clock menu more-arrow no yes

Filed under:

Why Silicon Valley is reconsidering its growth formula

New, 29 comments

Lessons from the Zenefits disaster

Steve Jennings/Getty Images

Fast-growing business software startup Zenefits pushed out its co-founder and CEO Parker Conrad yesterday following a months-long controversy involving the selling of health insurance without proper state licenses. It’s a sour turn for the buzzy startup, which helps small businesses manage their human resource operations. It’s also an illustration of what happens when a tech company tries to bring Silicon Valley’s gospel of disruption to an ultra-regulated industry — one that everyday people don’t know or care much about, and certainly aren’t willing to rally behind.

Three-year-old Zenefits is one of the fastest growing cloud computing companies in history, earning it more than $600 million in venture funding and a $4.5 billion valuation on the promise of shaking up the confusing health insurance brokerage market. Yet Zenefits’ compliance missteps appear to be a byproduct of its meteoric growth. The sales milestones consistently touted by the company were achieved in part thanks to deals made with unlicensed brokers.

Zenefits offers a lesson for other high-flying would-be disruptors

At a time when startup valuations are being cut in half and fundraising is becoming increasingly difficult, Zenefits’ stumble offers a lesson for other high-flying would-be disruptors. Hoping companies can transform industries at nearly three times the speed of Salesforce, as Zenefits has described its growth, is a heavy expectation — and the industry is already adjusting to the new reality. Conrad’s departure is the most visible sign yet of the reckoning.

If you’ve never heard of Zenefits, that’s because the company sells software services you don’t care about to small businesses you’ve never heard of. Its value as a company is associated with things we like to avoid talking about — insurance, payroll, forms, fax machines. For businesses, though, that’s the appeal of Zenefits: it promises to take away the administrative pain and bureaucratic hoop-jumping involved with managing a small company.

By giving away a software tool to companies for free, Zenefits is able to help with things like managing payroll and then take a cut every time an employer buys health insurance using the Zenefits platform. The real money comes in the form of commission fees for bringing customers to providers like Aetna and Kaiser, putting Zenefits in direct competition with brokers. That market is worth around $18 billion, by some estimates.

Zenefits' real money comes in the form of commission fees

The problem is companies like Aetna don't like selling insurance through an unlicensed broker, regardless of whether the salesperson is part of a multi-billion-dollar startup. The state licensing process involves background checks to ensure sellers aren't negligent or incompetent, meaning they can’t sell you bogus plans just to net a commission. And states hate missing out on receiving the application fee that must be paid every time a broker renews a license, which can be as frequent as once every two years.

Conrad, who has in the past said his company’s business model meant insurance brokers were "fucked," essentially lost his job by following the grow-at-all-costs playbook of Uber and Airbnb. But because Zenefits wasn’t delivering cars to your doorstep or radically undercutting the price of hotel rooms, few came to the defense of the company that wanted to sell insurance without the proper paperwork.

David Sacks, a well-known tech executive who joined Zenefits after roles at PayPal and Yammer, replaced Conrad as CEO, noting in a letter to employees that its "culture and tone have been inappropriate for a highly regulated company." Sacks would most likely avoid telling insurance brokers "we’re going to drink your milkshake," as Conrad did in 2013.

Conrad once said insurance brokers were "fucked"

"I believe that Zenefits has a great future ahead, but only if we do the right things," Sacks added. "We sell insurance in a highly regulated industry. In order to do that, we must be properly licensed. For us, compliance is like oxygen. Without it, we die." That kind of language would be unimaginable coming out of the mouth of Uber CEO Travis Kalanick, who has likened his company's competition with the traditional taxi industry to a political campaign against an "asshole" incumbent.

Is a taxi medallion much different than an insurance license? Uber argues it’s not actually offering you a taxi — it’s a marketplace for matching drivers with riders, the defense goes — so it could avoid regulations around who can ferry people in their cars. Airbnb says it’s helping a host offer you a spare room to stay in, not offering a platform to transform your apartment into a hotel. Meanwhile Zenefits was selling boring old health insurance, but doing it in violation of the law.

More strange, perhaps, is how Zenefits' struggles have gone largely unnoticed. BuzzFeed News first revealed the company’s licensing issues back in November, detailing at great length how the company’s fast-paced, aggressive culture created a sales environment susceptible to continuous slip-ups and a lack of regulatory responsibility. Until now, the subject hasn’t gained the same headline-grabbing attention as Uber and Airbnb’s regulatory battles, maybe because insiders at Zenefits clearly knew what they were doing was wrong and scrambled to remedy the situation. Because Zenefits was still growing at breakneck speed, everyone seemed to let the company figure it out — until the gravity of the situation became clear.

"For us, compliance is like oxygen. Without it, we die."

Washington is currently examining Zenefits’ operations in the state, where it’s a Class B felony to sell insurance without a state license, according to BuzzFeed. As many as 83 percent of insurance deals in Washington up until August of last year may have been conducted by unlicensed Zenefits salespeople, BuzzFeed revealed last week.

Zenefits' growth is remarkable — that much has not changed. But the company's narrative as an emerging peer of Uber or Airbnb doesn’t seem to hold as much water now as it did when Conrad was steering the ship. The day before Zenefits fired him, the venture capitalist Tomasz Tunguz warned that companies selling software as a service should prepare for much slower growth. Instead of burning tens of millions of dollars growing 400 percent a year, he said, the smart ones would grow 50 percent a year while breaking even. "Many software survivors of the dot-com crash pursued a more conservative strategy and were rewarded for their prudence," wrote Tunguz, a partner at Redpoint Ventures. If Zenefits is to succeed, the company’s anything-goes past must give way to a much more sober future.