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How one of the fastest-growing startups in Silicon Valley history raised $580 million then spiraled out of control

Zenefits employeesZenefitsZenefits employees on ‘Super Hero’ day.

One day in February 2015, a cheer rang through Zenefits’ sales offices.

The San Francisco-based company, which offers free benefits management software in exchange for becoming the customer’s insurance broker, had hit another sales milestone.

Everyone stopped working. Office cabinets were opened and giant bottles of Fireball whiskey, tequila, and scotch appeared.

“The entire company, including all of engineering, would line up at all the tables with shots as soon as a milestone happened. It was kind of fun, kind of an exciting place to work,” one former salesperson from the San Francisco office recalled.

Zenefits Parker Conrad ZenefitsZenefits co-founder and CEO Parker Conrad

The cause for celebration on this day was the close of a “700-life deal,” which was 300 “lives” over the previous record, according to a former employee who was there. That meant the salesperson had landed a customer who would use Zenefits as its insurance broker for 700 people. The insurance industry talks of its customers in terms of  “lives.”

Cofounder and then-CEO Parker Conrad and his right-hand man, VP of sales Sam Blond, tossed back shots with the team.

Conrad had a lot to celebrate: the smart and outspoken cofounder had overcome a lot in his past, including a bout with testicular cancer that had made him acutely aware of how health insurance was broken. He’d been “fired” (his words) from his previous startup, Wikinvest, by his cofounder.

Now he was doing remarkably well at his second startup. It had come through Silicon Valley’s hottest startup factory, Y Combinator, and was on its way to a multibillion-dollar valuation.

But there was one person who didn’t attend the celebration: Zenefits’ COO David Sacks.

Sacks didn’t think Zenefits should be pursuing large customer deals, but should stay focused on small business. So he didn’t join these celebrations, a person close to the company tells us. 

It was just one of a number of disagreements the two men would have over how to run Zenefits in the next year.

A year later, by February 2016, Zenefits had spun out of control and devolved to the point where: 

How did Zenefits do a 180 in a matter of months? And while Conrad shouldered the blame, where was Sacks while Zenefits spiraled out of control?

Business Insider spoke with a number of people who used to work for the company and others who are close to it, on the condition of anonymity. 

The general consensus: Zenefits mismanaged hyper-growth and collapsed under its own weight.

Skyrocketing growth

David Sacks is a legendary Silicon Valley entrepreneur who got his start at PayPal, went through a short stint in movie makinghad epic success as an angel investor, then founded work chat application Yammer and sold it to Microsoft for $1.2 billion. He had invested a large but undisclosed sum in Zenefits and was lured out of retirement to join the company as its COO in December 2014.

Zenefits COO David SacksZenefitsZenefits COO David Sacks

He joined at the urging of Lars Dalgaard, a Zenefits board member and partner at venture capital firm Andreessen Horowitz.

The rumour in the Valley was that Conrad, a smart but sometimes volatile CEO, needed a babysitter.

However neither of these men saw it that way.

People close to the situation say Sacks wanted to bring his truckload of management experience to the young, fast-growing company. 

Sacks and Conrad divvied up responsibilities. Sales had been going well, so that stayed with Conrad. Engineering reported to Zenefits’ co-founder Laks Srini, who reported to Conrad.

Sacks took over product, operations (including “accounts management,” the team that handled customers’ needs after the sale) and the analytics teams.

For a few months, everything went well.

By the spring of 2015, Zenefits was a high-flying Silicon Valley darling. Conrad publicly stated that Zenefits would have $100 million in revenue under contract by year’s end, up from $10 million in 2014. That would make Zenefits one of the fastest-growing startups ever.

The two-year-old company raised a whopping $583 million, and investors thought it was worthy of a $4.5 billion valuation. 

