(Reuters) — Software startup Zenefits FTW Insurance Services has cut a highly unusual deal with investors to increase their ownership while slashing the once-hot firm's valuation as it seeks to avoid litigation and mend damage in the wake of revelations of cheating.

The deal, a concession to investors in the firm's latest funding round, will boost the investors' combined stake to about 25% from about 11% but cuts the Zenefits' valuation by more than half to $2 billion from $4.5 billion.

Investors who will see their ownership rise include mutual fund Fidelity, Insight Venture Partners and private equity firm TPG, who took part in a $500 million financing round last year.

These investors, along with Andreessen Horowitz, which made two investments in about six months, have already approved the agreement, Zenefits CEO David Sacks said in a statement on Thursday. In return for a larger stake, investors will "sign a release of claims against the company," Mr. Sacks said.

Investors in earlier funding rounds will also have some of their dilution offset. Employees will get a special stock grant that vests over one year.

"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 said.

San Francisco-based Zenefits was once deemed by some investors to be the fastest growing software startup in Silicon Valley history. The company offers human resources software for free to businesses and makes money acting as a health insurance broker, working as the middleman between businesses and providers such as Anthem Blue Cross, and charging a broker fee.

But earlier this year the company disclosed that co-founder and then-CEO Parker Conrad had written a software program, called "Macro," that helped employees circumvent state licensing requirements.

Regulators in California and Washington launched investigations into Zenefits' business practices. Mr. Conrad resigned, and Mr. Sacks, a serial entrepreneur who had been serving as chief operating officer, took over.

Mr. Sacks has taken a number of steps to push the company into compliance. He said Zenefits self-reported problems to regulators, repaired and improved licensing systems and weeded out people involved in "Macro."

The new shareholder agreement does not include a release of claims for the $10 million of stock that Mr. Conrad had sold, according to Mr. Sacks' letter. Mr. Conrad has been largely silent since he resigned.

Zenefits has laid off more than 350 employees in recent months, and another 100 employees took a severance offer.