How High-Flying Zenefits Fell To Earth

Parker Conrad, left, the Zenefits co-founder and former CEO.

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The instructions that circulated through the offices of Zenefits, the fast-growing human resources startup, looked innocent enough. In six steps, new recruits were told how to download and run a simple piece of software that would speed up the process of becoming a licensed health insurance broker in California — a mandatory credential for their work selling insurance to small businesses.

But there was something about this program that seemed a little too sensitive to put into writing.

"Let's discuss what's below when we chat on the phone," one manager wrote in a 2014 email, in reference to the instructions.

Left unsaid was that use of the program, known as a macro, would allow a sales rep to shortchange a requirement under California law. By keeping them logged into an online course, even while they were sleeping or doing something else, the macro enabled Zenefits employees to spend less than the legally mandated 52 hours in pre-licensing training. Newly hired sales reps, who often lacked an insurance background, used the macro as early as 2013, the year Zenefits launched, and as recently as last year, former employees say.

This institutionalized cheating finally caught up with the San Francisco-based Zenefits last week, when Parker Conrad, the 35-year-old co-founder and CEO, was forced to resign over what the company described as widespread failures of regulatory compliance. The shakeup, announced in a blistering memo from David Sacks, the executive who took over as CEO, stunned the tech establishment, which had supported Zenefits' rise. It showed how Silicon Valley's cult of hypergrowth — of which Zenefits was a leading exemplar, having achieved a $4.5 billion valuation shortly after its second birthday — can create unexpected and even disastrous problems.

The macro, while leading to Conrad's ouster, according to two people familiar with the matter, was only one in a list of ways Zenefits sought to speed up its ascent, many of which have not previously been revealed. Sales reps threatened to charge a phony implementation fee as a lever to close deals. Managers urged new recruits to try to score not much higher than the minimum passing grade of 60% on the California broker license exam. Pervading the offices in San Francisco and Arizona, meanwhile, was an almost fraternity-like atmosphere, with whiskey shots, kegs, and bottles of champagne.

"We must admit that the problem goes much deeper than just process," Sacks told employees in his memo. "Our culture and tone have been inappropriate for a highly regulated company."

In a statement emailed to BuzzFeed News, Kenneth Baer, a Zenefits spokesman, added, "As Zenefits' new CEO has made clear, it is time to turn the page at Zenefits and embrace a new set of corporate values and culture. Zenefits is now focused on developing business practices that will ensure compliance with all regulatory requirements, and making certain that the company operates with integrity as its number-one value."

Sam Blond, left, the original head of sales, with Conrad. "Why are you guys so fucking bush league?" an investor told Conrad, he recalled.

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Investors were salivating over Zenefits from the start. The influential venture capital firm Andreessen Horowitz invested in early 2014, describing Zenefits as among the fastest-growing business software startups it had ever seen and dispatching one of its partners, Lars Dalgaard, to nurture the young company. But Dalgaard, who is best known for founding the software company SuccessFactors and selling it to SAP, delivered a surprising message at first: For all Zenefits' fast growth, it still wasn't growing fast enough.

"Why are you guys so fucking bush league?" Dalgaard said, according to Conrad, who recounted the conversation while on stage at a software conference in February 2015. While Conrad had planned to hire 20 sales reps by the end of 2014, Dalgaard said the target should be five times that. "You guys gotta get your heads out of your asses, start focusing on going big here," Dalgaard said, according to Conrad.

Conrad and Dalgaard would later clash, with the investor pushing the CEO to stop hiring altogether in the summer of 2015, a person familiar with the matter said. Dalgaard also urged Conrad to run audits, conduct an employee survey, hire more top executives, and expand the board -- all things that Conrad resisted, this person said. A spokesperson for Andreessen Horowitz declined to comment. Conrad did not respond to multiple requests for comment.

Going big meant closing deals, and Zenefits found its closer in Sam Blond, a young sales executive who had risen through the ranks at a startup called EchoSign. Blond hadn't sold insurance, but he understood aspects of selling that had eluded Conrad. Zenefits gives away free software to help small businesses manage their employee benefits, and it makes its money by collecting commissions from health insurance companies after selling those businesses on insurance. It never actually collects meaningful payments from the customer.

Blond, who joined Zenefits in late 2013, pointed out that it's not easy to sell a free product, according to Conrad. You can't offer discounts, and rebates aren't allowed in insurance. The solution? Sales reps warned customers that an implementation fee would soon be charged, pressuring them to sign up for insurance before it kicked in, according to former sales reps and internal emails. But the supposed fee, which made more than a few sales reps uneasy, was purely tactical and would always be "waived" or pushed forward at the last minute, the former reps said.

