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Why Zenefits and Other Tech Upstarts are Getting Their Comeuppance

Zenefits UtahZenefits Utah
Utah governor Gary Herbert sign HB141, a law that allows Zenefits to operate in Utah.Courtesy of

Part of the charm of successful tech-industry startups is their willful disregard of prevailing realities. They laugh at things as they exist, invent new approaches, and reap the rewards when they get it right.

They succeed, of course, unless they guess wrong and reality bites them in the rear end.

The current boom-bust cycle may best be remembered for the insouciance of a crop of startups that ventured into heavily regulated industries and are only now finding out it’s tougher than they thought to ignore government. The weekend edition of The Wall Street Journal carried news related to three good examples.

The first is Zenefits, an upstart provider of human-resources software that is attempting to “disintermediate”—remember that annoying word from the first Internet bubble?—traditional health-insurance brokers. Zenefits discovered that its founder and CEO might have been a little too cavalier in how the company sold health insurance, a licensed affair. Zenefits dismissed 17% of its staff Friday and is trying to get to the bottom of its licensing issues, which state regulators are investigating.

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Formerly high-flying LendingClub also is tweaking its business model because loans it hadn’t considered falling under regulatory scrutiny might be after all. According to the Journal, the company will “give up an undisclosed amount of revenue to avoid potentially being blocked from making loans by state usury laws.”

In a third example, the Journal reports that a variety of financial services companies that had hoped to use social media data to rate creditworthiness have been forced to retreat. The satisfying reason, at least for those who take umbrage at the screw-tradition crowd’s arrogance: Social media companies like Facebook don’t want to give out the data for fear of being regulated themselves as consumer-reporting agencies.

Zenefits is scrambling to create formal policies.

There are exceptions to this trend, of course. Despite setbacks in certain places, Uber and Lyft have thrived by acting first and seeking permission later. Yet by and large the upstarts who assumed regulations didn’t apply to them are getting their comeuppance. They’ll find business will get increasingly tougher, kind of like it is for the boring incumbents they seek to displace.