Zenefits is executing a change in its current ownership structure that will increase the overall ownership of the company for late-stage investors; it’s a move that revalues the company’s Series C round at $2 billion and looks to placate investor concerns over the company’s regulatory investigations.
As part of accepting the new ownership changes, the investors participating will sign a release of claims against the company. It’s another move that new CEO David Sacks is doing in what’s been a massive cleanup effort of the company following report after report of the company skirting insurance regulation. Since all those regulatory issues came to light, the company has laid off more than 350 employees and parted ways with its former CEO Parker Conrad. The biggest issue stemmed from a program called “The Macro” that would aid in circumventing state licensing requirements.
“Since shortly after becoming CEO, I have been in discussions with a number of our major investors about how we can reset our relationship in light of the fact that they (like I) were never informed about the Macro before investing in the company,” Sacks said in a memo released today. “We have been working on a new basis on which they can re-commit to the company and get fully aligned with the new Zenefits.”
It’s not surprising that investors, who have a big stake in the company’s success, would also want some kind of guarantee that their investment is still in decent shape given the company’s problems. The hope here it would seem is that Zenefits — and Sacks — can quickly put all this in the past and start rebuilding the company and placate investors, rather than having to face off against them.
Here are the details: Investors in the company’s Series C round, where it raised $500 million at a previous $4.5 billion valuation, will have their ownership stake upped from around 11 percent to 25 percent. A source tells us this amounts to a change in the share conversion rate upon a liquidation event. That change now effectively values the company at $2 billion in its Series C round, and earlier investors will receive small adjustments to offset the dilution.
The company’s common stock will be diluted by around 20 percent. Non-executive employees will receive a special stock grant equal to 25 percent of their current number of shares, to offset the dilution, that will be vested in 12 months and consist of restricted stock units rather than options. That move should help placate any employees who previously had an opportunity to accept a generous severance but decided to stay on board with the company.
Now, here’s the big question: What happens when it needs to raise money again?
Zenefits, even with its skirting of regulations and growth proclamations, reached $60 million in ARR in 2016, Sacks said in an email detailing the layoffs of 250 employees in February. Former CEO Conrad previously said, when the company raised its $500 million round, that Zenefits was on track to hit $100 million in annually recurring revenue by January 2016. This was certainly a miss, and raises a lot of questions as to whether Zenefits would be able to control its burn in the wake of missing those targets. At a $4.5 billion valuation, and with all the issues the company has had, that certainly could scare away investors. But it’s now going to be a bigger question as to whether they’ll buy in even at a lower valuation.
“At some point, this company will want to sell its shares again, and future prospective shareholders will look closely at how we treated our current shareholders,” Sacks wrote in a note coinciding with the announcement.
All this is basically a way to reset expectations for investors, as well as try to retain employees following the changes in the company’s ownership structure. Shareholders were kept in the dark in relation to the existence and use of “The Macro,” which required a reset of the relationship. Zenefits grew like a rocket ship, reaching a $4.5 billion valuation in just about two years after the company started. That, at the time, labeled the company as one of the fastest-growing SaaS startups ever — but, obviously, there was a bunch of shady stuff going on behind the scenes to pad that growth.
Sacks has made other moves to try to restructure the company, which was being torn asunder by investigations, a party culture and the break-neck growth that Conrad went after in its earliest days. Zenefits offered its employees a buyout package that equaled two months’ severance in an effort to effectively reset the culture of the company, of which Sacks said around 10 percent of employees accepted. It also open-sourced a new application that provides licensing controls to companies in what seemingly amounts to a mea culpa to the industry. “We are becoming the Compliance Company,” Zenefits wrote in an announcement of the effort.
And, of course, this is yet another instance of companies finding themselves resetting expectations for investors in the wake of a changing financing environment. If Zenefits wants to raise capital again, it’s going to have to deal with two issues: controlling its burn as it continues to try to grow, and resolving its regulatory issues.
One footnote to the announcement: The agreement does not include a release of claims for the $10 million in stock Conrad sold. “I hope that issue will be resolved in the near future,” Sacks said in the memo.
Andreessen Horowitz, Fidelity, TPG and Insight Venture Partners all agreed to the new investor agreement.
“I want to thank our investors for reaffirming their confidence in us. We take our commitment to you seriously to build value for all shareholders,” Sacks said in the memo. “As a result of The Offer and Investor Settlement, all of our employees and investors will be aligned, committed, and focused on what’s next, which is the launch of Z2 in October.”
Here’s the full memo:
