AVALARA, INC. - Annual Report: 2020 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2020

OR

Commission File Number 001-38525

AVALARA, INC.

(Exact name of Registrant as specified in its Charter)

Registrant’s telephone number, including area code: (206) 826-4900

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☒

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, based on the closing price of the shares of common stock on the New York Stock Exchange on June 30, 2020 was $10,322 million.

The number of shares of Registrant’s Common Stock outstanding as of February 18, 2021 was 85,426,659.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Definitive Proxy Statement relating to the 2021 Annual Meeting of Shareholders, are incorporated by reference into Part III of this report. The Definitive Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of the 2020 fiscal year.

Table of Contents

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements that involve substantial risks and uncertainties. All statements other than statements of historical facts contained herein, including statements regarding future events or our future results of operations, financial condition, business, strategies, financial needs, and the plans and objectives of management, are forward-looking statements. In some cases you can identify forward-looking statements because they contain words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “likely,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “target,” “will,” “would,” or similar expressions and the negatives of those terms. We have based these forward-looking statements largely on our current plans, expectations, and projections about future events and financial trends that we believe may affect our results of operations, financial condition, business, strategies, financial needs, and the plans and objectives of management. Our actual future results may be materially different from what we expect. Forward-looking statements are based on information available to our management as of the date of this report and our management’s good faith belief as of such date with respect to future events and are subject to a number of risks, uncertainties, and assumptions that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited to:

We caution you that the foregoing list of important factors may not contain all of the material factors that are important to you. New risk factors emerge from time to time, and it is not possible for our management to predict all risk factors nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in, or implied by, any forward-looking statements. Further, our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.

In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this report, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain and investors are cautioned not to unduly rely upon these statements.

You should not place undue reliance on our forward-looking statements and you should not rely on forward-looking statements as predictions of future events. The results, events, and circumstances reflected in the forward-looking statements may not be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements. The forward-looking statements made in this report speak only as of the date of this report. We undertake no obligation to update any forward-looking statements made in this report to reflect events or circumstances after the date of this report or to reflect new information or the occurrence of unanticipated events, except as required by law. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

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PART I

Item 1. Business.

Overview

Avalara is a leading provider of tax compliance automation for businesses of all sizes. Every business, regardless of size, faces a bewildering and burdensome array of constantly shifting transaction tax collection, reporting and remittance obligations imposed by a patchwork of local, regional, state, and national taxing authorities. The rise of omnichannel commerce and international trade has increased this compliance burden. Avalara’s mission is to eliminate this burden and allow companies to focus on their core operations. We offer a leading suite of cloud-based solutions to assist companies with transactional tax and related compliance requirements. This multi-product platform – the Avalara Compliance Cloud – consists of calculation, returns, compliance document management, licensing and registration, tax content, and insight solutions. Our vision is for the Avalara Compliance Cloud to be the leading, category-defining, global cloud compliance platform.

The changes in global economies and technology adoption are generational shifts in favor of Avalara’s compliance automation business. Increases in digital commerce and ongoing adoption of cloud technologies are behavior and productivity shifts that we expect to continue indefinitely. Alongside mounting regulatory change and government adoption of technology for fiscal transparency and efficiency, businesses around the world are looking for efficient, automated processes to mitigate risk and facilitate growth.

Transaction tax rules and regulations change frequently and are neither intuitive nor consistent across taxing jurisdictions, creating a massively complex compliance challenge. Determining the tax due on a particular sale depends not only on the precise geographic location of the transaction within relevant taxing jurisdictions and classifying the product or service into one of thousands of taxation categories, it also can vary based on the date of the transaction because of temporary tax incentives that change the tax rate for specific products, time periods, and transaction thresholds. Further complications to this multi-dimensional challenge arise from duties and taxes assessed on goods crossing national borders, and the thousands of rule changes enacted every year as taxing authorities amend their tax rates and taxability rules, modify jurisdictional boundaries, and implement other regulatory changes.

This complexity is often compounded by the necessity to perform transaction tax determination in real time, at the moment a transaction takes place or an invoice is created, and to determine and collect tax on numerous products or services in multiple jurisdictions. These circumstances are increasingly common with the rise of omnichannel commerce wherein businesses employ multiple channels to conduct sales, ranging from traditional in-store point of sale scenarios to multiple ecommerce platforms to digital marketplaces. Sales in these channels employ disparate transactional systems, each of which may contain their own transaction tax solutions ranging from third-party offerings like Avalara to rudimentary or homegrown capabilities. These basic tax calculation capabilities are often not sufficiently robust or current to provide accurate tax determinations for many businesses; more important, as each exists in a siloed channel, they do not offer businesses the ability to aggregate data across systems to enable efficient compliance. Data from those transactions and the associated taxes collected must be aggregated from each of the various systems to enable complete and accurate reporting, tax form preparation, filing, and remittance to the appropriate taxing jurisdictions. Traditional methods used by most businesses to aggregate and report transactions are burdensome, costly, and inadequate to the task. They involve manual aggregation and manipulation of data from disparate sources, reference to static tables in spreadsheet software, and reliance on internal staff to track relevant requirements and changes as well as to populate tax returns and ensure timely submission and payment.

Businesses relying on inadequate processes for transaction tax compliance risk miscalculations and incorrect collections on the front end, which can result in customer dissatisfaction, and inaccurate filings and payments to authorities on the back end, which can result in significant financial penalties.

The Avalara Compliance Cloud combines an advanced database of broad, deep, and up-to-date licensing, registration, and tax content with technology for executing compliance processes, including tax determination, aggregation of transaction data, tax document management, and tax return preparation, filing, and remittance. Our platform powers a suite of products that enables businesses to address the complexity of transaction tax compliance, process transactions in real time, produce records of transaction tax determinations, and reduce errors, audit exposure, and total transaction tax compliance costs. Businesses that use our solutions can allocate fewer personnel to manage transaction tax compliance and focus their efforts on core business operations.

The Avalara Compliance Cloud is designed to integrate seamlessly with our customers’ business applications and be easy to administer and maintain. As transactions are executed in our customers’ business applications, the Avalara Compliance Cloud performs a series of operations to deliver tax compliance functionality. This

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functionality is enabled through an application programming interface (“API”), with customers and partners leveraging our pre-built integrations that connect to business applications used for accounting, enterprise resource planning (“ERP”), ecommerce, marketplaces, point of sale (“POS”), recurring billing, and customer relationship management (“CRM”) systems, or developing API calls directly into their systems. These integrations are designed to reduce the need for custom configurations and ongoing oversight by customers. Our cloud architecture ensures that our tax content updates are automatically applied to tax determinations when called by our customers’ applications. Our powerful and intuitive web-based console simplifies configuration and unifies administration, reporting, and returns processing across a customer’s multiple business applications.

