Behind the Big Blow-Up and Controversial CEO Resignation at Zenefits

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Feb 11, 2016

For the past few years Zenefits, the startup HR technology company, has seemed invincible.

Investors everywhere were clamoring to be a part of what was supposed to be the biggest shakeup the health insurance industry had ever seen, apart from the Affordable Care Act. Just last May, the company was able to raise $500 million in funding at a whopping $4.5 billion valuation.

Zenefits, and its outspoken founder and CEO Parker Conrad, could seemingly do no wrong. Until now.

On Monday, Zenefits announced that Conrad had stepped down amidst allegations that the company had failed to comply with licensing requirements in at least seven states. In a company-wide email sent to Zenefits employees on Monday, the company’s COO, David Sacks, admitted that some of the decisions Zenefits has made were “just plain wrong,” and that this is why Conrad had resigned.

So what happened to derail Zenefits’ meteoric rise?

1. Debilitating growing pains

The human capital management (HCM) and human resources (HR) technology sector is no stranger to explosive growth. The real trick to success in these spaces is to have a plan in place to scale the company in a way that keeps pace with its dramatic rise to power and prevalence, something Zenefits has been unable to do.

In his email to Zenefits employees, Sacks owned up to the fact while Zenefits’ zealous attitude and focus on disrupting the insurance industry has helped propel the company in the past, the company has since “moved into a new phase of delivering at scale and needing to win the trust of customers, regulators, and other stakeholders.”

Zenefits is simply the latest example of a Silicon Valley startup seeking to upset traditional industries that grew faster than they could handle and cutting corners on compliance issues.

2. Too much emphasis on “software,” not enough on “service”

The service aspect of SaaS HR has been the downfall of many startups in this space. Businesses are entrusting HCM companies with arguably their most valuable resource: their employees.

While glitches in an eLearning technology platform may be mildly annoying, errors in employees’ paychecks or benefits can cause a real mutiny. And just one mistake when it comes to regulatory compliance can result in thousands of dollars in penalties, hundreds of thousands if it results in litigation.

Sacks admitted that many of Zenefits’ “internal processes, controls, and actions around compliance have been inadequate.” To have these kinds of compliance issues so early is a red flag within the HR outsourcing world.

Businesses choose to outsource their HR and administrative tasks (payroll, employee management, benefits administration, etc.), or engage an insurance broker, because they’re looking for an expert to provide them with the best possible solutions for their specific business needs. That’s the kind of service a business expects and deserves from a true HR partner.

3. Consistent losses isn’t as palatable as it once was

Like many of its predecessors in the enterprise software space, Zenefits initially spared no expense in its quest for market penetration.

At the beginning of 2015, the company confidently said that it had plans to burn through upwards of $100 million in the coming year on development and expanding its sales force, putting it firmly in the red. Consistently running in the red isn’t a new growth strategy (just look at Amazon), but it’s one that investors tend to lose patience with quickly.

Case in point: When Zenefits announced that it was not on target to meet its projected revenue goal of $100 million in revenue under contract last year, investors didn’t take the news lightly. Fidelity, one of the investors who bought into the company during the $4.5 billion valuation funding round, devalued its investment in Zenefits by 48 percent.

With the departure of CEO Conrad, the face of the company and driving force of its culture and tone (both of which Sacks called “inappropriate for a highly regulated company”), we will likely also see changes in the company’s growth and revenue plans and projections.

4. Just a new twist on an old game

From the beginning, Parker Conrad wanted people to see his company as revolutionary, visionary, disruptive, an outsider shaking up the traditionally closed-off world of insurance.

In reality, Zenefits is an insurance brokerage firm that entices clients by offering free HR software in exchange for being named the client’s broker of record, deals that were often inked by unlicensed reps.

Can Zenefits turn things around now under new leadership, or will the company be unable to dust off its tarnished reputation and earn back the trust of investors and consumers?

Only time will tell.