How Zenefits Reached About 10,000 Customers at a 65% Gross Margin While Targeting $100M ARR (Interview with CEO Jay Fulcher)

Introduction and Jay Fulcher's Background

Nathan Latka

00:00Hello everyone, my guest today is Jay Fulcher. He's the Chairman and CEO at Zenefits. He brings more than twenty years of experience in leading both public and private technology companies to Zenefits. Before the company, Jay served as CEO of another company and Agile Software. Before that, he was senior executive at both PeopleSoft and SAP. He's a member of the Global Leadership Council at the Lucas Graduate School and College of Business at San Jose State University. Jay,

00:25are you ready to take us to the top?

Jay Fulcher

00:27Let's go, Nathan.

Taking Over Zenefits: The First Week and the Pivot

Nathan Latka

00:28All right. So you have fun stories to tell. I want to kind of hop right in and then talk about where Zenefits is today and where you and the organization is going on the future. But first, I've got to talk about something only you can talk about, which is taking over a unicorn, right? Amongst all kinds of different things. Your first week, you're having to cut almost 50% of the company, but still keep everyone motivated around

00:49and unite around a new vision. What was that first week like back in 2017?

Jay Fulcher

00:53Yeah, mean, it's not the way any CEO would wanna kind of start their tenure, that's for sure. But in some ways it was kind of an exciting time, right? We were reimagining what we thought Zenefits could really mean to the marketplace. It did require really a resizing of the organization and a rethinking of really our business strategy. And one of the reasons why I was really attracted to the opportunity when the partners at Andreessen Horowitz

01:21called me to see if I would be interested was the fact that the company had already accomplished so much and we had already done some really incredible things in terms of establishing some kind of land speed records for SaaS company growth. But what we hadn't yet done is we hadn't necessarily perfected our business model and really what we wanted to do with the company in terms of our value proposition. And so, it's not often when you

01:48have thousands of customers and plenty of cash with which to be able to kind of affect this pivot and to go in this new direction. And so it was a hard first week, but it was also one that basically was really the thing to kind of set the tone for where we are today.

Managing Investor Expectations and Resetting the Vision

Nathan Latka

02:04In 2016, this was reported by CNBC, the annual recurring revenue by the middle of that year was about 60,000,000 down from obviously projections that Parker had raised on previously around a $4,000,000,000 valuation. Their reports valuation was cut in half and that, you know, there was about a 100,000,000 lost the first six months in 2016. All that being said, you know, at that time, the company was basically on track to run out of cash by the end

02:26of twenty seventeen. Let me ask you a question about VC. A lot of times people will say when you raise venture capital, you have to be on a different track than what you would rationally do because the nature of VC and timetables. How much of managing Andreessen and other investors expectations? How much resetting did you have to do in that first couple of months on the job?

Jay Fulcher

02:45Well, of all, I'm really fortunate because we have very sophisticated investors who really understood the overall opportunity that the company was trying to pursue. And quite frankly, was able to kind of get over some of the crisis management work that company obviously had to work through when we were kind of going through some of our compliance challenges. I didn't really have to reset a lot of expectations. Instead, what I basically tried to help everyone understand is

03:10that I felt like it was more important for us instead of being a broker of insurance, we needed to kind of get back to our roots of being a technology company. And we felt that by being a technology company, we could actually, instead of competing with brokers, we could collaborate and cooperate with brokers in bringing a completely new paradigm, new value proposition to small business where you could have HR payroll and benefits products side by side

03:39on a single platform and do all of the things that I think Zenefits now has become pretty broadly known for. So it really didn't take a lot of rethinking with the investment group. In general, what we really tried to do was we tried to resize kind of the cost of goods and the expense line for the business. You talked about being out of cash in 2017, that's clearly not the case at this point. We have actually

04:03several years of runway to go if we never raised another dime. And we have sort of cashflow breakeven in our sights. And so we've got a lot of nice momentum now where the company's really repivoted itself in a very healthy way to be a sustainable long term high growth business.

Controlling Cost of Goods Sold and Extending Runway

Nathan Latka

04:21What were one of the or two of things you did to really control the cost of goods sold? That's obviously what extended your runway significantly and now has put breakeven in your crosshairs.