Because our solutions are deeply embedded in our customers’ business processes and systems and provide an automated solution that is central to their ability to transact, we become critical business partners with our customers that foster substantial long-term relationships, as evidenced by our low revenue churn and high net revenue retention rate.

Businesses across industries and of all sizes, ranging from small companies to Fortune 100 enterprises, use our solutions. While mid-market and smaller customers, with 20 to 500 employees, have historically been our primary target segment for marketing and selling our solutions, we are focused on extending our customer reach through investments in product and go-to-market capabilities that address the enterprise and emerging small business market segments globally. We believe these markets represent significant long-term future growth opportunities to augment our large mid-market opportunity where we believe we remain minimally penetrated. We have been launching new compliance capabilities aimed at capturing larger shares of these market segments. These include calculating cross-border customs duties and import taxes as well as consumer use taxes, which are imposed by state governments on transactions in which sales tax was not collected correctly or at all. Additionally, we introduced new functionality into our tax calculation service that allows businesses with more complex tax scenarios to customize the rates and rules applied to specific transactions. Our acquisition of Transaction Tax Resources, Inc. (“TTR”) provides inroads to the enterprise market via new customer and partner relationships as well as broadened tax content capabilities. We introduced a new, simplified returns service specifically aimed at small businesses and another for use by accounting firms seeking to extend their transaction tax business and margins. Our acquisition of Business Licenses, LLC (“Business Licenses”) provides new offerings for all market segments, from enterprise customers to emerging small businesses.

We sell our solutions primarily on a subscription basis. We target most prospects via cost-effective digital marketing strategies and initially qualify them using predictive analytics. The majority of our sales, to new and existing customers, are direct and conducted via telephone, requiring minimal in-person interaction. We expect, as we continue to expand our efforts upmarket to customers with larger and more complex needs, that we may need to resource for higher touch and in-person sales and support efforts. Our small business customers can subscribe to certain of our solutions via an automated, self-service ordering process, and we expect to continue to invest in a lower-touch sales and onboarding process. Our sales force also manages a network of business application providers and other customer referral sources that provide us with qualified leads and, in some cases, purchase functionality from us for use by their customers. We execute marketing programs targeting the ecosystems of these business application providers.

We also have acquired multiple businesses, primarily to augment the tax content of the Avalara Compliance Cloud, serve the needs of businesses in different geographies or industries, or improve our ability to serve additional aspects of transaction tax compliance. Substantial portions of our business, including our tax return preparation and filing and our compliance document management solutions, are based on acquired content and technology. Since 2018, we have acquired beverage alcohol tax, cross-border transaction (e.g., tariffs and duties) solutions, and artificial intelligence technology and expertise. In 2020, we acquired TTR and Impendulo Limited (“Impendulo”), as well as the operating assets of Business Licenses. TTR primarily serves enterprise businesses and their internal tax teams, offering U.S. sales and use tax rates, laws, software, and customer support required by the biggest and most complex companies. Impendulo is a London-based provider of insurance tax compliance solutions. Business Licenses provides software and services for the research, procurement, and management of business licenses, registrations, and permits for businesses of all sizes. We intend to continue pursuing opportunities to broaden our suite of solutions, content, and international presence.

Industry and Competition

Transaction taxes are ubiquitous and complex, and compliance is increasingly difficult for businesses of all sizes. Businesses, regardless of size, industry, or location, are subject to transaction tax compliance requirements. These requirements can be burdensome, even for a business transacting in only a single location, and become exponentially more complex for companies doing business in multiple taxing jurisdictions and offering numerous products and services that are taxed in different ways.

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Transaction tax exists at the intersection of commerce and government, and therefore political, economic, social, and technological changes may impact our business. Shifts happening in these areas today are driving complexity for businesses to manage tax, interest from governments in introducing and enforcing regulation, and businesses to apply technology to drive efficient results in compliance. Prior to the COVID-19 pandemic, the rise of ecommerce was an existing tailwind for our business. The pandemic accelerated adoption of online shopping, proving to be a generational shift that introduces tax complexity and drives the need for tax automation for more businesses. Global governments are responding to fiscal challenges by expanding tax requirements to capture more revenue from more businesses, and around the world more tax authorities are adding technological requirements such as live reporting for added transparency into revenue streams. Businesses of all sizes continue to put cloud technologies in place as the digital transformation of business continues, and the demand to facilitate distributed workforces continues. The availability of and trust in these technologies has furthered an emphasis on streamlining business processes to drive efficient growth. Macro trends such as these directly contribute to our value promise of delivering a more efficient technology solution to manage global compliance requirements.

These trends have accelerated or introduced new compliance challenges for businesses. The responsibility for accurately determining and collecting sales tax generally falls on the seller, who must go through a series of steps to determine the tax applicable to each transaction. When conducted manually, these steps are time consuming, involve complexities that are difficult to manage, and often prone to error. The volume and velocity of ecommerce transactions make manually calculating sales tax in real-time impossible.

Commerce across multiple jurisdictions increases the burden of transaction tax compliance as a result of the complexity arising from location-by-location, region-by-region, state-by-state, country-by-country, and product-by-product application of tax laws. Ecommerce, electronic marketplaces, globalization, and omnichannel retailing have facilitated cross-jurisdiction transactions for businesses of all sizes, increasing their transaction tax compliance burden and risk and the need for an automated compliance solution.

Due to the importance of tax revenue, taxing authorities continually seek ways to improve the efficiency, speed, and thoroughness of their collection and enforcement processes. New transaction tax requirements such as those imposed by many states following the U.S. Supreme Court decision in South Dakota v. Wayfair increase complexity for online merchants with geographically distributed customers. Globally, with the rise of online marketplaces, many tax authorities now require marketplace facilitators to consolidate tax reporting and payments for all sellers, adding meaningful complexity in data collection and reporting for the marketplaces and sellers alike. Commercial transaction reporting requirements also are changing, particularly in the international arena, as are registration and licensing obligations. A growing list of countries now require real-time reporting of commercial transactions and payment of tax obligations, and many countries require data integrations with government systems.