Zenefits began to hire people in droves. The startup, which launched in May 2013, had grown to 500 employees by the start of 2015, and exploded to about 1,600 people by September 2015

The company seemed unstoppable, with salespeople working from  6 a.m. until 9 p.m. and deals closing rapidly, former employees recall. 

But soon, the fun, hard-working startup culture turned into something else — chaos.

Quit having sex in the office!

Zenefits signBusiness Insider/Julie Bortmotivational sign at Zenefits offices

Zenefits started getting a reputation as a party palace. There were “overindulgent” offsite company parties, one person said, and “a pretty extravagant President’s Club in Las Vegas” for top salespeople.

A former employee described Zenefits’ Arizona offices in particular as “a zoo.”

Parties in the startup tech world are not unusual. But with Zenefits adding gobs of new employees every week, many of them young college grads, they were harder to control.

“We used to have a tradition where, every time the biggest deal would close and we were breaking records, we would take shots,” a former sales manager in Zenefits’ Arizona office explained.

“We then started breaking records daily, sometimes twice a day. We should have cut out that tradition immediately, but we didn’t,” they said.

While Conrad took part in some of the partying, he wasn’t necessarily leading the way. He participated in the shots-during-work celebrations about five times, multiple people said. 

Zenefits CEO pouring shotswww.instagram.comZenefits CEO Parker Conrad pouring celebration shots

Still, the company cemented its frat-house reputation with an email sent on Monday June 8, 2015, asking employees to refrain from behaving inappropriately. Here is a copy of the email obtained by Business Insider (emphasis ours):

Subject: [MUST READ]-Urgent Building Announcement

Hey San Francisco,

It has been brought to our attention by building management and Security that the stairwells are being used inappropriately. The stairwells were recently opened up to Zenefits employees for our convenience in getting from floors 4 and 5… 

…Also, cigarettes, plastic cups filled with beer, and several used condoms were found in the stairwell. Yes, you read that right. 
Do not use the stairwells to smoke, drink, eat, or have sex. Please respect building and company policy and use common sense. Keep in mind that policy violations may be grounds for termination. 

If the stairwells continue to be used inappropriately, our privileges may be taken away.

Emily Agin
Director of Real Estate and Workplace Services

A former sales manager explains: “When we were smaller, we could act the way we were acting in the office. I don’t think Parker [Conrad] did a good job of growing up. He let things get out of control. There comes a point where hyper growth achieves diminishing returns.” 


 
Zenefits’ Arizona office.

An “environment of failure”

Ironically, by the time that email was sent, Zenefits was hardly a party palace, particularly in the San Francisco headquarters.

On the contrary, Zenefits was had become a very stressful place to work. The company told employees in mid-2015 that they had to suspend vacations, in part because the busiest time of year was coming up. (The company later discovered its employee manual wasn’t clear about vacations, and ended up offering to pay former employees if they promised not to sue over the unpaid vacation time.)

Things were so tense that Sacks grew concerned and approached Conrad, telling him that the company needed to do something to lighten the mood, like a hackathon, a person close to the situation tells us. (A hackathon is an all-night get together, where people spend 24 hours coding and coming up with new ideas for the company.)

Zenefits officesBusiness Insider/Julie BortZenefits employees in San Francisco.

A big source of stress was Zenefits’ exploding head count. The startup hired so many people so quickly that the right hand stopped knowing what the left was doing, former workers said.

It caused friction between Sacks and Conrad, with Sacks advising Conrad to slow down.

“Sacks had stopped hiring in operations by mid-2015. He raised the hiring issue and was in open contention with Conrad in meetings,” a person close to the company said.

As the chaos increased, Zenefits began to fall short of its lofty sales target of $100 million in 2015.

Take what happened in Zenefits’ enterprise sales department, for instance.

This group was tasked with selling Zenefits’ brokerage services and software to large companies. In the span of a couple of months, it doubled in size to about 30 people.

Zenefits liked to promote from within, but many of its team members were very young and had no experience managing, selling enterprise software, or selling insurance.