Jay Fulcher

04:29Yeah, there's several things, Nathan. I think number one, as you say, we did in fact kind of right size the company. And so as hard as that was, because these are employees that quite frankly did nothing wrong, they were actually stellar performers, they did great things for Zenefits, but we basically had to get to a better headcount perspective. And part of that was not only in San Francisco, but across the three or four offices we have

04:54around the world. So that was one piece. Second piece was, as I said before, basically no longer being a broker and instead relying on third party brokers to basically build their brokerage and advisory services on top of the Zenefits platform. That allowed me to take a lot of the headcount and a lot of the focus and the organizational calories that are expended around insurance brokerage and instead shift that to these partners. And it allowed us to

05:23retreat and kind of double down on being this tech platform. I think those two things were substantial kind of resizing elements that allowed us basically to kind of be in a very different place from a cash burn perspective, as well as making sure that the couple hundred million dollars that we had to work with was gonna really serve us over the course of the next several years.

Transitioning the Insurance Book of Business

Nathan Latka

05:48Jay, did you have to go through a period when you're pushing that insurance line of business off to now brokers doing it and building it themselves on top of your tech platform? That sounds like that's what the refocus was. But did you temporarily lose revenue as you push that revenue stream essentially onto somebody else to manage?

Jay Fulcher

06:02Yeah, the initial transition of what we call our book of business, which was the insurance business that we had, and that was a very large business at the time. This is

Nathan Latka

06:10Can you quantify it?

Jay Fulcher

06:11Yeah, that's a business that was coming up on a $100,000,000 in revenue. That was a substantial kind of transition as you ship that to third parties. And so for some of the customers who potentially wanted to work with any and whatever broker they wanted, or if in fact they really preferred to work with Zenefits as their brokerage, gave them an opportunity to think about for the first time, well, what brokerage relationship do I really want? And

06:38so there's some breakage that occurs in that kind of a transition, which is exactly what we expected. We were really excited at that, not only in all of the modeling that we did in that process, we actually lost a lot fewer customers than we sort of expected to. But the most exciting part of this is that when we moved everyone off of our brokerage, we also basically moved from a freemium model where people got our software

07:06for free in exchange for the brokerage commissions that we received to a subscription pay model. And the thing that was clearly a huge point of validation for me that I was excited about is more than 70% of our customers moved with us.

Gross Margin, Pricing and Average Contract Value

Nathan Latka

07:21Oh, that's great. Now, today are you a pure play SaaS company with SaaS like margins in the 85% range?

Jay Fulcher

07:28That's right. We don't have margins in the 85% range, and I know that in the past I've heard you say that you talked to a lot of companies that claim that. I'm actually dubious about that, but the reality is

07:37that

Nathan Latka

07:37Do think they're lying, they're not putting costs in the right spot?

Jay Fulcher

07:40I think that there is a lot of interpretation around COGS.

Nathan Latka

07:45What do you put above the line?

Jay Fulcher

07:47Well, think, you know, kind of rather than going through sort of an accounting tutorial, I think it's more of a situation where there's a certain amount of fixed costs that are sort of at a floor. We're sort of at the 65% gross margin place right now today. Over time, by the way, each incremental dollar I put on top of that floor causes that 65% to start to get into the 85% range. So I do believe that

08:11we have some targets that get us into the 80% plus gross margin range. My view is I believe that we're sort of somewhere between twelve to eighteen to potentially twenty four months away from that.

Nathan Latka

08:23Got it. Are you though today a pure play SaaS company or are there other professional services kind of high cost?

Jay Fulcher

08:30We're a pure play subscription software company and we're basically focused on HR, payroll, and we think really importantly benefits. So it's on a single platform and that's specifically focused on what we call SMB companies, which are defined as sort of one to 500 employees.

Nathan Latka

08:47Got it. And in that range, I mean, if an SMB kind of company listening right now wants to sign up with you, what are they gonna pay to get kind of a base layer in month one?

Jay Fulcher

08:55Yeah, I mean, it can be for really small companies that are maybe less than 10 employees or less than 20 employees, it can be as inexpensive as $5 per employee per month on up to potentially $50 per employee per month. Our average contract value today is in the sort of 4 to $5,000 range.

Nathan Latka

09:15A month?

Jay Fulcher

09:17A month? Well, we have them per month or per year. It depends on the size of the company. But the thing that we're pretty excited about is that we've got a fairly broad and deep set of capabilities across those three product areas that I mentioned. And that really allows us to provide value to companies of all sizes. And so on the one end of the spectrum, we might have somebody paying us 10 or $15,000 a year

09:45for what Zenefits is managing across HR, payroll and benefits. In other cases, we may have somebody paying us $150,000 a year. But on average, we probably mostly have the bulk of our contract values are somewhere between 5 and $15,000 per year.