On the enforcement side, taxing authorities in the U.S. and worldwide have always conducted transaction tax audits to verify accurate and timely collection and payment. These audits can be time consuming and distracting to a business and are costly, including internal and external audit management costs, as well as payment of uncollected taxes, penalties, and interest. As tax revenue needs increase, pressure on collections increases as well. Automated tax compliance solutions improve business compliance efficiency as regulations continue to change, and businesses must adapt to more advanced techniques of identification and tax enforcement. Also, geopolitical changes such as the United Kingdom’s exit from the European Union (the “E.U.”) have meaningful implications for sellers around the world reaching large markets. New U.K. value-added tax (“VAT”) reporting requirements interrupt established paths and processes to reach these markets and can halt supply chain, fulfillment, and payment processes if not proactively addressed by businesses.

Many businesses attempt to handle transaction tax compliance processes manually, risking miscalculations and incorrect collections, which can result in customer dissatisfaction and/or financial penalties. Some businesses supplement their internal manual efforts with costly outsourced professional service firms to perform tax compliance functions. Many businesses process transactions using business applications such as accounting, ERP, ecommerce, marketplace, POS, recurring billing, and CRM systems. These systems sometimes include rudimentary tax calculation capabilities, but they are usually not sufficiently robust or current to provide accurate tax determinations.

The industry that provides support for transaction tax compliance is highly competitive and fragmented, but it is maturing. Rising complexity and increasing need for automated solutions have resulted in greater awareness of external solutions and there are now multiple public companies offering automated tax compliance solutions. Avalara believes that, in the age of digital commerce, it is inevitable that all businesses will adopt automated solutions to tax compliance over time. Until then, businesses will continue to employ a mix of approaches to address transaction tax compliance, including:

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We believe customers, including customers that are business applications providers, consider the following factors when selecting a transaction tax compliance solution:

Although different customers will weigh each of these factors in different ways, we believe our cloud-based solutions compare favorably across all of them. While Avalara’s services historically were designed for mid-market and small businesses, recent enhancements to our product and service offerings, along with business acquisitions, have broadened our appeal to both the emerging small business and enterprise market segments. There is always room for further improvement and Avalara continues to pursue new functionalities, service offerings, pricing structures, and additional content and integrations to strengthen our competitive position.

Avalara Compliance Cloud

The Avalara Compliance Cloud enables customers to address the complexity of transaction tax and complementary compliance processes with advanced technologies and solutions. Key strengths of the Avalara Compliance Cloud include:

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Products and Solutions

We offer a broad suite of solutions for transaction tax and complementary compliance requirements. Our solutions can be purchased individually or as an integrated compliance suite. We organize our solutions in six product categories that represent the core requirements for achieving compliance.

Calculations. Avalara’s calculation products determine tax rates for transactions based on data and logic within our tax and product content database, which are then populated into our customers’ business applications. Certain Avalara calculations products are unique to a customer’s industry, including fuel and beverage alcohol excise, insurance premium, lodging, and communications taxes. Transaction tax calculation is also regionally specific, and we provide VAT and GST products for international customers and cross-border solutions for customs duties and import taxes. Calculation products are generally sold on an annual subscription basis and many times as part of an integrated solution with other products, including returns and compliance document management. Calculations are primarily delivered through cloud-based deployments but can also be deployed on-premises.

Returns and Reporting. Avalara’s tax returns and reporting products manage and automate the returns process, from form and data preparation to filing to remittance of funds to tax authorities. The products track filing calendars and deadlines, manage requirements for each of the customer’s required jurisdictions, and facilitate the payment process. For those customers that purchase calculations and returns products, Avalara’s integrated solution leverages stored transaction data from the calculation product to populate returns forms. Avalara offers returns products specialized for certain tax types, including sales and use, VAT, fuel and beverage alcohol excise, insurance premium, lodging, and communications taxes. For many of the returns types supported by Avalara, we also offer to execute the remittance of tax collections to the taxing authorities. Avalara is also a certified service provider in the Streamlined Sales Tax (“SST”) program, which is an initiative by certain U.S. state and local governments to simplify sales tax compliance for qualifying businesses. The capabilities required of a returns product can vary by business size or type, therefore Avalara offers additional returns solutions tailored for small businesses and accounting firms. Around the world, returns and reporting vary by region and the government’s adoption of technology within the reporting processes. Avalara is expanding solutions for businesses to comply with live reporting and e-invoicing requirements in Europe, India, and Brazil. Our returns products are available integrated and embedded with calculations products, offered on a standalone managed basis, or accessed online via a self-serve web tool. Returns products are generally sold on an annual subscription basis and can be purchased on a per filing basis.

Compliance Document Management. Avalara’s compliance document management products automate the creation, sending, receiving, storage, and management of a variety of documents required for compliance through a cloud-based solution. Businesses are required to collect and maintain numerous official forms, including tax exemption certificates, W-8 forms, W-9 forms, 1099 forms for contractors, power of attorney forms, and other tax-related forms for identification such as passports and drivers’ licenses. The solutions make tax documents available for easy retrieval and help our customers keep them up to date and validated. The solutions also limit our customers’ audit exposure by establishing an audit trail for tax exempt transactions and other audit scenarios. We offer a specific product for fuel excise document requirements, as well as a regional product for customers doing business in Brazil. Compliance document management products are sold as part of a compliance suite with calculation and returns products, or as a standalone product. These products are generally sold on an annual subscription basis with optional managed services to assist customers with collecting and validating documents.

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Licensing and Registrations. Avalara’s licensing products and services support businesses of all sizes in the research, procurement, and maintenance of business licenses, registrations, and permits. These products also help customers acquire country, state, and local transactional tax registrations. For global businesses, Avalara offers a service to assist businesses selling internationally to obtain and maintain VAT registrations, a pre-requisite process to collecting, reporting, and remitting VAT payments in required jurisdictions. Licensing and registrations products and services can be purchased standalone on an as-needed basis, or as a subscription for ongoing management, maintenance, and storage of business licenses.

Fiscal Representation. To address the requirement of businesses to have a local fiscal representative in foreign jurisdictions when transacting outside of their home country, Avalara offers fiscal representation services, acting as the responsible party and point of contact for local tax authorities in case of questions or audits. Avalara fiscal representative services are generally sold on a subscription basis.

