Zenefits is effectively cutting the value of its most recent funding round to $2 billion from $4.5 billion so the reeling San Francisco-based startup can give some investors a larger ownership share of the company, after laying off hundreds of employees.

"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," Zenefits Chief Executive Officer David Sacks said in a statement Thursday.

Common shareholders, mostly employees and the company’s founders, will see their shares diluted by 20 percent, while private-equity firm TPG and mutual fund giant Fidelity Investments will see their stakes increase, Sacks said in a statement.

Employees will get a special stock grant equal to 25 percent of their current shares, to make up for the dilution. Executives will receive extra grants, too. Sacks’ own $12.5 million investment in the company will be diluted by about 20 percent, and he said he offered not to take the new executive equity award.

Investors and employees who agree to the changes also have to sign away their rights to sue Zenefits, its founders and management. "This is important for the company to move forward and put the past behind us," Sacks said in the memo.

The lower valuation may make it easier for Zenefits to someday raise money again. "It’s a really smart move by David. Everybody takes a little bit of dilution and it resets expectations to a reasonable level," said Ben Ling, a partner at venture capital firm Khosla Ventures, a Zenefits backer. "Employees will be more motivated because when their valuation is realistic they can feel like they’re building for something realistic."

Not all investors are pleased. Zenefits is one of Andreessen Horowitz’s largest investments in the seven-year history of that venture capital firm, and it was not a champion of this deal, a person familiar with the matter said. Andreessen’s stake in Zenefits will go down after the adjustment, but it voted for the transaction anyway, the person said.

"This is a unique situation, we’ve never seen it before and we don’t expect to see it again," a spokeswoman for Andreessen Horowitz wrote in an e-mail. "We continue to believe in our investment in Zenefits."

In 2015, Zenefits sought new funding and TPG indicated it would pass on the deal. However, Parker Conrad, then chief executive officer, and Andreessen Horowitz partner Lars Dalgaard -- an adviser to TPG and a Zenefits director -- persuaded the private-equity firm to invest, people familiar with the matter said. In the end, TPG and Fidelity invested $500 million in Zenefits in May 2015 at a $4.5 billion valuation including the new cash, an eye-popping number even compared to other hot startups’ valuations.

In the months that followed the round, Zenefits missed its financial targets. Then the company got embroiled in scandal after it was revealed that some employees were using software that let them avoid taking the required training for a license to sell health insurance. Conrad, CEO at the time, built the tool.

Conrad resigned in February under pressure from the board, and Sacks, the company’s chief operating officer at the time, took the CEO role. Some employees with licensing problems had reported up to Sacks.

When Sacks took the CEO job, he declared a restart. He added venture capitalist Peter Thiel, TPG’s Bill McGlashan and Tesla board member Antonio Gracias to the board. Sacks, who worked at Zenefits for more than a year before Conrad’s ouster, has tried to distance himself from the company’s past problems.

Earlier this month, Zenefits cut 106 jobs, and Sacks invited employees who no longer wished to work at the company to leave, offering them four months severance and health benefits. The startup is down to about 900 employees, after at one point having more than 1,600.

During the May 2015 fundraising round, Conrad sold $10 million of his stock, Sacks said in his memo.

Bloomberg LP, the parent company of Bloomberg News, is an investor in Andreessen Horowitz.

Instant Insights /

Zenefits cuts valuation to $2 billion, makes deal with investors

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