Zenefits: Were the Valley's kingmakers wrong, or did they just lie?

By Sarah Lacy , written on February 9, 2016

From The Facepalm Desk

Last night TechCrunch held its annual “Crunchies” award ceremony to recognize startup greatness.

Along with so much of the unicorns-in-the-light-of-day motif of 2016, several of the nominations seem strange. Like, say, Zenefits for “fasting rising startup” (It didn’t win) and Uber for “best overall startup” (it did.)

Zenefits CEO and co-founder Parker Conrad probably didn’t spend much time mulling his Crunchies loss. Earlier that same day he was forced to resign, not only from the company but also from its board of directors.

Conrad’s resignation followed revelations that Zenefits acted as insurance brokers in at least seven states despite lacking the licenses to do so. Buzzfeed has been following the scandal closely, and we covered it here on Pando.

Often, disgraced executives are given a chance to resign with their dignity and a disingenuous “he got us to a great place!” Not so Conrad who is being replaced by David Sacks, the former founder of Yammer who recently joined Zenefits as COO.

Sacks announced the move like this:

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. As a result, Parker has resigned. 

He added:

We must admit that the problem goes much deeper than just process. Our culture and tone have been inappropriate for a highly regulated company.

Yow. David Sacks: A name, and a two word headline.

By the way, this is the same Parker Conrad who was described by investors back in 2014 “an uncommonly talented software visionary.” That same year Y Combinator’s Sam Altman went on a bizarre tirade against Pando after one of our reporters failed to gush about Zenefits while covering a YC Demo Day. A year later, Altman was still so pissed we overlooked the brilliance of Zenefits that he banned a different Pando reporter from his event.

And then there’s this:

(For “most people,” read “insurance regulators”, and for “vision,” read “a Class B felony, carrying a prison sentence of up to 10 years”)

Sacks’ shake up of Zenefits goes far beyond canning Conrad. He also announced the company has hired a former federal prosecutor as the firm’s new chief compliance officer and named three new board members.

Zenefits’ funding round last year which valued it at $4.5 billion was said by several in the industry-- in the usual “don’t quote me on this” cocktail party fashion-- to be the peak of the market. Despite investors gushing that Zenefits was one of the “fastest growing SaaS company” even two years before its “unicorn round.”

The deal wasn’t peak unicorn, in retrospect. But it was close. Mega rounds would peak roughly a quarter later. And in a figurative sense, it may wind up being one of those peak unicorns we look back on and wonder: Where was the due diligence? How could some of the most respected minds in the Valley like Ben Horowitz and, uh, Sam Altman be so bullish on this founder when less than a year later we learn he was so incompetent? And, by the way, how did David Sacks -- Conrad's own COO -- either not realize the company's culture was rotten, or not care?

This might be the first unicorn of 2015 that calls into question the myths of “great companies” and “real businesses.” So much of the defenses of the rise in valuations has been that these are “real businesses” with real business models, real paying customers, and real growth.

It’s reminiscent of the defense of telecom spending once concerns set it about the dot com bubble. At the time investors and analysts said that unlike dotcoms these were real companies with real assets of fiber being laid into the ground. Unlike dotcoms, there was something to sell off should the worst happen. We all know now the telecom bust took more capital with it than the dot coms.

Just because you have assets, just because you have paying customers, just because you have a business model that shows you making it up on volume and most especially just because you have growth doesn’t mean you are a “real business.”

What’s so scary about this correction is that some 140 unicorns driving employment and hype in the Valley in recent years are still private. On the plus side, that means mom and pop retail investors aren’t at risk the way they were in the late 1990s. But on the downside, it means we have no idea what their models actually look like, aside from statements like “fastest growing SaaS company ever!” or “real business” or “great company” lead by an “uncommonly talented software visionary.” So “uncommon” that he skirted regulations that could have put people’s healthcare benefits and hence their lives at risk. Or as we’d describe him in the consumer world: Travis Kalanick.

I don’t want to come down too hard on people who championed this company years ago. Board members don’t run a company day-to-day, and the cult of the founder has lead to far less oversight than ever before. But it goes to show how asinine it is during a correction to blithely shrug and say, “Great companies will be funded in any market. “Great companies will be fine.” “Great companies will always be able to IPO.”

Sure. The problem is none of us seem to know which of these unicorns are “great.” And judging from recent Tweets and statements on Zenefits, that includes some of the top investors in the Valley.

If I worked for a unicorn, I’d be watching the Zenefits crash from grace, Uber in full on warfare with its drivers, DoorDash still not having completed its reduced-price funding found despite Sequoia as a lead and be wondering, “Is a shoe going to drop at my company?”

And that’s before we throw in the longest IPO drought since 9/11 broken by just one biotech company so far, and a public market in the middle of a deep correction on high-flying tech stocks. Look around your workplace. If there are fresh mangos sitting out and a fridge full of $5 Blue Bottle iced coffee, I’d worry.