Zenefits CEO David Sacks just announced a deal with its investors to give them a bigger chunk of the company in exchange for their agreement not to sue.
In May 2015, investors plowed $500 million into Zenefits for about 11% of the company, valuing the then 2-year-old business at $4.5 billion.
The new deal gives them 25% and revalues the company at $2 billion.
In exchange, investors must agree not to sue the business after it disclosed that it was under investigation by multiple states for selling insurance without a license, and it openly accused its founder, ex-CEO Parker Conrad, of writing a computer program used by employees to “circumvent a state licensing requirement,” as Sacks puts it.
Sacks was the COO at the time and also an investor who had put in millions of dollars of his money. But he says that he had no idea about this program. As soon as he found out, he took action, Conrad resigned, and has been cleaning everything up ever since.
Because this agreement will also dilute common shareholders, including employees, Zenefits is giving workers more shares so they are “trued up” through a special stock grant that fully vests in one year. This is a grant, not stock options, so employees won’t have to worry about an underwater strike price. Their percentage of the company will essentially be unchanged.
Sacks says that the executives will get new four-year grants, except for himself and cofounder Laks Srini, who are forgoing the extra shares to make sure that there are enough shares for everyone else. That means that Sacks will see his stake reduced through dilution.
Several large investors have already agreed to this, including Fidelity, TPG, Andreessen Horowitz, and Insight Venture Partners, and Sacks says that all shareholders will be offered the agreement soon.
But there’s one exception: The $10 million of stock that Conrad personally sold to investors to cash out some of his equity as part of that C round. Zenefits isn’t offering them this deal and they don’t have to give up their right to sue, Sacks says, adding, “I hope that issue will be resolved in the near future.”
Zenefits is a private company and doesn’t have to freely air its dirty laundry like this agreement. But because Zenefits’ troubles became so public, Sacks is also being extremely candid about the things he’s doing to resolve them.
Here’s the full emailed statement Sacks sent to investors and employees:
“SUBJECT: Investor Settlement
“As you all know, I became CEO of Zenefits in February after it was discovered that the previous CEO/founder had written a software program (or ‘Macro’) that was widely disseminated in the company to circumvent a state licensing requirement. He resigned, the Board asked me to step in, and since that time, we have been working to remediate the situation and reset our relationships with all of our key stakeholders. These include regulators, industry partners, customers, employees and investors.
“Our efforts have included self-reporting the Macro issue, bringing our licensing into compliance, changing our leadership and governance, instituting new company values, and transforming the culture so that compliance is a top priority. We announced plans with Salesforce to open-source our licensing controls so the rest of the industry could benefit from our technology. We also offered a generous voluntary separation package (‘The Offer’) for any employee who did not agree with the new direction. I’m proud that roughly 90% of employees chose to stay and re-commit to the new Zenefits.
“Today we are announcing something similar for our investors. 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. 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. We are announcing that agreement today.
“This agreement will increase the ownership of our Series C investors, who invested approximately $500 million in May 2015, from about 11% of the company to about 25%. This effectively revalues the Series C at a $2 billion valuation. The Series A and Series B investors will receive small adjustments to offset their dilution. The common stock will be diluted about 20% from its current level — about the same as a typical financing round. In my view, that is well worth it to realign our existing shareholders with the company. 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.
“We do not want employees to be negatively impacted by this agreement. So each non-executive employee of Zenefits will be ‘trued up’ through a special stock grant equal to 25% of their current number of shares. This new grant will vest 100% in 12 months. It will consist of RSUs rather than options so that employees don’t have to pay a strike price. Our executive team will also receive additional 4-year grants to incentivize them. However, co-founder/CTO Laks Srini and I have offered not to participate in this true-up in order to ensure that there are enough shares for employees. We will be diluted to the same extent as any other common stockholder.
“As part of this agreement, each participating investor will sign a release, which will allow the company to move forward and put the past behind us. This agreement does not include a release for the $10 million of stock that Parker sold personally; I hope that issue will be resolved in the near future.
“The agreement also contains a few provisions to foster good governance, such as the creation of a permanent seat for the Series C on the Board of Directors (which is already occupied by TPG’s Bill McGlashan) and the creation of a Compliance Committee on the Board. Both the company’s management and its investors believe these are wise things to do.
“The investor agreement has already been approved by a number of the company’s major investors including Fidelity, TPG, Andreessen Horowitz, and Insight Venture Partners. We will be offering it to all our investors shortly.
“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. 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.