Tag Archives: Fidelity Investments

Zenefits’ Troubles Don’t Let Brokers Off

Zenefits is in trouble. Serious, existential trouble. Some community-based benefit brokers are watching the calamity at Zenefits unfold with a mixture of schadenfreude and relief. Given the scorn and ridicule Zenefits heaped on these brokers, taking pleasure from its misfortune is hard to resist. Feeling relief, however, misreads the situation and is dangerous to one’s career.

Zenefits’ Troubles 

Zenefits could go out of business, and several of its employees could be jailed as a result of the business practices reported by William Alden of BuzzFeed News and other journalists. While unlikely, this is a possibility because:

  • Zenefits created software enabling some California employees to lie to regulators concerning the time they spent on pre-licensing training. California law requires those applying for an insurance license to devote 52 hours to this curriculum. Zenefits employees signed a form, under penalty of perjury, that they had done so. Some may not have. Perjury is a felony in California, and conviction can result in as much as four years’ imprisonment. If Zenefits cheated in qualifying agents to sell in California, other regulators are no doubt looking into whether the company did this in their states, too.
  • If found guilty of violating consumer protection laws, state regulators could revoke Zenefits’ insurance licenses. Without the license, Zenefits could no longer sell new policies, and insurance companies would likely terminate, for cause, their Zenefits contracts. The insurers would then stop paying commissions to Zenefits even on previously sold policies. License revocation in one state could result in losing their licenses elsewhere. A cascade across the country of revoked licenses and terminated contracts could cost Zenefits tens of millions of dollars.
  • If Zenefits loses its licenses, commissions on current policies and ability to sell new ones, then some of its more recent investors may demand their money back. (Let me be clear: I am not accusing anyone at Zenefits of committing fraud or any other crimes. What follows is totally and only hypothetical and speculative.) In May 2015, Zenefits raised $500 million in a capital round led by Fidelity Investments and private equity firm TPG. If Zenefits management knowingly hid legal problems from them (and I’m not accusing anyone of doing so), then Fidelity and TPG could claim inducement by fraud, seek to rescind their contract and demand Zenefits return their investment. I’m not saying this happened or that investors were misled in any way. Nonetheless, I’d be surprised if Fidelity and TPG lawyers are not also speculating about this.

Zenefits’ worst case scenario, then, is that the company pays millions of dollars in fines, loses many millions more in revenue, sees employees jailed, can no longer sell insurance, irreparably damages its brand and must repay some investors.

Maintain Perspective

That’s a pretty scary worst-case scenario. Based on we know today, it is also highly unlikely to happen. No regulator has found Zenefits in violation of anything. Regulators are unlikely to impose the most severe penalties available to them if their investigations do not reveal consumer harm. The steps David Sacks, Zenefits’ new CEO, is taking will likely mitigate any penalties imposed on the company. Several employees, including former CEO Parker Conrad and sales VP Sam Blond have already left the company, and more may follow. Zenefits now has its first compliance officer. Mr. Sacks also seeks to change Zenefits values.

I’m skeptical, however, that Zenefits can or will quickly change its culture and core values. I respect Mr. Sacks’ intentions, experience and abilities. He deserves a chance to make his turnaround work. Yet changing a company’s culture usually takes considerable time, and Zenefits’ culture is deeply infused with the Silicon Valley ethos of speed, innovation, disruption and risk taking. To transform Zenefits requires a different world view. Yet in announcing Mr. Parker’s resignation, the company added three board members—all current investors with no domain expertise.

In fact, no current Zenefits board members or executives listed on the site appear to have any experience in running a human resources firm, payroll company or insurance agency—the services Zenefits delivers. What they share is deep experience in well-known tech companies. Zenefits may be a technology company, but that tech is supposed to accomplish something. Only in places like Silicon Valley would lack at the top of the company of this domain expertise be celebrated. Zenefits seems to exist in a Valley-sized bubble, and it’s tough to change what’s in a bubble from the inside.

The Real Lesson of Zenefits

Yet Zenefits is likely to survive. It reportedly has enough cash on hand and no need to seek more. The most probable outcome from the various investigations is that, absent findings of intentional and substantial criminal malfeasance, Zenefits will keep its licenses, carriers will continue paying commissions and investors will keep their money in the company.

We don’t yet know how Zenefits’ saga plays out. What we do know are some lessons this scandal teaches, especially to brokers:

Lesson one: Consumer protection laws matter. Violate them, and there’s a huge price to pay; as there should be.

