An­dreessen Horowitz schools a startup

Zen­e­fits moved fast and broke things—maybe even the law “Com­pli­ance is like oxy­gen. With­out it, we die”

Bloomberg Businessweek (Asia) - - CONTENTS - −Eric New­comer

In a Feb. 1 meet­ing at its Sand Hill Road of­fices, ven­ture firm An­dreessen Horowitz urged the chief ex­ec­u­tive of­fi­cer of one of its most prized and promis­ing com­pa­nies to re­sign.

Zen­e­fits makes soft­ware de­signed to sim­plify and au­to­mate such HR tasks as health in­sur­ance signups. At three years old, it’s val­ued at $4.5 bil­lion and is one of the fastest-grow­ing busi­ness soft­ware com­pa­nies ever. Un­der found­ing CEO Parker Con­rad, it also made soft­ware that al­lowed its em­ploy­ees to skirt state reg­u­la­tory re­quire­ments, the com­pany now ad­mits.

Days af­ter Chief Op­er­at­ing Of­fi­cer David Sacks gave that in­for­ma­tion to Lars Dal­gaard, an An­dreessen part­ner who sits on Zen­e­fits’ board, Con­rad was out, say three peo­ple fa­mil­iar with the mat­ter. At Con­rad’s sug­ges­tion, they re­placed him with Sacks, a Sil­i­con Val­ley fix­ture who’s worked at Mi­crosoft and co-founded Yam­mer, the busi­ness chat com­pany.

In Zen­e­fits’ early days, the peo­ple say, Con­rad cre­ated a de­cep­tive pro­gram called “the Macro,” which made it look like em­ploy­ees were watch­ing legally man­dated on­line train­ing when they weren’t. Work­ers who claimed to have com­pleted the train­ing may have been well short of the re­quired 52 hours. Con­rad used it him­self, the peo­ple say.

Cal­i­for­nia reg­u­la­tors are in­ves­ti­gat­ing Zen­e­fits’ use of the Macro, as well as whether its em­ploy­ees had li­censes when they started sell­ing in­sur­ance. On Feb. 8, Sacks an­nounced Con­rad’s res­ig­na­tion in an in­ter­nal e-mail. “For us, com­pli­ance is like oxy­gen. With­out it, we die,” Sacks wrote. “Many of our in­ter­nal pro­cesses, con­trols, and ac­tions around com­pli­ance have been in­ad­e­quate, and some de­ci­sions have just been plain wrong. As a re­sult, Parker has re­signed.” Con­rad de­clined to com­ment.

Among other things, the episode marks some­thing of a re­ver­sal of phi­los­o­phy for An­dreessen, which since

its 2009 in­cep­tion has pitched it­self to startup founders as a ven­ture firm that pro­vides guid­ance with­out get­ting overly in­volved. “Most of the great com­pa­nies in our in­dus­try were run by a founder for a long pe­riod of time, of­ten decades, and we be­lieve that pat­tern will con­tinue,” Marc An­dreessen wrote in a blog post when the firm be­gan. Zen­e­fits was one of An­dreessen Horowitz’s big­gest in­vest­ments—the firm owns 25 per­cent—and its ouster of Con­rad is a sign that with the startup mar­ket be­gin­ning to cool, Sil­i­con Val­ley in­vestors are grow­ing more hands-on.

“For the last few years, val­u­a­tions of­ten be­came de­tached from the un­der­ly­ing fun­da­men­tals,” says Anand San­wal, CEO of re­searcher CB In­sights. “In the cur­rent cli­mate, in­vestors are start­ing to think about old-fash­ioned things like cash flow.”

Like a dig­i­tal health in­sur­ance bro­ker, Zen­e­fits gives its soft­ware away and makes money by charg­ing in­sur­ers a fee when com­pa­nies use it to pick their plans. In 2013 and 2014, the com­pany gen­er­ated a grand to­tal of about $8 mil­lion in ac­tual rev­enue, ac­cord­ing to pre­vi­ously undis­closed fundrais­ing doc­u­ments, and ended 2014 with an­nual re­cur­ring rev­enue of $20 mil­lion. It’s grow­ing quickly, hav­ing topped $60 mil­lion in an­nual re­cur­ring rev­enue by the end of last year, but it’s missed rev­enue tar­gets, say two peo­ple fa­mil­iar with its fi­nances.