“Our performance dropped off,” one person said. “Nobody was hitting their quota and most of the team members weren’t even closing a deal. The majority of the sales team had a ‘zero’ on the board month after month.”

Worse, the Zenefits software “wasn’t enterprise-ready” with the kind of security and features that more expensive enterprise HR software offers.

Another gotcha, this person says, was a very long “claw-back provision.”

If a customer canceled with Zenefits within the first year, the salesperson had to return the commission to the company. 

Sources told us that some salespeople were docked $15,000 to $20,000, months after closing a deal.

“The reason you get into sales is to make a lot of money. But no one was making money on the enterprise team,” this person says. “It was an environment of failure.”

During his third week as CEO, in February 2016, David Sacks disbanded and laid off the entire enterprise sales division to concentrate on small businesses.

“It is no secret that Zenefits grew too fast, stretching both our culture and our controls,” Sacks wrote in an email to employees when he announced 17% of the staff would be laid off. 

Sacks has also since ended the “clawback” policy, a person close to the company said.

A “culture of dishonesty”

There were also serious issues with how sales people were trained at Zenefits in early 2015. Some now feel the process led to a culture of dishonesty, both with clients and colleagues.

Salespeople at Zenefits were taught to tell prospective customers that its product was an automated system, former employees said.

That means they told customers: Enter the data in once  —  such as the name of a new employee, or an address change  —  and the system will automatically update all of the other spots throughout the software where that update is needed.

Zenefits doorBusiness Insider/Julie BortZenefits door at San Francisco office

But the former salespeople say they later learned that wasn’t 100% true. 

In some cases, the Zenefits software was not interconnected with an insurance carrier’s software or other HR processes, like payroll. And then, the changes were being sent to a Zenefits employee in Arizona who was manually inputting them into the other system, much like a bookkeeper.

A person close to the company told Business Insider that when insurance carriers offer software automation, Zenefits uses it.

“It’s much more about a carrier limitation, not a Zenefits limitation,” this person said.

But some of the sales folks were unnerved.

“It doesn’t do what we sold it to do,” a former salesperson said.

At one point, a public fight broke out between Zenefits and payroll giant ADP in which ADP balked at the methods Zenefits was using to access payroll information for their joint customers. Zenefits countered by saying it was behaving just like bookkeepers have behaved forever.

But some salespeople were freaked out all the same. 

Laks Srini, Zenefits, sv100 2015‘TCDNY2013’ by Max Morse, © 2016, Flickr, licensed under Creative Commons Attribution 2.0 License.Zenefits cofounders Parker Conrad and Laks Srini happy as finalists for TechCrunch’s 2013 Disrupt conference.

“When I discovered that, ‘I thought how is this possible? We have almost no automation?’ That’s what caused the problem with ADP, automatic logging-in and scripts that ran in the background and wasn’t automated at all,” one of the former salespeople said.

On top of that, salespeople were told to urge their clients to sign contracts quickly in order to avoid a $10,000 broker implementation fee that would go into effect at the end of the month.

“We never ever charged anyone the fee, all this was a lie we told to everyone,” the former salesperson says.

“Lying spread in the culture,” this person said. “It was a culture of dishonesty and the reason why I left.”

Zenefits is currently “reviewing” its implementation fees as part of an overall compliance review taking place inside the company. 

Hot water with licensing laws

A big land mine for Zenefits had to do with employees who allegedly weren’t properly licensed to sell insurance. And the licensing issue was something “everyone knew about,” one former salesperson said.  

Zenefits employeesBusiness Insider/Julie BortZenefits employees

“Most of us had never been in the insurance industry,” this ex-salesperson said. “We were all software salespeople in the San Francisco Bay Area. I got the job and didn’t even find out I had to get a licence until they told me in an email later.”

The company told some new, unlicensed hires that, because CEO Parker Conrad was licensed in all 50 states, “we didn’t have to be licensed, we were acting under his umbrella licence,” this person said.

