Health IT, Startups

With devaluation, Zenefits tries to bounce back from scandal

In the revaluation, the onetime Silicon Valley darling allowed large investors to increase their ownership stake in the company in the wake of a scandal.

David Sacks

Zenefits, the online human resources and benefits company, downsized its stock valuation as its executives forged a deal this week to avoid investor lawsuits.

In the revaluation, the onetime Silicon Valley darling allowed large investors to increase their ownership stake in the company in the wake of a scandal.

In a Thursday letter to employees, Zenefits CEO David Sacks wrote that San Francisco-based Zenefits, once called the fastest-growing startup ever, would revalue itself at $2 billion, down more than half from an earlier valuation this year of $4.5 billion. A series of regulatory investigations compelled Sacks — an angel investor and the company’s former chief operating officer — to permit major investors like TPG Capital, Fidelity Investments, Insight Venture Partners and Andreessen Horowitz to increase their ownership stake in the company from 11 percent to 25 percent in exchange for dropping their right to sue over the stock devaluation.

The investor agreement has already been approved by those investors and a few others. “We will be offering it to all our investors shortly.” Sacks said.

Sacks wrote that “all of our employees and investors will be aligned, committed, and focused on what’s next, which is the launch of Z2 (the next version of Zenefits) in October.”

Holders of common shares of Zenefits stock, including employees, will see their shares diluted by 20 percent, but will receive a stock grant up to one-quarter of their current shares to compensate for the dilution.

Zenefits distributes its cloud-based software platform of HR services free to companies to organize and manage human resources functions, but makes its money as a middleman in brokering health insurance and other benefit packages.

Sacks has had his hands full since February.

The company, which once employed 1,500, has laid off 350 since co-founder and former CEO Parker Conrad resigned amid allegations that he violated state insurance laws in allowing unlicensed brokers to sell health insurance in at least seven states. Regulators in California and Washington state launched investigations.

In his email to employees, Sacks said the unnamed “previous CEO/founder” had written a software program — known as “Macro” — that was widely disseminated in the company to circumvent a state licensing requirement.

“Since that time, we have been working to remediate the situation and reset our relationships with all of our key stakeholders. These include regulators, industry partners, customers, employees and investors,” he wrote.

Sacks said Zenefits self-reported the Macro issue, brought its licensing into compliance, changed leadership and governance and worked to transform the culture to prioritize compliance.

Zenefits also offered voluntary separation packages to employees. “I’m proud that roughly 90 percent of employees chose to stay and re-commit to the new Zenefits,” he said.

The company’s big institutional investors approved the deal.

A spokeswoman for Andreessen Horowitz said the Zenefits revaluation is unusual. “This is a unique situation, we’ve never seen it before and we don’t expect to see it again. We continue to believe in our investment in Zenefits; the company serves 20,000 businesses today and is one of the best examples of product-market fit we’ve ever seen,” she said.

Andreessen Horowitz Co-founder and General Partner Marc Andreessen tweeted that his firm stands behind Zenefits 100 percent. “For clarity, we did not threaten to sue, nor did we have any intention of suing. To resolve the situation, we signed up for the agreement and took a haircut in our ownership in the process,” he said.

Fidelity Investments spokeswoman Nicole Goodenow said that as a general practice, the company does not comment on companies in which it invests. But she did elaborate:

That being said, when it comes to our investments in private companies, we have a rigorous and thorough valuation process for mutual fund holdings, overseen by our Fair Value Committee. It’s important to note that pre-IPO investments, while important, are very small positions in the relatively few Fidelity funds that make such investments. For example, YourPeople (a.k.a. Zenefits) represented just 0.02 percent of the fund’s total asset under management as of the most recently disclosed monthly holdings report (May 31, 2016).

 

 

Skip Fleshman, a partner with the Palo Alto, Calif.-based venture capital firm, Asset Management Ventures, characterized the Zenefits revaluation as “very rare. But in this case, it was because the founder, Conrad, was a little naughty and TPG and Fidelity likely invested with poor or inaccurate information.”

Fleshman said the revaluation “seems pretty smart in that it may avoid Theranos-esque lawsuits and make the last investors happy. It was likely overvalued anyway, but many unicorns are. It also lowers options prices and increases the option pool. This will help employee retention.”

Fleshman predicted the revaluation likely will only impact companies that failed to disclose vital information or misled investors during financing and are worried about lawsuits. He said the company’s brand “was already pretty tarnished, so this move may help.”

Photo: LinkedIn user David Sacks