Content, Data, and Insights. Avalara content, data, and insights products leverage Avalara’s tax and content databases to produce actionable, detailed insights, which tax and finance professionals use to make informed decisions about tax compliance and financial planning. Avalara offers tax content subscriptions that allow customers to research tax rates and taxability explanations, and also provide access to tax rate explanations and legal documentation that customers can use to plan or defend tax decisions. Through Avalara’s classification services, customers can identify and align their product databases to Avalara’s proprietary tax codes, harmonized system codes, universal product codes, and other tax classifications. By providing past transaction data, customers can leverage Avalara’s risk assessment tools to analyze where they may be obligated to collect and remit sales tax. Additionally, Avalara offers content generation products specialized for industry platforms such as point of sale systems for retailers. Content, data, and insight products are sold as subscriptions or on an as-needed basis.

In addition to our cloud solutions, a small percentage of our revenue is derived from a broad range of specialized tax compliance services that we deliver on a standalone basis or in conjunction with the sale or implementation of our cloud solutions. These services include such projects as nexus studies and analysis, voluntary compliance initiatives, complex tax registrations, reverse audits, audit defense, and specialized tax research.

Competitive Moats

Our competitive moats include:

Partner moat. We and our partners invest in developing and maintaining an extensive collection of pre-built integrations that are designed to connect our solutions to a broad range of leading business applications, including accounting, ERP, ecommerce, marketplace, POS, recurring billing, and CRM systems. We believe these integrations provide a competitive advantage as they dramatically reduce implementation time, effort, and cost; enable our solutions to function seamlessly with the core applications our customers use to process and manage their transactions; and allow customers to easily and efficiently manage tax compliance across multiple business applications. We offer far more pre-built integrations with these applications than other tax software providers, and we plan to continue adding more. We have pre-built integrations with leading business application providers such as Magento, Intuit QuickBooks, Microsoft, NetSuite, Sage, 3dcart, Salesforce Commerce Cloud, and Epicor. In addition, we have relationships with ecommerce platform providers, including BigCommerce, Shopify, and others, that include our pre-built integrations in their platforms, allowing customers to easily choose our solutions to automate transaction tax calculations.

We have strategically built a broad ecosystem of relationships with our network of business application publishers (including ecommerce platforms) and their reseller channels, integration developers, implementation specialists, and accounting and financial advisors. These relationships provide us with an effective distribution channel, the majority of our pre-built integrations, a source of referral business, occasions for cross-selling, new opportunities for compliance automation, and early access to developing technologies.

Content moat. We have amassed, expanded, and integrated an extensive database of statutory tax content, including product classifications and taxability rules, exemption conditions, tax holidays, jurisdiction boundaries, tax rates, thresholds, licenses and registrations, and returns preparation and filing requirements, as well as millions of UPCs, linked to taxability rules. We employ a large group of tax research analysts and utilize artificial intelligence to continually update this library, which is processed by our calculation engine and delivered to our customers via our integrations. In addition to internal development, we have acquired multiple transaction tax-related businesses and acquired or licensed databases containing deep stores of knowledge to augment the tax content that supports our products. In 2020, we acquired TTR, whose core business is a sales tax content subscription service for tax professionals to determine and validate tax decisions and avoid costly mistakes. The content required for TTR’s subscription services extends our content database to include detailed research and

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documentation. We also have built and acquired a library of thousands of local, regional, state, and national tax return forms, tax exemption certificate forms, VAT and GST invoice templates, business license and registration forms, and other compliance documents. Our extensive tax content and forms databases enable us to serve the compliance needs of an ever-expanding list of businesses in different size segments, geographies, and industries such as fuel, communications, beverage alcohol, and lodging.

Platform and technology moat. Our proprietary platform was born in the cloud and offers a comprehensive and integrated set of transaction tax compliance solutions that enable our customers to automate and more efficiently manage their compliance processes. Our platform combines an extensive proprietary database containing tax jurisdiction boundaries, tax rates, product- and date-specific taxability rules, and return preparation and filing requirements, with advanced algorithms for precise real-time address validation via geolocation technology, application of taxability rules, tax determination, tax return preparation and filing, tax remittance, and tax forms and records management. Our platform processes billions of tax determinations and millions of returns per year, with speed, reliability, and security capabilities designed to serve the needs of even the largest of enterprise customers.

On our platform, we provide a comprehensive and expanding suite of solutions to address a full range of transaction tax compliance burdens and use cases for tax determination and reporting compliance across multiple tax paradigms including sales tax, VAT, and GST; determination of cross-border customs duties and import taxes; determination of use tax obligations; in addition to several other compliance requirements such as managing exemption certificates, and business licenses and registrations.

Our solutions can be configured and managed using our intuitive administrative consoles, which we regard as a significant differentiator from other transaction tax services because they facilitate fast and easy company-specific configuration, detailed transaction analysis, and access to detailed reports, worksheets, calendars, and other management functions. The consoles also provide a single point of management for various compliance solutions, scale as a customer’s needs grow or change, and automatically aggregate transactions from multiple business applications. We believe our comprehensive solutions enable us to provide added value to our customers, increase their loyalty and satisfaction, and raise their potential long-term value to us.

Growth Strategies

We plan to continue investing to provide our customers with best-in-class solutions and to expand our market opportunity. Our primary growth strategies include:

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Customers

Businesses across industries and of all sizes, ranging from small businesses to Fortune 100 companies, use our solutions. While mid-market and smaller customers, with 20 to 500 employees, have historically been our primary target market segment for marketing and selling our solutions, we are focused on increasing our market share and global customer reach through investments in product and go-to-market capabilities that address the enterprise and emerging small business market segments globally. We believe these markets represent significant long-term future growth opportunities to augment our large mid-market opportunity where we believe we remain minimally penetrated. In 2020, we launched several new compliance capabilities aimed at capturing larger shares of these market segments. These include calculating cross-border customs duties and import taxes as well as consumer use taxes, which are imposed by state governments on transactions in which sales tax was not collected correctly or at all. Additionally, we introduced new functionality into our tax calculation service that allows larger businesses with more complex tax scenarios to customize the rates and rules applied to specific transactions. And our TTR acquisition provides inroads to the enterprise market via new customer and partner relationships as well as broadened tax content capabilities. We introduced a new, simplified returns service specifically aimed at small businesses and another for use by accounting firms seeking to extend their transaction tax business and margins. Our acquisition of Business Licenses provides new offerings for all market segments, from enterprise customers to emerging small businesses.

