising money to start a business has the same circular quality to it as running for prime minister. If you’re strong enough to stand the strain of getting there, you’re probably strong enough for the actual job.

Based on this reasoning, another Vancouver inventor named John Smyth just might make it. Smyth is a mature-looking 26, and for the past four years he’s been tinkering with a device that will enable timber firms to harvest logs by remote control. During the same period, with a sort of dumb, dogged persistence, he’s been raising the money he’s needed to support himself while he perfects his invention.

In 1970, after spending months dickering for additional financing

with a Toronto venture firm called Varitech Investors Limited, he finally lost patience and politely told Varitech’s principals where they could put their money. Varitech’s two partners, John Hardie and Jim McKinney, were so charmed by this that they promptly bought $15,000 worth of shares in Smyth’s young company, Forestral Automation Industries Limited. If the company shapes up the way Varitech is now betting it will, John Smyth could become a paper millionaire long before he turns 30.

Is Smyth a creature of the jungle?

Not exactly, but there’s something winning about him that moneymen can relate to. He’s had all the conventional disadvantages: broken home; mother raised eight kids on a stenographer’s salary in Terrace, BC; John quit school at 15 and went logging to help support his brothers and sisters. At 17 he joined the RCAF to learn a trade. By the time he quit the air force three years later, he knew enough about electronics to converse on more or less equal terms with PhDs in physics.

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Then he went back to contract logging and started wondering why logs couldn’t be harvested more efficiently. Many west-coast firms now use a grapple yarder for this job — a sort of crane with a giant clothesline attached. Once the trees have been felled, you hook the logs to the clothesline and haul them in. The trouble is, the operator in the grappleyarder’s cab, because of distance or fog or bush, can’t always see the logs he’s supposed to be picking up; and it’s hard for the man on the spot — the man who actually hooks up the logs — to communicate with the man who’s at the controls. Using Smyth’s remote-control system, the man who hooks the logs, by manipulating the levers on a small box, can personally control the machine. Tests using Smyth’s system have yielded fairly dramatic production increases.

The first $10,000 — which built the demonstration unit — was Smyth’s own money. The next $40,000 came from logging contractors and pulp companies in BC who could appreciate the idea’s potential. A federal government agency set up under IRDIA (Industrial Research and Development Incentives Act) came through with a $14,000 grant.

But when you’re trying to turn an idea into a product that will sell for $12,000, this kind of money isn’t enough. For four years Smyth’s life ran in two phases: he’d tinker with his machine until he ran out of money; then he’d put on a suit, pack his attaché case and go out looking for the next chunk of capital.

Smyth finally got his money late last year. A Vancouver-based lumber company called Whonnock Industries bought majority control of Forestral for $250,000. This should carry the firm to the point where it’s ready to sell its product, and will also finance the acquisition of a small electronics firm that has the facilities to build the machines.

In this case the intervention of a venture capitalist wasn’t crucial. But it does illustrate the peculiar chemistry that must prevail before the magical union of Idea and Money can happen. Hardie and McKinney, the Toronto venture capitalists, had started and built a successful company of their own before going into the vc business. They look at as many as 150 to 200 deals a year, and in three years they’ve invested in only seven. Forestral was one of them because, as Hardie puts it, “Smyth has this sort of fire in his eye, something that tells you, ‘I’ve got it.’ ”

This penchant for slightly mystical judgments seems to be about the only

thing that venture capitalists have in common. Otherwise they differ in their approaches, their backers, their willingness to take risks, and in the kind of deals that tend to interest them. Some venture capital firms — a surprising number, really — are run by the heirs to large family fortunes. Some are owned by consortia of banks and insurance companies. Some will gamble on anything from rock festivals to nursing homes. Some

— again, a rather surprising number

— are stodgier than the banks.

The freakiest outfit by far is Helix Investments Limited, run by Donald C. (Ben) Webster, of the Montreal Websters. Helix has invested in a Broadway play, lent $1,000 to a botanist for an expedition to the jungles of Colombia to track down medicinal herbs, and poured a fairly embarrassing amount of money into the search for buried pirates’ treasure on Oak Island. One

Venturetek president Jeremy Kendall: “We barely broke even.”

recent acquisition is Thunder Sound, a Toronto recording studio. Another investment is known, in venture-capital circles, as “the Monkey Movie” — a feature film, still unreleased, about monkeys making a film about people.

Helix isn’t that freaky, though. Investments in monkey movies and buried treasure are an expression of Webster’s intellectual frontiersmanship; but the bulk of the company’s money gets invested in such straight, sober deals as computer time-sharing, electronics and medical companies.

Still, Helix is one of the few firms with a consistent record for investing in really bizarre deals at the stage when they’re only a gleam in the inventor’s eye. Another is Venturetek International Limited, whose young president, Jeremy Kendall, is one of the few men on Bay Street who can claim to have attempted to invest in cranberries; they had a nice bog picked out and were all ready to roll, but in the end decided the competition was too tough.

Most other venture firms — UNAS, Charterhouse and Canadian Enterprise Development Corporation are among the biggest — seem less prone to make investments at the very early stages of a company’s development. They like to see a “track record”; and in practice this usually means the entrepreneur must raise his first few hundred thousand somewhere else, and perhaps even generate an earnings record, before they’ll look seriously at the deal.