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Blond, 30, with nicknames like Agent Blond and 007, contributed to Zenefits' culture in other ways as well. His partying sometimes spilled over into his work life, with company dinners and other events getting unusually rowdy, former employees say. Once, Blond said, he wrestled with Conrad on the floor of Bobo's steakhouse in San Francisco. Another time, according to text messages obtained by BuzzFeed News, Blond pitched Zenefits to a cocktail waitress during a wild night at his apartment.

"I dunno u kept tellin me bout this Zenefit thing and made me sign up for it that night…," she texted him later, saying she had received a welcome email from the company. "Then I remembered you telling me some Parker guy was gonna show me a demo."

Reached by phone this week, Blond said, "I have no recollection of anything even close to the sort." He called the episode with the waitress "a lot of hearsay" and later added, "Over the course of what we've been through, it's kind of been a roller coaster. My guess is that stuff spreads around pretty easily."

Blond left Zenefits last week. He was succeeded by Jeff Hazard, a sales manager whom Sacks promoted to head of sales.

In a sign that Agent Blond-style partying will no longer fly at Zenefits, Sacks this week banned alcohol from the office -- a step that many in tech would view as crossing a red line. "As part of our commitment to making this a great place to work, we will find other ways for employees to socialize and have fun," Sacks said in a staff memo on Wednesday.

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While Zenefits was hardly the only tech startup to pursue superfast growth, it did so in a highly regulated industry, where flouting the rules can carry serious legal consequences. This reality, however, often seemed not to register at a company whose motto was "ready, fire, aim."

Health insurance brokers in California, for example, have to score at least a 60% on a state exam to get their license. But a running joke among the Zenefits sales staff was that anyone who scored significantly above 60% was a nerd who had studied too hard, former employees said. Even managers, including Hazard, the new head of sales, promoted the idea that a barely passing score was more than good enough, according to former employees.

"D for done," managers would say, giving a high five to those who scored close to 60%, according to two former employees.

The existence of the macro program, while surprising to many outsiders, is consistent with Zenefits' high-pressure sales culture, where, former employees say, almost nothing mattered as much as closing deals, and attitudes toward the rules were blasé at best. Conrad created the macro near the start of Zenefits' existence, according to two people close to the company, based on his belief that the required 52 hours was too long to spend in training.

Employees who used the macro to shortchange an online Kaplan course still had to click through the learning material and quizzes. But much like an online driver's ed course, the health insurance training was designed so that if you guessed wrong on a particular quiz, you could just click the right answer and move on, former employees said. Newly hired sales reps who used the macro were directed to certify, under penalty of perjury, that they had actually spent 52 hours doing the work, according to a lawyer for Sacks.

"It became apparent that maybe their brokers didn't know as much as they should," said John Arroyo, the founder and CEO of Arroyo Labs, a software development agency in Los Angeles that used Zenefits until recently.

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For a company born and raised in Silicon Valley, Zenefits' technology was frustratingly limited, former employees said. The software, delivered for free over the internet, is built around a central dashboard and lets small businesses onboard new employees, generate health insurance quotes, and manage 401(k) plans and other benefits. But while this system looked slick and did a fine job with small tasks, much of the important work on the backend was done manually, including sending crucial information to most health insurance carriers, according to former employees.

"The back office is really heavy in terms of bodies," one former Zenefits employee said. "It's really archaic. It just seems automatic to the customer."

A number of customers say they've had positive experiences with Zenefits. Indeed, for companies with relatively straightforward health care needs, Zenefits can feel like a dream. Mike Placido, the chief financial officer of SupplyFrame, a tech company in Pasadena, California, said he has had a "really seamless" experience with Zenefits, and that he appreciates how the software lets new employees do their own onboarding online.

But interviews with former Zenefits employees show that the backend process is heavily reliant on manual work by often inexperienced staff. With the exception of Anthem, which gets data from Zenefits electronically, most health insurance carriers and several payroll service providers, including ADP, have no automatic link to the Zenefits system, former employees said. To help customers with open enrollment, or to help them make changes to their payroll, former Zenefits employees said they entered customer information into Excel spreadsheets, which they emailed to insurance carriers or payroll providers.

