Gusto's software pulls what the company knows about its 30,000 small-business customers from their payroll data —such as the number of employees, their salaries, and Zip codes—and then recommends the best benefits plans for a given business.

When a customer buys a plan, Gusto said it typically gets a 5 percent to 8 percent cut of each monthly premium from the insurance provider.

Gusto began in 2011 under the name ZenPayroll. Sensing an opportunity to sell its customers other things they might need as they grow, Gusto started work on a benefits service more than two years ago, Reeves said.

Last fall, the company ditched its old name and encouraged clients to input their health insurance information and manage accounts using Gusto's system. It offered to help customers renew their insurance plans via licensed brokers, but they couldn't shop for new plans.

Zenefits and Gusto had previously existed harmoniously in the Web browsers of HR departments across the U.S.

Many companies rely on Zenefits for its known services—in this case, insurance and other employee benefits—and Gusto for others, such as payroll management. They separately grew into venture-capital darlings, with Zenefits attracting a $4.5 billion valuation and Gusto a $1 billion valuation.

But Reeves saw an opening: "It was very clear—the frustration with data syncing and client-service problems they were facing."

He said Zenefits took shortcuts by hiring too quickly, spending money irresponsibly, and skimping on customer service, according to Reeves. "They hired 1,000 people to do a lot of these things behind the scenes by hand," he said. "But this has to be done in software. When you transmit lots of documents and data, it's not just more efficient; it's more accurate."

Zenefits CEO David Sacks countered, saying his company is "years ahead" in providing a service that combines payroll, HR, and benefits. "Payroll-only solutions appeal to a very limited segment of the market, which is why a few of these companies are trying to copy our all-in-one model," he said in an e-mailed statement. "We wouldn't be hearing this competitive rhetoric if they didn't think Zenefits was the company to beat."

Meanwhile, Zenefits has been moving onto Gusto's turf.

Zenefits started offering a payroll tool in November. Sacks, who took over as CEO in February, has said the company is refocusing on small businesses. The average business using Gusto's services has 10 employees.

Gusto's expanded insurance sales will first be made available in California. Companies in seven other states can transfer existing insurance policies to Gusto's software in the meantime.

"Our approach has been to build payroll as the core and add these insurance services," Reeves said. "Zenefits took a different approach. By doing insurance first, you have to exist on top of other payroll services. We feel we have a significant advantage and head start."

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