Customer Count and Retention Metrics

Nathan Latka

10:00And I wanna get into more kind of as a CEO, how you're managing all the different cohort analysis. Not only do you have different customer cohorts, you also have a bunch of different products that probably all have separate unit economics depending on where people get onboarded. I want to talk about that in a second, but first tell us about the success here. How many customers have you scaled to today?

Jay Fulcher

10:20Yeah, so what's really, I think exciting for us is that we have basically around 10,000 customers. These are customers that are in some cohort consuming some or all of our product line. We've been able to, as I said before, we've been able to not only convert the customers that we have today, but we've also been able to kind of expand the amount of dependence they have on our products for how they run their business. Today we're

10:52retaining more than 90% of our customers who have not annual contract with us.

Nathan Latka

10:57Okay, so what And that's are logo or revenue retention?

Jay Fulcher

11:00That's logo.

Nathan Latka

11:01And that's gross or net?

Jay Fulcher

11:03That's gross.

Nathan Latka

11:05Okay, that's great.

Jay Fulcher

11:06And then on the negative net churn, you know, what's really cool for us is that obviously to the degree that we do churn some of our revenue and it's for us in the 15 to 20% range. And by the way, for SMB, when you're talking with especially we super small think that that's actually pretty much best in class. But one of the things that we're excited about is because of the negative net churn with new products

11:31and new seats, we're more than making up for the amount of churn revenue we have every month.

Nathan Latka

11:31What does expansion

Jay Fulcher

11:31We're

Nathan Latka

11:31look

Jay Fulcher

11:31really pleased with, we got a really, really big customer base that's very much rooting for Zenefits. They really like what we've done for them over the years. I think they're really glad to see that we're back on track. And I think that in general, because we've been able to sort of stabilize the business here

11:55over the course of last year, now we're back to really growing the company pretty quickly. I mean, the SaaS part of our business separate from the insurance business is right now growing 100% year over year. And we expect it to do the same this year.

ARR Milestone Target and Revenue Discussion

Nathan Latka

12:09Can you share what that's at today? Run rate wise?

Jay Fulcher

12:11Yeah, I'm not gonna share. You know, I know you've got CEOs all over the map around how they handle this.

Nathan Latka

12:16Do you know what actually you listen to, have you listened to episodes before?

Jay Fulcher

12:20I have.

Nathan Latka

12:20Nice Jay, I'm excited about

Jay Fulcher

12:20I'm

12:23a fan of your show.

Nathan Latka

12:25I'm not gonna go soft on you the rest of the interview though.

Jay Fulcher

12:27No, know. I understand that. I would expect nothing like

Nathan Latka

12:30A 100% year over year growth though. Mean, that's good stuff. Tell me though, I am doing some sort of math here wrong. If I take those 10,000 customers times that $4,000 ARPU, that puts you at 40,000,000 a month. I know you're not there, maybe in a couple of years. I know you're not there yet, but where am I doing that math wrong?

Jay Fulcher

12:44Well, obviously, first of all, it's a bell curve, right? So you've got customers at all different places in terms of how much revenue and how much revenue per customer. The other part of it is that it's not all SaaS, some of it's also a part of our brokerage business. One of the things that we think is kind of unique about our insurance business is that when we did move that to a third party, we created a

13:05rev share vehicle over the course of several years now, where we claim some of that revenue as does some of our partner. Fairly soon, we're gonna be announcing some additional new broker partners who will also be starting to build some of that capability on top of our platform, which means it gives us an opportunity to sell more of our HR and payroll and benefits products to their customer bases. Conversely, they're able to use some of the

13:31efficiency that we provide with our tech into their insurance book. So it's a very kind of a symbiotic relationship with the broker community. We're excited about that, but it's sort of in motion. So some of what you're doing there is you're kind of conflating our SaaS business with our insurance business. And of course there's customers of all different sizes.

Nathan Latka

13:52Understood, understood. I won't try and pay down on a specific number, but I am interested. I mean, when you look at the growth of the company in terms of run rate, mean, you think you'd break a 100,000,000 this year or have you already broken that? Give me a big range?

Jay Fulcher

14:04I think the best thing I can tell you Nathan is the next imminent milestone that we're focused on is a $100,000,000.

Team Size and Office Locations

Nathan Latka

14:11Great, that's perfect. I love that. Thanks for sharing that. Appreciate it. So give more about the breakdown of the team today. So obviously I had to go through some restructuring. A lot of that was tied to costs on supporting that insurance business. What's the team size today and what's the breakdown look like?