We monetize our solutions through direct sales to customers and via certain partners, such as ecommerce platform partners, that include some of our solutions in their offerings and pay us for usage by their end customers. These platform customers may be core customers to Avalara, and their end-user customers represent opportunities to upsell additional products and become direct customers of Avalara over time. We use core customers as the primary metric for our current customer count reporting. As of December 31, 2020, 2019, and 2018, we had approximately 14,890, 12,150, and 9,150 core customers, respectively.

We define a core customer as:

Currently, our core customer count includes only customers with unique account identifiers in our primary U.S. billing systems and does not include customers that subscribe to our solutions through our international subsidiaries or certain legacy and acquired billing systems that have not been integrated into our primary U.S. billing

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systems (e.g., recent acquisitions and our lodging tax compliance solution). While most of our revenue is currently generated by customers located in the United States, we support transaction tax compliance and registration in Canada, Europe, South America, and Asia, and we are continuing to expand our international presence. As we increase our international operations and sales in future periods, we may add customers billed from our international subsidiaries to the core customer metric.

We also have a substantial number of customers of various sizes that do not meet the revenue threshold to be considered a core customer. Many of these customers are in the emerging and small business segment of the marketplace, which represents strategic value and a growth opportunity for us. Customers who do not meet the revenue threshold to be considered a core customer provide us with market share and awareness, and we anticipate that some may grow into core customers. In addition, we have larger customers that are early in their adoption or only utilize our services for small segments of their business, providing opportunities over time for us to extend our relationship and make them core customers.

In addition to customers with whom we have a direct relationship, some of our customers are business application publishers (including ecommerce platforms) that include automated tax determination powered by Avalara. While those platform customers may be core customers to Avalara, their end-user customers generally are not.

A summary of our core customers and net revenue retention rate is as follows:

For additional information regarding these metrics, see section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Business Metrics.”

Sales and Marketing

We sell our solutions primarily on a subscription basis with volume-based pricing. Our solutions are capable of addressing the transaction tax compliance needs of businesses of all sizes, from the smallest sole proprietors to Fortune 100 enterprises. While Avalara started by selling primarily to mid-market and small businesses, growth opportunity and customer need has expanded our reach into enterprise and emerging small businesses. To grow in these areas and expand beyond the mid-market, Avalara invests in specialized go-to-market strategies for sales and marketing unique to each segment.

While we generally identify and engage directly with our prospective customers, we leverage the sales and referral resources of a broad ecosystem of partners across all market segments. These partners include technology partners, systems integrators, and accounting firms. This ecosystem provides us with qualified leads through a variety of incentive programs. In some cases, providers purchase functionality from us for use by their customers, and we market our additional services to those end users. Additionally, we actively conduct programs to engage with state regulators, tax and accounting firms, payroll vendors, and financial services providers. In some cases, we use customer data obtained from our products or tools to help our customers anticipate compliance requirements and trigger expanded product adoption, such as the procurement of new business licenses in new regions, or risk assessment tools for economic nexus.

The majority of our mid-market and small business sales are conducted via telephone, requiring few to no in-person interactions with customer prospects. We target prospects via an omnichannel marketing program, including paid and unpaid digital advertising, direct mail, event marketing, account-based marketing, content marketing, prospect database nurturing, and other digital marketing activities. We also engage in awareness advertising activities using traditional print and electronic media.

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In addition to reaching highly targeted enterprise and mid-market prospects, our marketing investments and activities generate interest from large numbers of emerging and small businesses that also are burdened by transaction tax compliance requirements. Emerging and small business customers can purchase and configure smaller plans at lower price points through our self-service online marketplace without the involvement of our primary selling or customer onboarding teams. Additionally, we have established relationships with certain business application providers that target small businesses that have purchased our functionality for use by their customers and embedded our solutions into their offering. We believe serving small businesses is important because it expands our footprint and establishes customer relationships that may become more valuable to us over time as these customers grow, and also provides a potential barrier to entry from competitors that may seek to build market share by targeting the small business segment.

We reach each market segment, from emerging small business to enterprise, through channels and tactics that match their expectations for content, outreach, timeliness, and service level. This can require high touch service for some enterprise customers and a fully automated purchase path for the smallest companies. We hire and train both sales and marketing teams specialized for each segment.

Partners

Expanding and maintaining our partner ecosystem has been an essential part of our growth. We strive to be true and recognized instruments of our partners’ success, constantly engaging, investing in, and supporting them to create mutually valuable relationships that best serve our mutual customers. We emulate our partners’ go-to-market strategies to ensure alignment with their business processes. These relationships, along with our pre-built integrations, form a powerful moat against our competitors. Our goal is to be tightly integrated into our partners’ offerings, facilitating fast, simple onboarding and an easy-to-use experience for our shared customers.

Our partner ecosystem is comprised of technology partners, such as software developers and publishers, independent software vendors, ecommerce platforms, and marketplaces; systems integrators, including value-added resellers, services firms, and ecommerce companies; and accounting firms, including CPAs and bookkeepers. Partners have multiple ways in which to engage with Avalara. All partners can refer Avalara products and earn commissions. Many partners choose to become certified to implement Avalara solutions for their customers. Our technology partners integrate Avalara solutions into their applications and receive revenue share, and a subset of technology partners embed Avalara AvaTax into their platform as the default tax engine and offer their customers a bundled price.

Our partners range from globally known enterprises to startups and entrepreneurs who recognize the opportunity to add value to their customer relationships by leveraging our solutions. We offer these partners access to dedicated Avalara teams that provide sales and marketing assistance, as well as training and technical resources.

Research & Development and Tax Content Team

Our research and development organization is responsible for the design, development, security, and testing of the Avalara Compliance Cloud. We devote substantial resources to continuously improve and scale our platform, add innovative new features and functionalities, build technology to support new products and content types, and improve the user experience for our platform and solutions.

Our global content teams are responsible for building and maintaining our propriety database of tax and product content required to calculate transaction tax for our customers. Tax analysts rely on advanced technologies to acquire and maintain tax content, keeping existing content up to date with changes and using teams of researchers and tax experts to edit, validate, and apply the changes to our database. This large team monitors, tests, and updates our tax content to incorporate new and revised tax rates, rules, taxing jurisdiction boundaries, and exemption conditions.