Lesson two: Arrogance is unbecoming and unhealthy. Zenefits is a company whose leaders proclaimed that community-based brokers were dead meat, promised to drink brokers’ milkshakes, claimed brokers barely knew how to use email, described their profession as a dead beast lying in the desert and, well, you get the idea. The danger is that arrogance of this magnitude easily morphs into hubris. Zenefits’ hubris was the apparent belief that it could ignore rules if they get in the way of achieving the growth promised investors.

Lesson three: Even broken companies get some things right. Zenefits identified a latent customer demand. Clients want more from brokers than help with benefit plans. They want to focus on their businesses and not be distracted by HR and benefit administration. Zenefits success makes clear there’s a disadvantage to only selling and servicing insurance plans. Clients want more from their brokers. Even in the unlikely event Zenefits goes away, this client need will not.

Lesson four: There’s more where they came from. Zenefits’ demise would not mean the end of well-funded tech companies challenging community-based benefit brokers. If Zenefits falls to the wayside, others are ready to take its place using the same tactic of giving away software to employers in exchange for being named the employers’ broker of record on benefit policies.

Seeing a bully humbled is always fun, and there’s no harm in brokers enjoying the sight of Zenefits in disarray. Those brokers who believe Zenefits predicament means they no longer need to step up the services and value they deliver their clients, however, are making a costly mistake.

Zenefits’ Problems Are Real but Not Fatal

Zenefits has hit a rough patch. Given the insults the company’s CEO, Parker Conrad, has heaped on brokers, the schadenfreude percolating through the broker community is understandable. Yet declarations of Zenefits’ demise are premature.

Zenefits raised $500 million in May at a valuation of $4.5 billion. At the time, Conrad claimed the company was “on track to hit annual recurring revenue of $100 million by January 2016.” That was then.

Now, the Wall Street Journal is reporting that Zenefits is falling short of its earlier revenue projection. According to the Journal and Business Insider, through August Zenefits’ revenue came in closer to $45 million, and the $100 million annual revenue figure is likely out of reach. In response, Zenefits is reportedly instituting a hiring freeze and imposing pay cuts. The latter step is cited as a reason at least eight executives left Zenefits.

In light of the news, in August or September Fidelity Investments reduced the value of its Zenefits investment by 48%, estimating the company was now worth about $2.34 billion. That’s a seismic event: In May, Fidelity thought Zenefits was worth $4.5 billion. Just five months, later Fidelity thinks this was being a tad optimistic… if by “a tad” we mean “$2.16 billion.”

In an interview with Business Insider, Conrad admits Zenefits is unlikely to keep his promise of $100 million of recurring revenue this year. However, he claims Zenefits continues to hire (although not as fast as in the past) and is happy with its revenue growth — “more than $80 million of revenue under contract” (which, it should be noted, is not the same as saying “we’ve taken in $80 million so far this year,” but maybe that’s what he meant). Conrad also asserts that Zenefits is getting “closer and closer” to being cash flow-positive, although he doesn’t expect it to get there until 2017 at the earliest.

Missing his $100 million commitment and having to address the subsequent fallout is no doubt adding to Conrad’s stress levels. Because Conrad went out of his way to insult community-based benefit brokers on Zenefits’ way up, the joy that brokers are taking in his discomfort now is to be expected — and is arguably earned.

Should brokers assume Zenefits is no longer a threat, however? No. It is still bringing in tens of millions of dollars in revenue. According to what I’ve heard, only about 60% of this revenue comes from commissions. An ever-increasing portion of Zenefits’ revenue flows from fees earned by selling third-party services or its own non-commission services. Zenefits launched its own payroll service, so its non-commission revenue will continue to climb. Zenefits may not be valued at $4.5 billion any more, but it is still valued at more than $2 billion. And while no CEO is happy when a serious investor marks down his company by nearly 50%, Conrad says Zenefits won’t be out raising money anytime soon. As a practical matter, the impact of the devaluation on Zenefits is minimal.

In short, Zenefits is sticking around.

But I predict Zenefits is in for a rough time. Direct competitors like Namely and Gusto are raising money and stepping up. Community-based brokers are increasingly leveraging technology. (Full disclosure: Im co-founder of the company launching NextAgency, software that will help brokers level the playing field against Zenefits, so I’m delighted to point out this trend.)

While new initiatives like the payroll offering will create revenue streams for Zenefits, they also carry significant risk. Current partners will view Zenefits as a potential competitor. Management will be distracted from the company’s core business. New skills and expertise need to be acquired. There’s something to be said for focus, and Zenefits may be losing its.

Schadenfreude is German for deriving pleasure from the misfortunes of others. That Zenefits’ current problems generate this impulse in the brokers they’ve insulted should surprise no one. That Zenefits will face challenges, problems and setbacks moving forward is inevitable. That community-based brokers should continue to take the threat Zenefits represents seriously is wise.