Zenefits Stumbles Into PayPal’s Old Drama

The tech world was stunned last week when Zenefits — the unicorn that had once been called “the fastest growing SaaS business in history”– announced that its founding CEO Parker Conrad was leaving the company and that it was under investigation in California. The company cited regulatory compliance problems as a factor in the decision.

David Sacks, who is replacing Conrad in the top spot, was PayPal’s first COO and was the founding CEO of Yammer. Sacks had been serving in the COO position for Zenefits for over a year. The company also restructured its board of directors. Conrad stepped down while Antonio Gracias of Valor Equity Partners, Bill McGlashan of TPG Growth, and PayPal co-founder Peter Thiel joined it.

(Disclosure: Thiel and Sacks are investors in our company CapLinked, and we also use Zenefits’ software.)

The news flew in the face of what previously had been conventional wisdom about the company. Forbes once called Zenefits hotter than Uber and Airbnb and Business Insider said was a startup to bet your career on. But now its path forward now looks very murky as risk and uncertainty obscure what had been a bright future.

A Familiar Refrain

Regulatory fights. Management upheaval. A high flying startup crashing to earth. If it feels like you’ve read this book already, it might be because Eric wrote a similar one. It’s called The PayPal Wars.

The similarities between what the challenges confronting Zenefits with the obstacles PayPal faced 15 years ago go far beyond just the involvement of Sacks and Thiel. Many of the problems suddenly confronting Zenefits are similar to what the early PayPal team had to confront back when Eric served as the company’s first director of U.S. marketing.

Regulatory Woes

News broke in November that Zenefits is facing scrutiny in some states over selling insurance without proper licenses.

In a bluntly worded letter to employees that was posted on the company’s blog, Sacks acknowledged that Zenefits had played fast and loose with regulatory compliance: “We sell insurance in a highly regulated industry… 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.”

Similarly, PayPal found itself facing scrutiny in its early years as regulators in a number of states –including authorities in New York and Louisiana — initiated action against the company. The biggest problem was that no one was exactly sure what label to apply to PayPal.

The startup wanted to avoid being classified as a bank given the arcane rules and burdensome regulations that went along with that status. Eventually the FDIC issued a ruling classifying PayPal as a money transfer service, which was regulated at the state level. This meant the company had to get licenses on a state-by-state basis.

Management Upheaval

This very visible change of CEOs will no doubt cause concern for Zenefits’ stakeholders, especially its employees and customers. But Zenefits isn’t unique in this regard. PayPal went through a similar level of change and tumult in its early years, with accomplished leaders such as Elon Musk, former Intuit CEO Bill Harris, and ultimately Thiel taking a turn at the helm before the company was acquired by eBay.

The company was able to weather the storm of changing CEOs in part because it had a strong culture as well as a deep executive team (e.g. Sacks, Max Levchin, Reid Hoffman, Roelof Botha, etc. etc.) leading the company.

Economic Headwinds

Zenefits faces the headwinds of a market that’s turned decisively less friendly toward tech valuations. Last November, Fidelity Investments marked down the value of its stake by 48%, calling into question Zenefits’ $4.5 billion valuation. Meanwhile, reports also indicate that the company’s revenue growth has disappointed. Since small businesses are the company’s primary revenue source, it’s feasible to assume that a slowing economy could be at least part of the reason for this.

As bad as that sounds, PayPal faced an even more daunting economic environment in its early years. The stock market crash from 2000-2002 erased $5 trillion of market value. Those aren’t headwinds–that’s a hurricane.

Meanwhile, venture funding began to contract at a time when the company was burning through $10 million a month. And yet, PayPal was still able to continue raising funds while it overhauled its business model, found a way to become profitable, and became the first dot-com to go public after the 9/11 terrorist attacks.

A Narrative Run Awry

Up until recently, the external narrative surrounding Zenefits had been all about growth and disruption. Case in point, on the day that Parker was dismissed, the company was a nominee in the Fastest Rising Startup category at the 2016 Crunchies. But now that narrative seems to have taken a dramatic U-turn.

Again, PayPal had a similar experience. Its initial public narrative was overwhelmingly positive. But as legal and regulatory woes mounted and news of the management changes got out, the press turned on the company, suddenly heaping scorn on the former media darling. In the months leading up to its IPO, when the company was still in its mandated quiet period, outlets that had previously been friendly (e.g. BusinessWeek, The Wall Street Journal, and CNET) all turned critical. One columnist even penned a piece called “Earth to Palo Alto” that suggested PayPal was meant for “drug dealers and domestic terrorists” and that the company lacked “adult supervision.” Ouch.

There’s Still Hope

The good news for Zenefits is that PayPal not only survived, but it thrived to the point of creating a new product category. It wasn’t easy, but with a talented team, strong culture, and commitment to execution, the company pulled it off.

This should be encouraging to Zenefits. While the challenges facing their company are real, PayPal’s history clearly shows that a determined company that executes well can overcome even these big odds.

History never repeats itself, but in Silicon Valley sometimes it does rhyme.