Zenefits’ Hard Times Means Good Times for Rivals

Before Zenefits derailed earlier this year, it was upending the human resources and insurance industries by giving away cloud-based core HR management software to small companies as an incentive to become their benefits broker of record.

Zenefits might be going through a tough stretch, but the so-called “freemium” concept the former high-flier popularized is alive and well. Strike that; it’s booming. As Zenefits reorganizes, competitors such as BambooHR, Deputy, GoCo, Gusto, Justworks Inc., Maxwell Health, Namely Inc. and a host of others are marketing their own core HR tech for small and midsize businesses, including a handful with “freemium” services where the software is free but you pay for certain features.

There’s a lot at stake. Small businesses comprise the bulk of the country’s economy but have long trailed larger enterprises in adopting any HR technology more sophisticated than Excel spreadsheets. That’s changing as small companies are buying enterprisewide HR software at a much earlier stage than before, according to Sierra-Cedar Inc.’s 2015-16 HR Systems Survey. That could be based on a need created by the Affordable Care Act for smaller employers to adopt better benefits accounting.

HR Tech Contenders

As Zenefits tries to right itself, rival HR tech startups are wasting little time raising capital to compete for small and midsize business customers.

Sources: CrunchBase, Owler Inc., companies listed

Zenefits was among the first to capitalize on those trends. The company grew fast by promising to streamline HR processes such as onboarding and tracking paid time off through a free app. It attracted $500 million in venture funding, tripled recurring revenue in 2015 to $60 million, and almost quadrupled its workforce to close to 1,500.

“They attacked the complacency of the market,” said Mark Stelzner, managing principal at HR tech consultant Inflexion Advisors. Zenefits put benefits advisers on notice that they had to do more than just advise. “The downstream impact has been wonderful for the market,” he said. “It’s fantastically hot right now.”

Zenefits’ fortunes plummeted after revenue fell short of projected milestones, customers complained about fumbled benefits, Fidelity Investments downgraded the value of its interest in the business and news reports alleged unlicensed employees were selling insurance. In February, Zenefits founder and CEO Parker Conrad resigned and was replaced by Chief Operating Officer David Sacks. After the longtime Silicon Valley executive and investor took over, Zenefits revealed employees used computer programs to stay logged into online training they needed for insurance licenses. In an effort to right the company, Sacks eliminated an enterprise sales group, cut other staff and put an end to its now-infamous frat-party atmosphere.

Today, competitors such as Deputy, GoCo and WebHR have their own free or low-cost cloud-based core technology for small and midsize businesses, and others offer extended free trials so potential customers can try before they buy.

Justworks CEO Isaac Oates said he began the 4-year-old company after his own run-in with clunky HR processes at his previous startup. Oates, an ex-Amazon.com Inc. software engineer, differentiated Justworks by structuring it as a professional employer organization so the company and its customers are co-employers. Oates wouldn’t disclose revenue, but said Justworks signed up small and midsize clients with an aggregate of 6,000 employees since launching 18 months ago.

After Nir Leibovich sold a software developer he’d co-founded to a larger company, he used Zenefits to manage the businesses’ 75 to 85 employees. He loved the software until the day his wife called from the dentist’s office saying their insurance had been denied — a problem he traced back to Zenefits. It inspired him to start GoCo Inc., which he said is built on popular open-source software code used by Facebook Inc. and Netflix.

Concurrent with introducing its cloud-based HR suite late last year, GoCo raised $1.8 million from benefits broker Digital Insurance Inc., a subsidiary of Fidelity National Financial Inc. As part of the deal, Digital Insurance is pitching GoCo to its base of 30,000 customers, Leibovich said.

Other HR tech startups have raked in even more venture backing, though none has raised as much as Zenefits. In the first quarter of 2016, Justworks closed a $33 million deal in a third round of financing for a total of $53 million, and Namely raised $30 million, bringing its total funding to $110.6 million. Gusto, which changed its name from ZenPayroll in September 2015 to reflect its expanded business, raised $91.6 million during the year, bringing its total to $117.7 million.

Startups aren’t operating in a vacuum. Established HR tech players such as ADP, Kronos Inc. and SAP’s SuccessFactors sell cloud-based HR technology for small and medium-size businesses that’s built from scratch or derived from base code from their midmarket and enterprise-level platforms. Stelzner said he wouldn’t be surprised if major players waited for HR technology startups to gain ground and then snapped them up to round out their own offerings — not unlike the rollups of talent management and Web-based learning startups of a decade ago.

“There’s tremendous opportunity, but there’s not room for all of them to thrive,” he said.