Startup Zenefits Shows How Hard Hitting Revenue Targets Can Be

By | February 22, 2016

Zenefits probably couldn’t have predicted it would spend the first two weeks of February dealing with the resignation of its founding chief executive officer under pressure from the board and the loss of its biggest customer—all while facing investigations by authorities in at least two states. That stuff can be hard to foresee. But financial performance is something businesses are expected to better at forecasting. Yet the corporate benefits startup missed the mark there, too.

Bloomberg Businessweek chronicled some of the recent drama behind co-founder Parker Conrad’s departure and the creation of a deceptive tool known as “the Macro.” Still, the numbers are worth a closer look. Fundraising documents obtained by Bloomberg show that Zenefits offered prospective investors an optimistic outlook on growth that it failed to deliver on almost immediately. The documents were distributed in advance of the financing round from May 2015 that valued the company at $4.5 billion. Zenefits declined to comment.

Zenefits develops software designed to simplify and automate human resources tasks, including signing up for health insurance. It’s a cloud software company and, as such, it typically measures performance using a financial metric known as annual recurring revenue. This is a fairly common way to gauge the health of a cloud business, and it has the added benefit of reminding investors that the subscription revenue will keep coming every year. Investors have been offering serious love to the cloud, so you’ll hear more technology companies talk about annual recurring revenue.

Zenefits said it had annual recurring revenue of about $20 million in 2014. In the fundraising documents, the company projected annual recurring revenue of $127 million for 2015. By the time Zenefits closed its financing round, the forecast had dropped to $100 million in a statement it sent to reporters.

While Zenefits increased annual recurring revenue at least threefold in 2015, topping $60 million, it was well short of even the more conservative target. The startup’s more distant projections were no less aggressive. It expected to generate $3.26 billion in annual recurring revenue by the end of 2019, according to the fundraising documents. That would make it bigger than Photoshop creator Adobe Systems Inc.’s digital media business is today.

Annual recurring revenue refers to the value of all customers’ subscriptions over the course of a year. It can be a predictable way to estimate full-year revenue because subscribers tend to stay aboard, said Lou Shipley, a lecturer at MIT. “The benefit for this model is that as long as you can keep your renewal rate in the mid-90 percent range,” he said, “you can plan your spending better with less risk.” In 2014, Zenefits lost 11 percent of customers but expected to reduce its churn rate to 4 percent by 2019, according to the fundraising documents.

However, when customers do leave, the recurring revenue number can give the impression that a company has booked revenue it doesn’t have. This month, Zenefits lost its biggest client, Inc., according to BuzzFeed. “It’s hard,” Shipley said. “Companies get acquired. Companies go out of business. There’s a natural melt-off.” Zenefits said on Thursday that it had made several changes to its executive leadership, appointing a chief strategy officer and a vice president of product management.

Annual recurring revenue and actual revenue can differ substantially. While Zenefits had 2014 annual recurring revenue of $20 million, actual revenue that year was $7.8 million, according to the financial documents. The discrepancy makes sense because Zenefits was growing rapidly and probably added many of its customers in the latter half of the year.

Younger companies can more easily recover from these kinds of stumbles, particularly those such as Zenefits that are far outpacing their rivals. “When they’re growing that quickly, they really get a little bit of a break before they’re public,” Shipley said. “Once you become public, you kind of have to beat and raise and work the Wall Street game. I don’t think it’s going to hurt them that much. The way to think about is, ‘Are there any competitors growing faster than them?’ And I don’t think there are.”

Zenefits is still expanding quickly, but missing targets can take a toll. Fidelity Investments, which led last year’s $500 million financing round with TPG, wrote down the value of its Zenefits stake last year. Fidelity and TPG declined to comment.


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Latest Comments

  • February 25, 2016 at 5:33 pm
    Agent says:
    Yet another failure by the goofy millennial crowd.
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