The willingness to accept early risks, not surprisingly, seems to bear some relation to the profits these venture firms eventually earn. Venturetek started about three years ago with a kitty of $200,000 — the bulk of it from Jeremy, the rest from Kendall House Limited (the family holding company), Michael Holt and Donald Loeb, now his partners. This year the estimated value of their holdings is more than five million dollars.

How do they do it? The answer seems to be that the liveliest venture capitalists are entrepreneurs themselves. Jeremy Kendall, now 31, made a small killing in the market while still in business school, buying marginal stock with money he’d borrowed from the bank. While working as a junior executive at Atlas Steels, he bought up some houses around St. Catharines which had been abandoned to make way for an extension of the Welland Canal, then bought land to move them to. “We barely broke even,” he says, “but it taught me that in business you can’t do anything part-time.”

Kendall and his two partners, who also played the market at tender ages, believe in dreaming up a lot of their own deals instead of waiting for some inventor to wander in the door. They’ve put together a company in England which sells small computers, backed a small Vancouver-based firm called Hobrough Limited which makes mapreading equipment and, with a lot of financial assistance from the federal and Nova Scotia governments, bought a faltering electronics firm in Dartmouth from its British owners, Electrical and Musical Industries, renamed it Hermes Electronics and reshuffled management. The company made a decent profit in 1970 and the Dartmouth plant, instead of closing, now employs about 460 people.

Venture capitalists don’t compete. They cooperate. If they can’t handle a deal, they’ll often pass it on to one of their rivals. Two or more firms will sometimes join forces to invest in a single deal. They go to one another’s parties, they phone each other a lot, they play squash together. “If you

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talk to one venture-capital firm,” says Rudy Haering, “you’ve talked to them all.”

Once they’ve explored an idea, made their hunch judgment of the man behind it and put up some money, one of two things can happen. Either the company develops on its own momentum and without much further attention from the venturer, or it becomes what people in the trade call “one of the living dead” — a company that’s constantly in trouble, constantly needs attention. Venture capitalists feel that at least part of their job is to be high-level management consultants; they help guide the firm’s inexperienced management, put a representative on the board of directors and, in many cases, insist on the power of veto over major corporate decisions.

This isn’t a fast-buck game. It usually takes seven to 10 years before a company develops to the point where its shares can be sold at a profit. In the meantime, the newer venture firms have to move fairly slowly, until they develop a cash flow from matured investments. “It’s a little like forestry,” says one executive.

Sooner or later, the government is going to have to get into this game. The Canada Development Corporation, with two billion dollars to play around with, is expected to allocate some of its funds to providing seed money to young Canadian companies. The Ontario government is experimenting with the same approach, through the Ontario Development Corporation.

It’s doubtful, though, that a large financial bureaucracy will be able to make the kind of shrewd, intuitive decisions that are routine in the private venture trade. Very few of the vc firms now operating in Canada have decision-making groups of more than six people. Also, it’s going to be hard to avoid political factors entering into the CDC’s decision-making process.

One solution, and one that’s been attempted with some success in the U.S. by the Small Business Administration, would be to have the CDC, in effect, subcontract its decision-making function to private venture firms. Once a private firm found a deal it liked, it could apply to CDC, which would match the private firm’s investment, dollar for dollar. This would instantly double the amount of money available for investment in young, high-risk ventures; and it would probably at least double the number of firms willing to go into the venturecapital business.

The CDC’s long-term objectives, presumably, are to stimulate employ-

ment and to promote Canadian control of the economy. There are a number of government programs that now make loans or grants for these purposes; the Department of Regional Economic Expansion, for one, advertises that it will make grants of up to $30,000 to industries in slow-growth areas for each new job created. The creative use of risk capital can often do the same job for much less money. Ben Webster estimates that the $3.6 million his firm has invested in new Canadian ventures in the past three years has helped create 644 new jobs. If Ottawa matched him dollar for dollar, he says, each job created would cost only $1,000 of taxpayers’ money.

Some kind of government stimulus is assuredly needed, because there are two things wrong with the venturecapital business at the moment: there isn’t enough capital, and it isn’t venturesome enough.

Even Polypump, which is often cited as a classic venture-capital success story, had to resort to a roundabout strategy to get the money it needed to develop the invention.

Tom Joy, the entrepreneur who has stage-managed the whole thing, used the glamour of Polypump’s “story” to interest stock market investors in the company. (This was in 1968, back in that misty and fondly remembered era when small investors were willing to put money into anything that sounded new.) He got a Bay Street brokerage house, Mills, Spence and Co. Limited, to sell shares in the company to a select group of private investors. One of them was Charterhouse, the venture-capital firm. Later, Polypump made a public offering of further shares at five dollars each, thus putting two million dollars in the kitty.

Instead of using this money just to develop the invention, Joy bought a string of moribund companies that make plastic cups and containers and turned them into a tightly-knit organization which is now the biggest manufacturer of rigid containers in the country.

It was the cash flow from this functioning business that Joy used to develop Harold Humphrey’s invention. And it's still being developed; at the moment Polypump is all excited about a new way of manufacturing the pump as an integral part of the container, instead of a thing that screws on top. The new device is being market tested in several areas of the U.S. The day may come when everything in the home will be squirted through Harold Humphrey’s earlymorning inspiration. But that day hasn’t arrived yet. ■