Jay Fulcher

14:25Yeah, so we have about 500 employees and we probably have another 150 or so contractors around the world that are working with us. We have a headquarters here in San Francisco and then we have a very large operation in Tempe, Arizona. If you're familiar with sort of the greater Phoenix area, that's a hub for insurance and benefits companies. And so

14:46we've loved being down there because it's been a great source of talent for us. We also have a fairly large office now in Vancouver, BC.

Nathan Latka

14:53Okay.

Jay Fulcher

14:54That's primarily an R and D office, although it's now got some multifunctional parts. And then we've got a large group of about 50 employees or so in Bangalore.

Nathan Latka

15:04Bangalore.

Jay Fulcher

15:05So that's kind of the current mix. We just opened a satellite office elsewhere here in the Bay Area to try to help with traffic issues and ease of commute and that kind of thing. This is interesting, I think everybody's aware that the Bay Area's struggling with being a place that can kinda manage the needs of a young workforce. And so we're working on that. And we've got some plans that I'm not really gonna divulge about some

15:35additional offices that we're about ready to open, but that'll come between now and the end of the year.

Capital Strategy, Runway, and M and A

Nathan Latka

15:39Love hearing that. You said you've got break even in the crosshairs. If you've got them in crosshairs and people really believe it, that means you have an incredible amount of leverage when it comes to capital markets. Do you see a raise happening in the near future for Zenefits or no?

Jay Fulcher

15:51You know, I've never known a credible CEO at least that would say that they're not done raising money, because you never know. One of the things that's really interesting in this day and age is that I think we're in a really frothy kind of M and A market. And we're constantly looking at companies and frankly, we're constantly pitched with different companies that are looking for a home. And so there could be some scenarios here where we

16:17would do some additional things. That being said, I've got a three year plan that doesn't require us to raise any additional capital. And that frankly gets us not only to break even, but to gets us to profitability well before that three year period. And so we're excited about being more or less in control of our own financial destiny.

Nathan Latka

16:36Are you in M and A talks right now with anybody in terms of Zenefits exiting?

Jay Fulcher

16:41No, we're not. And our company's not for sale. We're really excited about what we're doing. You

16:50know,

Nathan Latka

16:50Come on Jay, my not for... If Benioff comes and offers you 10x ARR, you don't look at that?

Jay Fulcher

16:57Oh, we look at everything. You ask me, am I in a conversation with somebody? I know. I'm not. And if you know something about my background, you know that I've been relatively active and successful in monetizing companies over the years. So me, my job is to make sure all the options are on the table, whether we take the company public, whether there's some other kind of a monetization event out there. Quite frankly, like I said, or

17:22maybe I think you were the one that said it, having the leverage to be able to make those choices as and when you want to is is basically the key for any entrepreneur.

Competitive Landscape and the HR Market Opportunity

Nathan Latka

17:31It's huge. It's huge. Yeah. Your space is interesting. You know, in preparing for this interview, Colin Day was just on from iCIMS. Right? I mean, he's built a bootstrapped, the $180,000,000 AR company doing basically one thing on what you guys do. Then there's other companies like Gusto that have raised a bunch, but they're attacking you kind of from a different angle. It's funny. I mean, when you look at this space and you look at all the

17:49competition, if you had, I'm gonna make this up, 1,000,000,000 from a private equity firm, there's a lot of these companies you could roll up at essentially like 0.7 to 0.9 X ARR. And basically, if you thought you could buy and get leverage across, having all these assets under one thing, you could do it. I mean, do you think like that or is it something you're considering or?

Jay Fulcher

18:09Well, first of all, I think that there are some segment of the private equity market or the private equity community that does think that way, that's actually been a fairly proven model for them in different enterprise sectors. I think the HR space, and I think you're well aware of this, the HR space is an interesting one because it's so damn big. It's just such a big opportunity. I mean, 99.7% of all companies in The US have

18:34fewer than 500 employees. So this is such a huge market. Globally, is about a $95,000,000,000 market. And so for a lot of us, we have sort of the luxury of being able to follow in the footsteps of companies that have come before us that are now pretty much incumbent companies that have built software maybe ten or fifteen years ago, and in some cases, unfortunately, even longer ago than that. And that really doesn't serve the needs of

19:01what I consider to be sort of this new nature of work. These are young companies that have only digital natives that are working in them. They expect a product to work on a cell phone, they expect mobility, they expect products to be able to talk to one another, seamless integration. I mean, you don't need the commercial here, but this ability for young businesses especially not to be distracted by all the administration of running a business is

19:36crucial. And what is really cool, I think about what we're trying to go do is that we have this opportunity to not only do that with our own products, but with a really neat ecosystem of partners that kind of extend our capabilities in ways that companies did not have prior to this. And they certainly didn't have it with the likes of ADP or any of the Paycoms, Paylocities, the companies that have been at this for a

20:01long time. In the last five years, we've made a lot of progress here and we've driven and built our software with what I consider to be sort of the latest and greatest technology capability that lets these young companies focus on driving their businesses.