Zen­e­fits has strug­gled to hire a lot of good sales­peo­ple quickly and to keep com­pa­nies us­ing its soft­ware once they have big HR de­part­ments. It’s also suf­fered from in­ter­nal turnover. Some sales­peo­ple who joined from Yelp re­turned to the re­views site within months, says a per­son fa­mil­iar with the mat­ter.

Zen­e­fits’ fi­nan­cial is­sues were dis­cussed dur­ing the Feb. 1 board meet­ing. An­dreessen co­founder Ben Horowitz, who isn’t a Zen­e­fits di­rec­tor, at­tended. But two peo­ple close to the post-Con­rad Zen­e­fits say the Macro, not sales misses, was re­spon­si­ble for the CEO’s res­ig­na­tion.

At the meet­ing, Con­rad ten­ta­tively agreed to re­sign, re­lin­quish his board seat, and make Sacks CEO, say three peo­ple close to the com­pany. Peo­ple close to Con­rad now say he’s ag­i­tated by how Sacks’s very pub­lic let­ters to em­ploy­ees have char­ac­ter­ized his de­par­ture and blamed him for Zen­e­fits’ com­pli­ance prob­lems.

The claims that un­li­censed Zen­e­fits bro­kers were sell­ing in­sur­ance be­came pub­lic on Nov. 25 when Buz­zFeed reporter Will Alden be­gan pub­lish­ing ar­ti­cles on the mat­ter. Cal­i­for­nia and Wash­ing­ton state are in­ves­ti­gat­ing Zen­e­fits’ sales. The com­pany says it’s co­op­er­at­ing with those probes and con­duct­ing its own. It’s hired Price­wa­ter­house­Coop­ers for a third-party as­sess­ment. Sacks de­clined to com­ment.

Two peo­ple close to Sacks say he first be­gan to worry about the Macro’s pos­si­ble crim­i­nal im­pli­ca­tions in late Jan­uary, af­ter re­ceiv­ing new in­for­ma­tion from the in­ter­nal in­ves­ti­ga­tion. To ver­ify that an in­sur­ance sales ap­pli­cant has com­pleted the 52 hours of train­ing, Cal­i­for­nia re­quires a sig­na­ture that car­ries a per­jury charge if vi­o­lated.

“The re­cent res­ig­na­tion of Zen­e­fits’ CEO Parker Con­rad is an im­por­tant de­vel­op­ment, but it does not re­solve our on­go­ing in­ves­ti­ga­tion of Zen­e­fits’ busi­ness prac­tices and their com­pli­ance with Cal­i­for­nia law and reg­u­la­tions,” the Cal­i­for­nia Depart­ment of In­sur­ance said in a state­ment.

While An­dreessen Horowitz has seen strong re­turns from in­vest­ments like Ocu­lus VR, some of its big picks have stum­bled, in­clud­ing Jaw­bone, a maker of fit­ness-track­ing equip­ment, and Quirky, which runs a so­cial net­work ded­i­cated to in­ven­tion. The firm is rais­ing money for a new ven­ture fund, says a per­son fa­mil­iar with the mat­ter. (Bloomberg LP, which owns Bloomberg Busi­ness­week, is an in­vestor in An­dreessen Horowitz.)

As even the hottest star­tups be­gin to worry about show­ing re­sults, An­dreessen Horowitz re­mains com­fort­able with its bet on HR soft­ware, ac­cord­ing to Dal­gaard. The board just added three high-pro­file in­vestors, in­clud­ing PayPal founder Peter Thiel. “Zen­e­fits has had com­pli­ance is­sues, and we have taken strong ac­tion,” Dal­gaard said in an e-mailed state­ment. “We are very happy to be the largest in­vestor in Zen­e­fits.” Not so happy, though, that the firm would let the com­pany keep polic­ing it­self.

The bot­tom line Zen­e­fits is strug­gling to re­cover from a scan­dal that led the com­pany’s pri­mary backer to push for the ouster of its CEO.

Parker Con­rad

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