Or, if a manager with a licence was sitting in on calls, “that was good enough.”

But as the hiring grew, managers stopped listening in on every call, the source said.

By January of 2015, Zenefits executives learned that certain states like Utah and Washington were taking a hard look at Zenefits and its out-of-state licence issue. 

‘Macro’ brings Conrad down

With some states beginning to take issue with Zenefits’ licensing process, salespeople were told to get their licenses as fast as they could.

Zenefits websiteZenefitsZenefits website

This is what ultimately caused Conrad’s downfall.

It came down to a “Macro” program, software that fools a web browser into thinking a person is still actively working on a web application  — even if they aren’t. 

In California, insurance salespeople were legally required to spend 52 hours doing a certain training course. But it often didn’t take people that much time, so they would leave the app running “clicking on their browser to keep it from timing out,” until it ran for 52 hours, one person described.

The Macro program automated that process, so Zenefits salespeople were using it to keep them logged in for the full 52 hours while they did other things. It didn’t advance the pages or take the quizzes or the final test for them. But they did have to certify that they had met the 52-hour requirement, and the macro let them skirt that.

Macro wasn’t a secret at Zenefits. The sales teams used it and talked openly about it, according to all the former salespeople we spoke with.

Zenefits alleges that Conrad “authored the Macro himself.” (Conrad declined to comment.)

It’s possible Conrad didn’t realise how widespread the Macro had become within his sales organisation. In the fall of 2015, under advice of his legal counsel, Conrad ordered an internal investigation to look into it.

By November 2015, he learned that the Macro was widely used and “everyone, including Sacks, was briefed on it by then,” one person with knowledge of the matter said.

Sacks then hired an independent firm to investigate further, to examine who was using it and any legal ramifications.

The firm presented its finding to Sacks in late January. 

“This was the first time Sacks learned of any possible criminal wrongdoing,” a Zenefits spokesperson told Business Insider.

“Sacks, with the support of the Board, also instructed company counsel to self-report the issue to the California Department of Insurance (CDI), even before Parker’s termination,” the spokesperson stated. “
The independent third-party investigation into Macro cleared Sacks completely of having any involvement in or knowledge of Macro. All the evidence — including interviews with Parker himself — confirm this fact.”


Conrad’s last day

Not long after the Macro investigation was completed, on February 8, Parker Conrad resigned as CEO.

The board voted unanimously for David Sacks to replace him. Even Conrad voted in favour of Sacks, one person told us. Conrad agreed to be the be the fall guy because he thought it would give the company he founded its best shot to get through its issues and move on.

Although Conrad knew he’d be vilified, he didn’t expect Sacks to lead the charge against him internally.He left with a generous severance package, a person familiar with the situation said.

Before Conrad resigned, the executives and the board had agreed on how his resignation would be announced, both internally and to outsiders.

But on the day Conrad left, Sacks sent a companywide email that Conrad was not briefed on, stating that “compliance is like oxygen.” It called out Zenefits’ licensing issues and the Macro program, lashed out against the company’s culture, and seemed to blame Conrad for the company’s problems.

“The fact is that many of our internal processes, controls, and actions around compliance have been inadequate, and some decisions have just been plain wrong,” Sacks wrote. “As a result, Parker has resigned.”


Is Parker really to blame?

Zenefits’ meteoric rise and subsequent fall can be traced back, at least in part, to Conrad’s controversial leadership style.

Some former employees can’t stand him. Others love him.

“A lot of us were confused by Parker,” a former Zenefits salesperson said. “He’s one of those individuals who makes decisions during the heat of his emotional state. He was a very emotionally immature leader and showed it time and again. He would berate people in front of large crowds and call people offensive names.”

For instance, Conrad publicly rescinded a job offer to a candidate after the candidate wrote a post on Quora saying he couldn’t decide between multiple offers. Conrad lambasted the applicant for wanting to choose a job “based on buzzwords.”