Famous Five: Books, CEOs, Tools, and Sleep

Nathan Latka

20:16Jay, let's wrap up here with the famous five. Number one, what's your favorite business book?

Jay Fulcher

20:21Yeah, so my favorite book, this is a hard one because I love all of them. I love so many of them, but my friend Ben Horowitz wrote The Hard Thing About Hard Things and that is a phenomenal book. For any entrepreneur that's listening, if you've not only read it, but then begun to dog ear it and frankly use it as a reference point, I really recommend you do that.

Nathan Latka

20:44Number two, Jay, is there a CEO you're following or studying right now?

Jay Fulcher

20:48So I had the luxury of reporting to both Dave Duffield at PeopleSoft and Hasso Plattner at SAP, And that just means I'm really old, but it also means that I got to see these guys up close and personal. So I learned so much from those guys. But the guy that right now I think is really blazing a trail for what I consider to be sort of next generation CEO thinking is Marc Benioff. I think Marc's done

21:11a great job around being a socially responsible company. I think he's done a great job around the 1-1-1 model. I love what he means around the whole diversity and inclusion ethic. And then lastly, he built a platform business in a SaaS context when people kinda made fun of them for doing it. And now look at all of us. We're all wanting to build a business like that. That's exactly what we're doing here at Zenefits.

Nathan Latka

21:36Number three, besides your own, what's your favorite online tool for building your business?

Jay Fulcher

21:39Well you know Zenefits is my number one, but I really like Slack. You know, we extend our solution where people don't actually need to leave Slack in order to be able to fire off transactions and Zenefits. I think that's really cool and I think Slack is just a really good collaboration tool. I like Alexa, we're actually using voice recognition products for actually utilizing and leveraging HR capability. I mean, there's a lot of online tools, but I

22:08think Slack and some of these voice products are cool examples.

Nathan Latka

22:11And number four, Jay, how many hours of sleep are you getting every night?

Jay Fulcher

22:16I have a very good friend of mine in the last couple of years who I've spent a lot of time with, Ariana Huffington, and so I've learned a lot about sleep and the importance of sleep. And I will tell you as a younger guy, I did a crappy job of getting enough sort of restorative rest to be able to be as good as I need to be. But yeah, get eight hours and I'm pretty religious about

22:35it.

Nathan Latka

22:35That's good. And what's your situation? Married, single, you have kiddos?

Jay Fulcher

22:39Way married, four kids.

22:40Way married, four kids.

Nathan Latka

22:41And how old are you, Jay?

Jay Fulcher

22:43I'm 56.

Nathan Latka

22:4456, last question. What do you wish your 20 year old self knew?

Jay Fulcher

22:48I

22:50wished I would've known that I could go slower in order to go faster. I wished that I could've been a little more introspective. One of the things that entrepreneurs ask me a lot of times when I'm speaking is, what's the one thing that you would really have me focus on in order for me to kind of realize all my dreams? And I think self awareness, not self absorption, but self awareness is such a critical thing for

23:15people to focus on, spend time with, and really delve into. Because the better you know yourself, the better you can work with other people and that's what makes everything go.

Nathan Latka

23:24Go slower to go faster. You heard it here from Jay, had a lot of courage to jump into Zenefits back in 2017. First week he's right sizing the business. He's changing the cost structure completely. A combination of those two things has put breakeven and profitability in his crosshairs. The next big milestone they're going for is $100,000,000 in ARR now sobering over 10,000 customers and in a market that's really a $95,000,000,000 plus market. 90% annual logo retention,

23:50that's gross. That's a gross number. In addition to that, to 20% gross revenue churn annually, net negative once you add expansion back onto that team of 500 people based between San Fran, Arizona, Vancouver, Bangalore, a few other locations. Zenefits. HR. Jay, thank you for taking us to the top.

Jay Fulcher

24:06Thanks, Nathan.