How Crazy Market Conditions Lead to Company Failures

The car market is crazy right now. With supply chain issues and a burst of new demand, both new and used cars are selling for record prices. It’s so wild, that a dealer at Downtown Toyota of Oakland, in California, has marked up a $50,000 Toyota Rav4 to $96,422. I own a Toyota Rav4 🚗 It has me thinking - What’s my hottest investment right now?

My car is worth $100,000…and it’s a Toyota Rav4. 

The car market is crazy right now. With supply chain issues and a burst of new demand, both new and used cars are selling for record prices. 

It’s so wild, that a dealer at Downtown Toyota of Oakland, in California, has marked up a $50,000 Toyota Rav4 to $96,422.

I own a Toyota Rav4 🚗…

It has me thinking - What’s my hottest investment right now?


Public Equities?....Nah

My used 2017 Toyota Rav4…Hell Yes 🚀

In all seriousness, when the market looks like this, there’s a big problem. 

The same thing is happening in the private investment market right now. Startups are raising at record valuations, which on paper is great, but it comes with enormous risk. 

If a startup raises at an exceedingly high valuation, it is expected to grow to support that valuation, despite market changes. 

If a startups growth slows, or the funding market changes, it can lead to catastrophic events for the company, most notably, down rounds! 

Today we’re going to explore down rounds - What are they? How do they happen? And what happens when it all comes crashing back down 🎡? 

Let’s dig in! 

Today we’ll explore: 

  1. BuzzFeed’s Journey 🚀 : How BuzzFeed achieved mass popularity through viral content
  2. Down rounds 📉 : The disaster that leads to dilution and the devaluation of companies 

BuzzFeed’s Humble Beginnings

Jonah Peretti and his custom “Sweatshop” Shoe

In 2001, MIT student Jonah Peretti’s customized shoe order was rejected by Nike. Jonah sent a snapshot of his back-and-forth correspondence with Nike to friends. 

It went viral 🔥

Unbeknownst to him, his content was eventually viewed by millions of people.

In 2006, Jonah Peretti started a side project creating viral content called BuzzFeed. BuzzFeed was originally part of the Huffington Post network. Its rapid growth pushed Peretti to focus on the company full-time.

BuzzFeed’s Meteoric Rise 🚀

BuzzFeed content had the virality factor.

  • The content was easily shareable with friends and family. Topics included animals, sports, pop culture, fashion, and more. It is distributed across various channels 📱. 
  • BuzzFeed incorporated the full range of modern-day media. Content types included written content, videos, audio. The infamous interactive quizzes and memorable memes appealed to users 👀. 
  • From the start, BuzzFeed used data science to forecast the stories that would circulate. At the same time, the product and design teams collaborated to improve the website user experience 📈.
  • BuzzFeed took advantage of early major technology movements, which paid off. It published content on Snapchat and Facebook. This allowed them to experiment and grow an audience 🚀.

By 2008, BuzzFeed had garnered millions of monthly visitors. Users were obsessed with the clickbait-loving viral content. 

The business model of BuzzFeed is based on multiple streams of income. It makes money using affiliate marketing, display ads, podcast advertising, and native advertising. BuzzFeed also distributes its own physical and digital products.

BuzzFeed’s Hiccups

BuzzFeed was once one of the hottest media startups.

What went wrong? Platform risk.

Viewers increasingly found BuzzFeed through articles posted on Facebook. BuzzFeed built its business model around Facebook Instant Articles, which depended on Facebook Audience Network. 

Less traffic came from users viewing the native BuzzFeed site. This meant that Facebook received most of the ad revenue. 

BuzzFeed was left with only pennies 😔.

At the same time, BuzzFeed’s most beloved stars - Candace Lowry, Michelle Khare, the Try Guys - felt a lack of motivation. They were frustrated and unmotivated with the creative restrictions and the inability to create their own video channels.

So they quit.

Thus, BuzzFeed lost relevancy with users. 

This explains why BuzzFeed missed the 2015 revenue target in 2016. BuzzFeed then had a 2016 Series G “flat” financing round and later performed multiple rounds of layoffs. 

Source: What is a down round and how to avoid one | Toptal 

BuzzFeed was too dependent on Facebook’s article feature.

Users discovered BuzzFeed through Facebook. This dynamic has long been established. When users land on sites like Google and Facebook that collect content, these conglomerates have full control.

This was a huge red flag 🚩.

Flash forward to 2019, Peretti explained the newest layoff round. 

In an internal memo, he stated “unfortunately, revenue growth by itself isn’t enough to be successful in the long run. The restructuring will reduce our costs and improve our operating model so we can control our own destiny, without ever needing to raise funding again.”

Basically, BuzzFeed had to detach itself from its funding path to avoid a down round. 

Today, BuzzFeed has more than 1,800 employees and 14 offices. Each month, 200 million unique users visit the BuzzFeed site.

The Mechanics of Down Rounds 

Down rounds happen for a few reasons:

  1. Initial over-valuation by investors ❤️
  2. Slowed company growth 📉
  3. Worsening competitive environment 🥊

New competitors limit market share for existing players. This can weigh heavily on valuation.

  1. Failure to satisfy investors’ earnings targets 💰

Let’s say that a company does not achieve the obligatory benchmarks. Milestones include service or product development, revenue creation, and profitability milestones. Investors’ growth forecasts will have to be shifted downwards. Along with that, the company’s valuation will also be lowered

  1. Constricting of basic funding conditions 🧮

This is an uncontrollable factor. Lower investor interest for private company equity will reduce valuations for all.

Down Round Example:

Source: What is a down round and how to avoid one | Toptal 

A down round happens when a company is devalued. This takes place when the pre-money valuation of a subsequent round is lower than the post-money valuation of the previous round. 

Down Rounds are tragic. 

They indicate that something went wrong--either with planning or in the business.

What are the implications of Down Rounds?

Down rounds catalyze anti-dilution protection. 

  • Usually, investors own a different class of shares from founders and employees. The main difference between regular shares is anti-dilution protection. 
  • This means that when shares are sold at a lower price than the investor had initially paid for them, they’ll be diluted less than the other entities. But this is typically done at the cost of the founders’ shareholding. 
  • For existing investors, down rounds dilute ownership and lower the value of your investment.
  • New and potential investors usually want compromises. They might ask existing investors to reduce their preferences or seek better terms for themselves. They might force strong suggestions for management changes.

To avoid the risk of a down round in the future: ensure the startup raises at a reasonable valuation today.

When evaluating startups, ask yourself: Can the startup attain profitability with the current capital? 

  • ✅ If the answer is yes, you don’t have to worry about a down round as an investor. This means that the valuation is maximized. The startup likely won’t need to raise again. 
  • ⛔ If the answer is no and the company needs more capital, as many do, tread carefully. Analyze the point at which they’ll likely need to raise again. 

Today’s Recap:

There’s much to learn from BuzzFeed. Here are a few callouts:

  • Avoid investing in companies raising at crazy valuations.
  • Look out for red flags that signal a potential down round. 
  • This includes low company growth, increasing new competitors, unmet earnings targets, and deteriorating economic conditions.