Intellectual Property

We primarily rely upon a combination of confidentiality procedures, contractual provisions, copyright, trademark, patent, and trade secret laws, and other similar measures to protect our proprietary information and intellectual property. Our trademarks and service marks include Avalara, the Avalara logo, AvaTax, the Avalara Compliance Cloud, “Tax compliance done right,” “The Power of Orange,” marks for our acquired businesses, and various marketing slogans. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our solutions or to obtain and use information that we regard as proprietary and may also attempt to develop similar technology independently. Our means of protecting our proprietary rights may not be adequate.

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The software and internet industries are characterized by the existence of a large number of patents, trademarks, and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. Third parties may claim that our current or future solutions infringe their intellectual property rights. We have in the past and may in the future have to defend ourselves against claims of intellectual property infringement, which could be expensive for us and harm our business and financial condition even if such claims are unsuccessful.

Government Regulation

Our business is subject to a range of complex laws and regulations, mostly relating to our involvement in our customers’ financial transactions. To be successful, we must promote and monitor compliance with these legal and regulatory requirements.

We perform critical business functions for our customers, including tax determination, returns preparation and filing, and tax remittance. The federal Bank Secrecy Act requires that financial institutions, of which money transmitters are a subset, register with the U.S. Department of Treasury’s Financial Crimes Enforcement Network and maintain policies and procedures reasonably designed to monitor, identify, report and, where possible, avoid money laundering and criminal or terrorist financing by customers. Most U.S. states also have laws that apply to money transmitters, and impose various licensure, examination, and bonding requirements on them. We believe these federal and state laws and regulations were not intended to cover the business activity of remitting transaction taxes that taxpayers owe to the various states. However, if federal or state regulators were to apply these laws and regulations to this business activity, whether through expansion of enforcement activities, new interpretations of the scope of certain of these laws and regulations or of available exemptions, or otherwise, or if our activities were held by a court to be covered by such laws or regulations, we could be required to expend time, money, and other resources to deal with enforcement actions and any penalties that might be asserted, to institute and maintain a compliance program specific to money transmission laws, and possibly to change aspects of how we conduct business to achieve compliance or minimize regulation. We have contractually agreed with certain states collecting sales tax that in determining and remitting taxes on behalf of certain customers, we will comply with various technical, filing, privacy, confidentiality, bonding, and trust account requirements.

In the course of selling products and services, retailers and other businesses often come into possession of credit card numbers and other personal information of consumers. Determining the transaction taxes owed by our customers involves providing our solutions with the types and prices of products they sell, as well as information regarding addresses that products are shipped from and delivered to. Our tax exemption certificate management solution also requires input of certain information regarding the purchasers who are entitled to tax exemptions. Our beverage alcohol business requires collection of personal information about certain individuals associated with each customer, as well as information regarding beverage alcohol product purchasers and recipients. Numerous local, regional, state, and national laws and regulations govern the collection, dissemination, use, and safeguarding of certain information that could be used to commit identity theft or fraud. Although most of the data that is provided to our solutions by our customers cannot be used to identify individual consumers, we may be subject to these laws in certain circumstances. Most states and many countries have also adopted data security breach laws that require notice to affected consumers of any security breach as to their personal information. In the event of a security breach, our compliance with these laws may subject us, depending on the personal information in question, to costs associated with notice and remediation, as well as potential investigations from federal regulatory agencies, state attorneys general, and other governmental authorities.

Failures to safeguard data adequately or to destroy data securely could subject us to regulatory investigations or enforcement actions under federal or state data security, unfair practices, or consumer protection laws. The scope and interpretation of these laws, and the burdens and costs of complying with them, could increase in the future.

Human Capital Management

We believe our corporate culture provides an advantage in recruiting new employees and retaining our best talent, as well as driving behaviors across our entire organization that help us succeed. This culture is characterized in the many employees who embody our nine success traits: optimism, passion, adaptability, humility, fun, ownership, curiosity, urgency, and simplicity. The rallying point of our culture is the color orange. Our employees wear this color with pride every day, and we have trademarked the slogan “The Power of Orange.” Our culture permeates our sales and marketing outreach, and the significance of the color orange has been featured in multiple news articles. As a result, we believe our customers, partners, and many prospects readily identify and appreciate our culture in their interactions with the Avalara team.

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As of December 31, 2020, we had 3,351 full-time employees. Of these employees, 1,893 are based in the United States, 18 are based in Canada, 305 are in the United Kingdom and continental Europe, 968 are based in India, and 167 are based in Brazil. Our global workforce is highly educated, with most of our employees working in engineering, technical, or professional roles. With the exception of Brazil and certain countries in the E.U., where collective bargaining agreements are commonplace, none of our employees are covered by collective bargaining agreements. We believe our employee relations are good and we have not experienced any work stoppages.

We offer a competitive compensation package that is designed to attract new employees and retain, motivate, and reward current employees. Our compensation program includes base salaries, cash bonuses, and equity compensation for certain employees. In addition, we offer a range of benefits to our employees, including employee stock purchase plan for U.S. employees, retirement plans, medical, dental, and vision insurance, health and dependent care flexible spending accounts, health savings accounts, basic and voluntary life and accidental death and dismemberment insurance, and disability insurance.

Beginning in 2019, we engaged a leading polling and analytics firm to measure our employee engagement performance and have invested in company-wide initiatives to support our engagement goals. We are committed to continuous improvement through our investments in coaching, mentorship, training, and other initiatives designed to support our employees. These initiatives include an employee assistance program, commuter benefits, professional training and development platforms and opportunities, tuition reimbursement for eligible employees, employee resource groups, virtual events such as trivia contests and a global talent show, and free and subsidized exercise and mindfulness programs.

We have a number of employee resource groups that enhance our inclusive and diverse culture, including Women of Avalara, Veterans of Avalara, Prism (LGBTQ+), and Ujima (African American/Black). We continue to recruit technical talent in diverse communities, including by engaging as a sponsor of the annual Grace Hopper Celebration (the world’s largest gathering of women technologists) and AfroTech (a multicultural tech conference that brings leaders in technology and business together to exchange ideas and build a strong Black technology community). We require anti-harassment training as part of our new employee onboarding process and regularly for all employees, and we also conduct managing bias training for our leadership and executive teams.

In 2020, the COVID-19 pandemic had a significant impact on our workforce. Most of our employees have worked remotely since March 2020, and we anticipate that most of our employees will continue to work remotely for a significant portion of 2021. We have instituted safety protocols and procedures for the limited number of employees who continue to work on site. During the pandemic we launched an employee resource group for remote workers. We also conducted employee surveys to help us understand how the company is doing as an employer and identify employee concerns specifically in the context of handling COVID-19 requirements for our office locations and the impact of the pandemic on our employees.

