
Zenefits Loses Over Half of Its Value - prostoalex
http://fortune.com/2016/06/30/zenefits-loses-over-half-of-its-value/
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grellas
The repricing is, in effect, a form of settlement agreement with the company's
preferred stock investors.

What the former CEO did amounted to a form of fraud on the investors. They
thought they were investing in a company they thought was worth x but whose
real value was less than half the value of x. The company had actual or
constructive knowledge of the facts underlying the fraud, to wit, that there
was in place an automated program that facilitated and attempted to cover over
blatant regulatory violations. This was a material fact known to the then CEO
and the company, legally speaking, is charged with his knowledge. Therefore,
it constructively knew the truth as well and failed to disclose it to
investors when they invested in the prior round (Series C). Since this was
highly material to their investment, the sale of securities to such investors
without such disclosure amounted to securities fraud.

Now, when something like this has happened, people can sometimes let it slide
but the impact here was _huge_ and the investors have easily lost at least
half the value of their investment.

So what does new management do? With the historic problem cleaned up, it
reprices the shares in the previous round to set the valuation at the level it
should have been (or least much closer to it) had all facts been known and
disclosed to investors. This is speaking hypothetically, of course, because
investors of this type do not invest in a company that is committing serious
legal wrongs and they would not have actually invested here had they known all
the facts at the time of their original investment. But, given that the damage
had already been done, the proposal made to investors gives them the chance
after-the-fact to affirm their investment, release their legal claims, and
take the hypothetical value that presumably would have more accurately
reflected the real value of the company at the time of their investment had
all facts been known and disclosed to them.

Is this a perfect solution? No, of course it cannot be. This is a real mess
and the wrongs committed were serious. But it gives investors a path through
repricing to get more than double the shares they had bought at the prior
pricing. The trade-off: they must release all legal claims against the
company.

Now the carve-outs: if any given investor sees this as an imperfect solution,
they can always just say no and file suit against all parties, including the
company; and, even for investors who take the deal, there is no absolving of
the former CEO in that the release of claims does not extend to him - hence,
they reserve all rights to sue him if they like.

On top of all this, employees are given RSUs that help minimize the effect of
the dilution that is built into this for the benefit of investors. Again, not
perfect but another indicator that this has been carefully thought out. If the
company revives and its stock value goes up, the employees will essentially be
paid bonuses via the RSUs to help make up the difference.

This is actually a pretty elegant attempt to salvage what must have been seen
by many as a situation beyond repair, first (and formally), by setting up a
mechanism to prevent the company from being swamped by lawsuits and, second
(and much more importantly) by taking a good faith (and, for the company,
painful) step in order to save its relations with its key investors.

People should not flippantly dismiss this action just because it is unusual.
It may wind up being right or it may wind up being wrong but it clearly is a
carefully thought-out attempt to deal with an exceedingly difficult set of
circumstances in a creative and constructive way. If it does work, it will be
because the investors perceive the business model of the company as
fundamentally sound in spite of the earlier illegality and corner-cutting. It
is their opportunity to register a vote of confidence for new management to
give it another try, this time with an honest respect for the relevant
regulatory environment even as the company attempts to disrupt its target
market.

Whether it works or not, only time will tell.

~~~
zaroth
Excellent analysis as usual! If this type of rewriting the cap table is legal,
then what is/are the defining factors of illegal manipulation of the cap
table?

~~~
moritzplassnig
It could have happened anyway because the Series C investors could have sued.
The company (obviously) didn't disclose any of the fraudulent behavior when
they raised the C round (= they can get sued). Doing it like that is cleaner
and makes sure that the company has a future.

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SwellJoe
Despite all the turmoil around the company, I've been using them for payroll
and looking into more HR stuff through them, and it works really well. Much
better than Intuit, certainly (which has cost me a fortune in late filing fees
and other stuff, because they don't automate tons of stuff that ought to be
automated and invisible to the end user, and I suck at doing taxes).

I'm surprised they need 900 employees to do what they do, though. But, I guess
a huge part of their business is interacting with decrepit old systems used by
insurers and states, and often require humans and fax machines and other such
nonsense.

This is a pretty astounding turn of events; it's not something I've ever even
heard of happening. It's certainly better than exploding under the pressure of
investor lawsuits, I guess. But, aren't their still regulatory issues being
investigated and so catastrophe is still possible?

~~~
x0x0
Zenefits works well until it doesn't. They botched a commuter benefit payment
to me, and it took either four or five phone calls and me being pretty rude to
the last couple employees to get it fixed. I couldn't understand how correctly
crediting me my $80 was so difficult, particularly since it had repeatedly
worked before.

~~~
driverdan
Exactly this. In general they're great but when you have a problem it's a
giant pain. One of our employees had a lot of trouble getting his spouse
insured. It took them months to work it out.

~~~
boise
Zenefits screwed up a bunch of our state registrations and payroll taxes. The
worst thing was the hideous customer service in trying to resolve this.

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zaroth
Can't imagine this is legal. It sounds like they are trying to dilute out
Conrad specifically by significantly repricing the earlier rounds and then
covering existing employees with new grants. Anyone out of the good graces of
the current management sees massive dilution and everyone else is untouched.
How is this not just stealing Conrad's shares?

The extra kicker is investors signing up for the free shares agree to waive
all claims... _except_ against Conrad. Wow, that's vengeful!

