An Obvious Reason Why Some Startups Fail Shortly After Raising Tons Of Money

Some startups that fail initially look like they'll be giant successes. That's because they're able to drum up a ton of traffic or users very quickly, and early adoption can be a sign of a lasting product. It's also easiest to attract investors when a company is in hyper-growth mode.

Sometimes, those high traffic numbers are fleeting; they're uncontrollable gifts from a big source like Facebook that can be taken away. Other times, startups use tricks to inflate growth and attract investors, but they're usually unsustainable.

Publishers may buy traffic on Outbrain or StumbleUpon, for example. E-commerce companies may offer discounts that improve gross sales but cause them to operate at a loss. Others master Facebook's platform temporarily and get a flood of referrals.

When investors see big growth numbers, in their haste to get into the deal, they may forget to ask an important question:

What is causing the rocket ship growth, one source or many?

If the answer is one source, will there still be a business if it's suddenly taken away?

In 2012, a few startups grew incredibly quickly on the heels of Facebook's platform then raised tons of money. Those startups include Viddy, Socialcam and BranchOut (Fab and Path did also, but those businesses are still alive and working themselves out). Socialcam sold for $60 million at its peak. Viddy, a Socialcam competitor, went on to raise at a $350 million valuation. Branchout, a professional networking tool for Facebook, raised $25 million and had so much traffic that journalists were urging LinkedIn to buy it.

In each case, the rocket ship growth disappeared shortly after the fundraises.

Viddy's President, who is currently returning millions of dollars to investors because the idea didn't pan out, recently said: "Viddy raised a substantial amount of capital last year, during different market conditions."

AllThingsD's Mike Isaac explains those market conditions well. What Viddy's president really meant to say was it had one source of traffic, Facebook, and it disappeared.

"The market conditions Aguhob speaks of, I’d estimate, involve Facebook’s proclivity to giveth and taketh away. Viddy, along with other social video startups like Socialcam, rose to prominence last summer on the back of Facebook, when the social giant was delivering massive amounts of traffic to social video apps. Alas, after wide reports of Socialcam spamming users and general distaste for its viral reach, Facebook turned off the traffic funnel to social video apps, leaving companies like Viddy and Socialcam in the lurch.

"So essentially, Viddy raised tons of money when traffic was rich and scaling, hiring and expanding resources rapidly made sense. Now, in its post-Facebook-aided future, Viddy is downsizing — both in bank balance and in team size."

Branchout faced a similar situation. It climbed from 400,000 monthly active users in December 2011 to 8 million four months later, raised a ton of money, then lost two-thirds of those users by June 2012. Marini told Business Insider then that his team stopped making user acquisition on Facebook its priority, which is why the number nosedived.

In other words, once BranchOut stopped getting Facebook referrals, it found it had no business. Yesterday, TechCrunch wrote that BranchOut had failed and was pivoting.

The smartest investors see past hockey stick charts and examine why companies are growing quickly. They ask for access to Google Analytics, care about engagement, and don't get distracted by big, artificial numbers. Those who don't may think they're buying into something great, only to find themselves out of a lot of cash. And startups who rely on one source may find themselves suddenly out of business.