Available Information

We also maintain a website at investor.avalara.com, through which we make available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act. All such filings are available free of charge. The information on, or that can be accessed through, our website is not part of this report and the inclusion of our website address in this report is an inactive textual reference only.

Item 1A. Risk Factors.

You should carefully consider the risks and uncertainties described below, together with all of the other information in this Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, before making an investment decision. If any of the events or circumstances described in the following risk factors actually occurs, our business, operating results, financial condition, cash flows, and prospects could be materially and adversely affected.

Risks Relating to Our Business and Industry

We have incurred significant operating losses in the past and may never achieve or maintain profitability.

We have incurred significant operating losses since our inception, including net losses of $49.2 million, $50.2 million, and $75.6 million in 2020, 2019, and 2018, respectively. We had an accumulated deficit of $559.4 million

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as of December 31, 2020. We expect our operating expenses to continue to increase in future periods as we hire additional sales and other personnel, improve the Avalara Compliance Cloud, invest in sales and marketing initiatives, expand our international reach, and potentially acquire complementary technology and businesses. If our revenue does not increase to offset increases in our operating expenses, we may never achieve or maintain profitability. Revenue growth may slow, revenue may decline, or we may incur significant losses in the future for a number of possible reasons, including slowing demand for our solutions, increasing competition, a decrease or slowing in the growth of the markets in which we compete, or if we fail for any reason to capitalize on growth opportunities.  If these losses exceed our expectations or if our revenue growth expectations are not met in future periods, our financial performance will be harmed.

Our revenue growth rate may not be sustainable.

Our revenue has grown rapidly, from $272.1 million in 2018, and $382.4 million in 2019 to $500.6 million in 2020. As our revenue base grows, we expect that our revenue growth rate will decline over time, and you should not rely on the revenue growth of any prior period as an indication of our future performance. This risk may increase with any future acquisition, particularly if the revenue growth rate of the acquired business has been lower than ours.

Our revenue growth rate depends on existing customers renewing and upgrading their subscriptions, and if we fail to retain our customers or upgrade their subscriptions, our business will be harmed.

Our customers have no obligation to renew their subscriptions for our solutions after the expiration of their subscription periods. Our customers may not renew subscriptions for a similar mix of solutions or transaction volumes. Our renewal rates may decline because of a number of factors, including customer dissatisfaction, customers’ spending levels, decreased transaction volumes, increased competition, changes in tax laws or rules, pricing changes, or legislative changes affecting tax compliance providers. If our customers do not renew their subscriptions or reduce the solutions or transaction volumes purchased under their subscriptions, our revenue may decline and our business may be harmed. Our future success also depends in part on existing customers upgrading their subscriptions. If our efforts to sell upgrades to our customers are not successful, it may decrease our revenue growth.

If we are unable to attract new customers on a cost-effective basis, our business will be harmed.

To grow our business, we must continue to grow our customer base in a cost-effective manner. Increasing our customer base and achieving broader market acceptance of our solutions will depend, to a significant extent, on our ability to effectively expand our sales and marketing activities. We may not be able to recruit qualified personnel, train them to perform, and achieve an acceptable level of sales production from them on a timely basis or at all. If we are unable to maintain effective sales and marketing activities and maintain and expand our partner network, our ability to attract new customers could be harmed, our sales and marketing expenses could increase substantially, and our business, results of operations, and financial condition may suffer.

If we fail to effectively manage our growth, our business, results of operations, and financial condition would likely be harmed.

We expect to continue to experience rapid growth in our headcount and operations, domestically and internationally, which may continue to place significant demands on our management and our administrative, operational, and financial reporting resources. We have experienced significant growth in the number of customers, number of transactions, and the amount of content we support. Our growth will require hiring additional employees and making significant expenditures, particularly in sales and marketing but also in our technology, professional services, finance, and administration teams, as well as facilities and infrastructure. Our ability to effectively manage our growth will require the allocation of management and employee resources along with improvements to operational and financial controls and reporting procedures and systems. In addition, as we continue to expand internationally, we will encounter unexpected challenges and expenses due to unfamiliarity with local requirements, practices, and markets. Our expenses may increase more than we plan, and we may fail to hire qualified personnel, expand our customer base, enhance our existing solutions, develop new solutions, integrate any acquisitions, satisfy the requirements of our existing customers, respond to competitive challenges, or otherwise execute our strategies. If we are unable to effectively manage our growth, our business, results of operations, and financial condition would likely be harmed.

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Revenue received as a certified provider in the Streamlined Sales Tax program is subject to price negotiations, and any decrease in payment rates or discontinuation of the program could adversely affect our business, results of operations, financial condition, and growth prospects.

We currently derive and, at least in the near term, expect to continue to derive significant revenue as a certified provider in the SST program. SST payment rates are subject to price negotiations with the SST Governing Board and its member states. For example, during 2021, we expect significantly lower revenue growth from SST services due primarily to a reduction in the fee we earn from these transactions. If SST payment rates were to decrease further or if the SST program were to be discontinued, our business, results of operations, financial condition, and growth prospects will suffer.

We may not successfully develop or introduce new and enhanced solutions that achieve market acceptance, or successfully integrate acquired products, services, or content with our existing solutions, and our business could be harmed and our revenue could suffer as a result.

Our ability to attract new customers and increase revenue from existing customers will likely depend upon the successful development, introduction, and customer acceptance of new and enhanced versions of our solutions and on our ability to integrate any products, services, and content that we may acquire. Moreover, if we are unable to expand our solutions, our customers could migrate to competitors. Our business could be harmed if we fail to deliver new versions, upgrades, or other enhancements to our existing solutions to meet customer needs on a timely and cost-effective basis. Unexpected delays in releasing new or enhanced versions of our solutions, or errors following their release, could result in loss of sales, delay in market acceptance, or customer claims against us, any of which could harm our business. The success of any new solution depends on several factors, including timely completion, adequate quality testing, and market acceptance. We may not be able to develop new solutions successfully or to introduce and gain market acceptance of new solutions in a timely manner, or at all. Additionally, we must continually modify and enhance our solutions to keep pace with changes in hardware systems and software applications, database technology, and evolving technical standards and interfaces. As a result, uncertainties related to the timing and nature of business application providers, announcements or introductions of new solutions, or modifications by vendors of existing hardware systems or back-office or internet-related software applications, could harm our business and cause our revenue to decline.