This kind of work is standard practice in the insurance brokerage business, but it's notable for Zenefits, which purports to be an "automated" solution. The lack of true automation behind the scenes led to numerous problems, according to former employees. With one customer, Plated, a food delivery startup in New York, mistakes by Zenefits staff in entering payroll deduction information caused a string of erroneous paychecks to be issued, according to one former employee and an online comment by Plated co-founder Nick Taranto. Zenefits is "not connected well enough with payroll providers," Taranto wrote, "so we're having to cut lots of manual checks."

Breakdowns, often the result of a Zenefits employee's clumsiness, were common — sometimes causing employees of client companies to go for stretches of time without health insurance.

Arroyo, who runs the Los Angeles software agency, made Zenefits his company's health insurance broker in 2014. He experienced a string of minor problems at first, he said — annoyances like an inability by Zenefits reps to explain a mysterious charge on his insurance bill. Then, last fall, he was told he would have to submit to a random audit by his insurance carrier. He gave his information to Zenefits, trusting that it would make its way to the carrier.

"A week or two later, I got a letter saying I wasn't compliant, and our insurance had been canceled," he said. Zenefits, he said, "never gave me an answer of what happened. They just said, 'Oh, it must have gotten lost somewhere.'" Arroyo dropped Zenefits in December.

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The first public indication that something was amiss at Zenefits came last summer, when BuzzFeed News reported that customers were complaining of software glitches and seemingly careless errors. Then, in an article last fall, BuzzFeed News revealed that Zenefits had repeatedly failed to enforce legal requirements that anyone selling a health insurance policy have an appropriate state license. BuzzFeed News reported that Zenefits was under investigation by insurance regulators in Washington state, where, according to a third BuzzFeed News article, 83% of the insurance policies sold or serviced by the company through August 2015 were peddled by employees without necessary state licenses.

At the same time, Zenefits was falling short of its ambitious financial targets. The company said it generated $20 million in annually recurring revenue in 2014 and aimed to record $100 million for 2015. But the 2015 number came in at just above $60 million, according to a person familiar with the matter. It became clear in 2015 that sales reps weren't being as productive as when the company was smaller, a worrisome sign. As of the end of September, the mutual fund giant Fidelity, which bought Zenefits shares in May, marked down the value of its stake by 48%. Zenefits started to curb certain expenses after missing sales targets, according to a Wall Street Journal article in November.

Zenefits opened an internal review last fall that produced evidence of the macro, according to people familiar with the matter. The company then hired the auditing firm Cooley to investigate further, one person said. In early February, at an emergency board meeting, Conrad was ousted, and Sacks, who is well known in tech circles for his previous work at PayPal and Yammer, was installed in his place.

Soon after, the California insurance commissioner announced that he was investigating whether Zenefits complied with laws and regulations in the state, its biggest market. The investigation covers the macro, as well as the question of whether sales reps were properly licensed, according to someone briefed on the matter.

This was a striking turnabout from the early days of Zenefits, when the company seemed like the greatest thing to hit Silicon Valley in a while. Investors loved the clever business model — giving away software for free, while still generating recurring revenue — and Conrad talked up the opportunities created by the Affordable Care Act.

"We're trying to replicate — or, actually, really, improve on — everything that a small group commercial insurance broker does for their clients," Conrad said in his application video to join the startup factory Y Combinator in early 2013, seeming more energetic and genuinely excited than he would in subsequent interviews. "The end goal here is that, as a company founder, or HR person, or what have you, you never have to think about this again. It just works, and you don't have to worry about it."

The Affordable Care Act, Conrad said in the video, would push down commissions for traditional insurance brokers, which relied on outdated technology. That, he said, would lead many brokers to stop working with small companies, creating a window for Zenefits. "One of the really interesting things here," Conrad said, "is that I could be launching this product at a time when the wheels are really coming off the cart for the existing solutions in the marketplace."

Before long, Zenefits became huge. Andreessen Horowitz, in a string of deals starting in early 2014, plowed so much money into Zenefits that for a while it was the firm's single largest investment. (Andreessen Horowitz is also an investor in BuzzFeed.) In May 2015, Zenefits raised $500 million at a $4.5 billion valuation -- one of the larger funding rounds in a year of big deals.

The company hired like mad, expanding from 15 employees at the start of 2014 to more than 600 in early 2015 -- and to around 1,600 later that year. "We're hiring about 100 a month, right now," Conrad said at the February 2015 conference. To house its growing sales force, the company opened two offices in the Phoenix, Arizona, area. At the jam-packed San Francisco headquarters, employees often shared desks.

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