Learning From the Fall of Zenefits

Source: Techcrunch

Zenefits had it all.

After graduating from Y Combinator and launching in February 2013, Zenefits — an HR software company with attached services such as health insurance — grew faster than imaginable right out of the gate.

Fast forward to May 2015, just two short years later, and Zenefits closed a $500 million round of funding, boosting its market valuation to a whopping $4.5 billion. Financiers included Andreessen Horowitz, Fidelity, Khosla, IVP, and many others. The company was a Silicon Valley darling and exemplified the type of hyper-accelerated growth that startups should strive for. VCs that missed out of prior rounds tried to fight their way into similar companies.

Unfortunately, when something sounds too good to be true, it usually is.

Earlier this year, news emerged that fast-growing Zenefits was cutting corners — a lot of them. Members of its sales team were selling insurance in at least seven states even though they were unlicensed to do so. In order to gain licenses in California, workers need to spend 52 hours in training. Former CEO Parker Conrad created a macro that allowed employees to stay logged in at all times in order to speed through the training and sidestep the formal licensing process altogether.

The very creation of the macros begs the question: Is the reason why many startups are so successful because they are able to skirt the law? When is the Silicon Valley motto “ask for forgiveness, not permission” taken too far?

Conrad was forced to resign from Zenefits due to these compliance issues and was replaced by David Sacks. As that story broke, reporters began digging deeper into the company and the frat house culture it had created.

Source: Buzzfeed

How Zenefits Symbolizes What’s Wrong With Silicon Valley

I first heard Conrad speak in March 2015 at SaaStr, a conference focused on Software-as-a-Service (SaaS) companies, which is the vertical Zenefits falls under.

Wait, What is SaaS?

For non-tech geeks, SaaS basically means a business that sells software month-to-month so companies (or people) don’t need to keep it in-house — this can range from Human Resources or IT to services like Dropbox (keep files in the cloud instead of your PC).

Now this sort of model is essentially a sales-driven business. Sales reps bring in customers and are compensated based on reaching a quota, which is often an amount of revenue they are required to bring in every month, with a bonus for beating it. This makes a SaaS business model fairly predictable — given a certain number of sales reps and the required revenue quota, companies can forecast sales quite easily.

So What About Zenefits?

Zenefits launched in May 2013 and by the beginning of 2014, they were at a $1 million revenue run rate. VCs quickly realized that Zenefits was one of those once-in-a-lifetime, right-place-at-the-right-time companies. Zenefits story was so compelling that David Sacks, a member of the PayPal Mafia, both invested and joined the company as COO in December 2014.

Conrad recounted that the original plan for 2014 was to go from 2 sales reps to 20 sales reps, and grow from $1 million of revenue to $10 million. On hearing this, Andreessen Horowitz, their Series A lead, told him:

“Why are you guys so f***ing bush league? Why 20 reps? You guys got to get your heads out of your a**es and start focusing on going big here.”

$10 million and 20 reps was not enough; the company should target $20 million of revenue and hire 100 sales reps to fast-track revenue growth.

At first, Conrad thought it was crazy. However, the what-if’s began — he brought the question back to his team and, as a “thought experiment”, asked if they were to shoot for $20 million, how many people would each department need to hire and what would the company need to change?

The team brought these numbers back to Conrad, where he then took them and decided it was no longer an experiment. As a SaaS company, Conrad knew exactly how many salespeople the company needed to hit revenue targets and the structure the company needed to support them. They began hiring.

Zenefits started the year with 50 employees; they had 600 year-end. They began the year with 1 salesperson; they had 95 by year-end.

The company was hiring 100 people per month. The sheer amount of human capital needed meant that Zenefits could not get enough people through their offices and therefore opened offices in places like Phoenix. This was where one of many alarm bells sounded for me — when a company is scrambling to fill bodies, that often means quality is thrown out in favor of quantity.

My misgivings with the company were furthered when I heard ADP and Zenefits publicly brawled it out last year. To be more precise, I heard the story before it was public, when I sat stunned in the front seat of an Uber pool while two Zenefits employees I didn’t know loudly complained about the lawsuit and certain internal processes at the company. The icing on the cake occurred when one employee finished the conversation with:

“I’m under NDA, so I probably shouldn’t even be saying any of this.”

When a company can’t even properly manage its own employees, it’s a very telling sign of the internal controls and processes put in place.

Zenefits is the perfect example of the side of Silicon Valley which embraces the mantra “growth at all costs.” They didn’t care if they hired sub par employees, and they didn’t care that they were skirting laws to achieve growth.

Source: Buzzfeed

With that in mind, here are five takeaways from the Zenefits saga:

1. Culture Starts at the Top

Companies almost always reflect the values of their CEOs. If a company is willing to do everything they can to win at all costs, they might be able to get away with it. But 9 times out of 10, they’ll get caught, and they’ll fall hard.

If you’re investing, you should always get to know the CEO. Is this a company you want to support? Same for potential employees — make sure you’re a culture fit and that you want to work for a company that has the ethics of its CEO.

2. Don’t Buy Into the Hype

Silicon Valley loved the Zenefits story. It had the perfect makings for drawing in media PR and potential employees: the underdog in a stale space that needed innovation, a reputation fueled by play-hard-party-harder culture, the fastest growth of any company ever, and well-known investors backing the company.

But in digging deeper, so many things raised red flags. When something sounds unbelievable, it probably is. Be careful with your investments and business decisions.

3. Investors Are Taking a Step Back

Zenefits’ collapse doesn’t mean the end for Silicon Valley. Many other factors over the past few months have contributed to a slower funding environment for certain company stages. Zenefits’ fall caused a flurry of media excitement heralding the end of easy money. However, hopefully this just means that investors are stepping back and being a bit more careful with their investments so that they fund the right companies.

4. Zenefits Can Still Rebound

This isn’t necessarily the end for Zenefits, either. New CEO David Sacks is righting the ship and the news coming out of the company has been good so far. More importantly, Zenefits does have a strong product foundation that fulfills a real need in the market.

If they want to rebound, though, they’ll need to address and learn from their past mistakes, and make sure they follow the rules more carefully. Luckily, people love a comeback story just as much as a fall from grace.

5. People Are Asking More Questions

Zenefits is being used as an example to show that the tech bubble has popped. I don’t think it has yet, but it does mean that people are asking more questions, which is always good for a healthy market.

Whether or not Zenefits successfully rebounds, let its misfortune be a learning experience: Ask questions, be careful with investments, and make sure you fully understand a company’s ethics before you buy in.

If you like what I’ve written, visit my blog or follow me on Twitter @L4yuan

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Cofounder @ Moddio | Building Games in Web3 | eSports & general tech enthusiast

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Linda Yuan

Cofounder @ Moddio | Building Games in Web3 | eSports & general tech enthusiast