~~~
JonFish85
That's kind of the point of shares, isn't it? They're super manipulatable and
for just this reason: you can get rid of people you don't like. They can fight
in court all they want, but a private company will probably win.

~~~
SilasX
Wait, what? I though the whole point of shares (per GP) is they're all (within
the same class) treated equally, regardless of holder, specifically to
_prevent_ these kinds of shenanigans!

Imagine if the management of a company voted to void some arbitrary 10% of the
shares -- the ones held by people they didn't like, merely to claim more of
the company for themselves. That would absolutely not be kosher.

But then (assuming the grandparent's description of what happened is
accurate), Zenefits is doing _exactly the same thing_ by more roundabout
means. Surely the laws on this aren't so easily circumvented? And even if not,
isn't this as a big red flag to future investors?

~~~
JonFish85
That's one way of looking at it, of course. I think another is to say that the
concept of stock as compensation (especially in a private company) is to give
the company maximum flexibility. They (presumably) don't have cash, so they
give stock as a proxy for that. However, if they hit hard times, they can
issue as many new shares as the BoD will allow to any new investors they want.

This includes new classes of shares. It's not "standard" practice, but it's
also not uncommon--to get rid of people they want to get rid of, they can
dilute them out (issuing new shares and everyone except X gets new shares),
issue new classes of shares with preference, etc.

I'm sure there are laws around this, but it's also a private company so it can
be tricky there. Stock in a private company is much more difficult to hold,
since there are many, many ways for the company to manipulate it to the
company's advantage.

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kriro
So employees get roughly 25% extra shares (RSUs, vesting in 12 month) and the
C series investors get >50%? Just out of curiosity, could the employees sue
(and are they also releasing their legal claims if they accept the deal)?

The same logic of fraud applies to employees. The argument would be that they
were thinking the company is doing more amazing that it actually is doing and
thus "wasted" time of their life working there under false assumptions. Why do
they get a worse deal?

~~~
againstgreed
The hard truth is it's not about the legal problem in Zenefits. Zenefits is
not growing from last October. ARR remains the same 60M for last 10 months. If
the company is not growing and it's burning more cash than revenue (way more
in Zenefits case), the company should be valued at (cash in hand + ARR) which
is 700M. No idea how Zenefits still gets 2B valuation.

~~~
brianwawok
> If the company is not growing and it's burning more cash than revenue, the
> company should be valued at (cash in hand + ARR)

Is that really true? Maybe if a company had NO HOPE of growing. Zenefits has
clearly shown some huge growth. The market is huge. Just being not profitable
and not growing for the short term does not mean you are guaranteed dead...
just that you are default dead and need to get working on it, which they seem
to be.

Edit - and if truly a company was never going to grow again, I would value
them at something like cash on hand + ((total rev - min expenses to stay
afloat) * 3) or something... In your example if someone had ARR of 100
million, min expenses to keep doors open of 300 million, and cash on hand of 1
million.. you would value them at 101 million, I would value them at - 599
million.

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iaw
>> “This is a unique situation, we’ve never seen it before and we don’t expect
to see it again,” said a spokesperson for Andreessen Horowitz.

This is the golden line in the article, with the "bend the rules" mantra VC's
have for their founders I suspect we'll be seeing more of these come to light
in the future. Thinking this to be an isolated incident could be very wishful
thinking.

Even if AH expects every Unicorn to go through a similar event in the near
future they wouldn't say as much to the press, there is no benefit for them as
VC fund.

~~~
x0x0
This may be isolated in the sense of how very clearly against the
law/regulations the behavior was, and some of those laws/regulations appear to
have teeth if regulators wish them to.

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embiggen
Not a huge surprise given the events of late, especially considering they laid
off more than a hundred of their employees.

If this is the public slash they are announcing, how bad do you think reality
is looking on the inside? Just imagine the spin masters trying to spin this to
their employees.

I can't help but chuckle a little. Kids.

That being said, I'll add that there are certainly aspects of this that are
_not_ funny at all. Real people lost their jobs due to the tomfoolery of
others. I feel for them.

 _edit_

Are you saying that all 100 people got the generous severance package?

~~~
foota
At the end of the article it states that they offered their employees a chance
to leave if they wanted with a generous severance package and that 10% took
it. Doesn't sound like they forced them to leave.

~~~
rhizome
It's only generous in dotcom terms. My mom took an early-retirement package
from Kaiser Permanente as a bog-standard phone-room nurse: free no-copay
health insurance for the rest of her and my dad's life. Free treatment, free
prescriptions, free _equipment_. Free everything, for life.

~~~
vecter
That's a great deal for your mom, I'm glad she was able to get such an amazing
deal.

On the other hand, Zenefits is an unprofitable startup with huge internal
problems. Clearly, expecting them to provide such sorts of benefits would be
beyond unreasonable.

~~~
rhizome
_On the other hand, Zenefits is an unprofitable startup with huge internal
problems._

That's the "dotcom" part, but yeah.

~~~
vecter
I strongly beg to differ. That's just every startup in general. The dotcom
days were way more debaucherous and perverse than what's going on today with
startups.

~~~
rhizome
Sorry, my mistake, I was using "dotcom" for the larger movement beyond the
2000 crash, including today. I was there, I can see the differences and
similarities.

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gatsby
Amazing that repricings like this are so rare that even investors like A16Z
never / rarely see it:

>>“This is a unique situation, we’ve never seen it before and we don’t expect
to see it again,” said a spokesperson for Andreessen Horowitz.

What's the advantage for the company?

The article makes it seem like this was David Sacks' decision and he's trying
to coerce existing investors into signing off on this "new deal," making it
even more strange.

~~~
55555
Yeah I don't get it. Is the company offering investors more equity in order to
prevent a lawsuit for failing to disclose the shady stuff they were doing?

~~~
borski
Yes. That is precisely what is happening.

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encoderer
I think we'll find David Sacks is going preserve his blue chip reputation by
leading the crippled Zenefits into the safe harbor of a rich insurance
conglomerate or PE firm. Getting these investors paid out would be the
ultimate amends.