Zenefits Parker ConradBusiness Insider/Julie BortZenefits cofounder CEO Parker Conrad

Yet, he was admired by many employees, too.

“Parker is a good guy, a workaholic. He didn’t do everything correctly but no one’s perfect. People make mistakes,” said a former employee who worked with him closely from the early days. 

“He knew people by first name, went out of his way to talk to you. I’m incredibly grateful for the opportunity he gave me.”

Many employees were shocked by his resignation. An employee hired in 2015 in Arizona wrote this on her Instagram about Conrad’s final day: 

Somber day at #zenefits today. I feel eternally lucky to work for a company founded by such an incredible visionary. My parents are entrepreneurs and started many small businesses while I was growing up. I can’t help but think about how Zenefits would have helped them along their journey. I started a small business of my own before coming to Zenefits. …Parker always inspired us with his passion and driving mission- to help those with big dreams and make them that much easier to achieve. Zenefits will continue to push forward so many others can pursue their dreams. #thisisday1 And he is a super cool dude to boot! #parkerconrad”

Can Sacks save the $4.5 billion startup?

During the time Zenefits was unravelling, David Sacks was a full-time executive there.

So where was he when all this was happening? Did Sacks know about the Macro and other Zenefits’ licensing issues? If yes, could the scandal take him down, too?

“The whole Sacks thing was obviously a mystery to a lot of us,” one person said.

“We never saw him. What makes it really interesting, is, if he’s the COO, where is he on this insurance licence that wasn’t happening?”

Said another, “It’s hard for me to believe that he didn’t know the things going on about licensing, it’s the stuff people talked about in the halls.”

One person close to the company says Sacks truly didn’t know about the licensing issues and Macro because he was respectfully trying to stay out of Conrad’s domain.

And, even if conversations were happening in the sales office, Sacks may not have heard them because his operations team was on a different floor than Zenefits’ sales team.

However, another person familiar with the matter told us that the account management team, which was part of Sacks’ operations organisation, also needed to deal with “licensing issues in ongoing accounts.”

That would imply that Sacks knew at least something about the licensing compliance issues before he took over as CEO. 

A Zenefits spokesperson says his knowledge was “limited” and sent Business Insider the following statement: 

Prior to November 2015, Sacks had limited knowledge of licensing issues and understood they were being addressed. It wasn’t until late November that Sacks learned of the potential extent of licensing non-compliance. At that point, he fully supported an independent review by a big four auditing firm that the company has self-reported to regulators.

Either way, people feel more confident about Zenefits’ future now that it rests in Sacks’ hands. He has proven time and again he can build successful businesses in Silicon Valley.

One of Zenefits’ earliest investors, Box founder Aaron Levie, still has hope. When asked how he thinks Zenefits will will fair under Sacks, he proclaimed: “I’m still very bullish on Zenefits!”

And Sacks is determined to give Zenefits a second shot at greatness.

“As a friend once told me, ‘successful companies have multiple founding moments,” Sacks told all 1,200 Zenefits employees the day Conrad resigned. 

“This is one of them. This is a founding moment … This is Day 1.”

Somber day at #zenefits today. I feel eternally lucky to work for a company founded by such an incredible visionary. My parents are entrepreneurs and started many small businesses while I was growing up. I can't help but think about how Zenefits would have helped them along their journey. I started a small business of my own before coming to Zenefits. Entrepreneurs are the driving force behind what makes this country so great- dream big and make it happen! Zenefits was founded to help small business and small business owners pursue their dreams. Parker always inspired us with his passion and driving mission- to help those with big dreams and make them that much easier to achieve. Zenefits will continue to push forward so many others can pursue their dreams. #thisisday1 And he is a super cool dude to boot! #parkerconrad

A photo posted by Mandy Cousins (@amandalily5) on

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