Our business and success depend in part on our strategic relationships with third parties, including our partner ecosystem, and our business would be harmed if we fail to maintain or expand these relationships.

We depend on, and anticipate we will continue to depend on, various third-party relationships to sustain and grow our business. We are highly dependent on relationships with third-party publishers of software business applications, particularly our largest partners, because the integration of our solutions with their applications allows us to reach their large customer bases. Our sales and our customers’ user experience are dependent on our ability to connect easily to such third-party software applications. We may fail to retain and expand these integrations or relationships for many reasons, including due to third parties’ failure to maintain, support, or secure their technology platforms in general and our integrations in particular. Any such failure could harm our relationship with our customers, our reputation and brand, and our business and results of operations.

As we seek to add different types of partners to our partner ecosystem, it is uncertain whether these third parties will be successful in building integrations, co-marketing our solutions to provide a significant volume and quality of lead referrals and orders, or continuing to work with us as their own products evolve. Identifying and negotiating new and expanded partner relationships requires significant resources. In addition, integrating third-party technology can be complex, costly, and time-consuming. Third parties may be unwilling to build integrations, and we may be required to devote additional resources to develop integrations for business applications on our own. The contracts applicable to third parties’ development tools may be unfavorable and add costs or risks to our business or may require us to push additional contract terms to our customers that affect our relationship with our customers. Providers of business applications with which we have integrations may decide to compete with us or enter into arrangements with our competitors, resulting in such providers withdrawing support for our integrations. In addition, any failure of our solutions to operate effectively with business applications could reduce the demand for our solutions and harm to our business. If we are unable to respond to these changes or failures in a cost-effective manner, our solutions may become less marketable, less competitive, or obsolete, and our results of operations may be negatively impacted.

In addition, we leverage the sales and referral resources of our partners through a variety of incentive programs. In the event that we are unable to effectively utilize, maintain, and expand these relationships, our revenue growth would slow, we would need to devote additional resources to the development, sales, and marketing of our solutions, and our financial results and future growth prospects would be harmed. Additionally, our partners may demand, or demand greater, referral fees or commissions.

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Our acquisitions of, and investments in, other businesses, products, or technologies may not yield expected benefits and our inability to successfully integrate acquisitions may negatively impact our business, financial condition, and results of operations.

Since 2018, we have acquired beverage alcohol tax, cross-border transaction solutions, European insurance premium tax, and business licensing, as well as artificial intelligence technology and expertise. We likely will make additional acquisitions of or investments in businesses, products, content, and technologies in the future. We may not realize the anticipated benefits, or any benefits, from our past or future acquisitions. In addition, if we finance acquisitions by incurring debt or by issuing equity or convertible or other debt securities, our existing shareholders may be diluted or we could face constraints related to the repayment of indebtedness. To the extent that the acquisition consideration is paid in the form of an earnout on future financial results, the success of such an acquisition will not be fully realized by us for a period of time as it is shared with the sellers. Further, if we fail to properly evaluate and execute acquisitions or investments, our business and prospects may be seriously harmed and the value of your investment may decline. For us to realize the benefits of past and future acquisitions, we must successfully integrate the acquired businesses, products, or technologies with ours. Some of the challenges to successful integration of our acquisitions include:

Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and investments could cause us to fail to realize the anticipated benefits of such acquisitions or investments and negatively impact our business, financial condition, and results of operations.

If we fail to compete effectively, our revenue growth could be negatively affected.

We face significant competitive challenges from do-it-yourself approaches, outsourced transaction tax compliance services offered by accounting and specialized consulting firms, and other tax-specific software vendors. Many businesses using do-it-yourself approaches believe that manual processes are adequate and may be unwilling to pay the costs of our solutions, resulting in an inertia that can be difficult to overcome.

There are a number of competing tax-specific software vendors. Many of our competitors, as well as large accounting firms, have historically targeted primarily large enterprise customers, but also may market to small to medium-sized businesses. Other competitors who currently focus on small to medium-sized businesses may be better positioned than larger competitors to increase their market share with such businesses by competing on price, service, or otherwise. We also face competition from private transaction tax compliance businesses focused primarily on ecommerce. It is also possible that enterprises operating in adjacent compliance, finance, or ecommerce verticals may decide to pursue transaction tax compliance and become significant competitors. Increased competition may impact our ability to add new customers at the rates we have historically achieved. Our failure to successfully and effectively compete with current or future competitors could lead to lost business and negatively affect our revenue growth.

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We face significant risks in selling our solutions to enterprise customers, and if we do not manage these efforts effectively, our results of operations and ability to grow our customer base could be harmed.

Sales to enterprise customers typically involve higher customer acquisition costs and longer sales cycles. The historical sales cycle and conversion rate trends associated with our existing mid-market customers may not apply to larger enterprise businesses for whom purchasing decisions may require the approval of more technical personnel and management levels. In addition, larger customers may demand more integration services and customization, and our standard pricing model may be less attractive to certain customers with very high volumes of transactions. As a result, sales opportunities to larger businesses may require us to devote greater research and development, sales, support, and professional services resources to individual prospective customers, resulting in increased acquisition costs and strains on our limited resources. Moreover, these larger transactions may require us to delay recognizing the associated revenue we derive from these prospective customers until all revenue requirements have been met.

Our quarterly and annual results of operations are likely to fluctuate in future periods.

We expect to experience quarterly or annual fluctuations in our results of operations due to a number of factors, many of which are outside of our control. This makes our future results difficult to predict and could cause our results of operations to fall below expectations or our predictions. The other risk factors discussed in this “Risk Factors” section may contribute to the variability of our quarterly and annual results. In addition, a percentage of our operating expenses is fixed in nature and is planned based on forecasted financial performance. In the event of revenue shortfalls, we may not be able to mitigate the negative impact on our results of operations quickly enough to avoid short-term impacts.

Because we recognize revenue from subscriptions for our solutions over the terms of the subscriptions, our financial results in any period may not be indicative of our financial health and future performance.

We generally recognize revenue from subscription fees paid by customers ratably over the terms of their subscription agreements. As a result, most of the subscription revenue we report in each quarter is the result of agreements entered into during previous quarters. Consequently, a decline in new or renewed subscriptions in any one quarter will not be fully reflected in our revenue results for that quarter. Any such decline, however, will negatively affect our revenue in future quarters. Our subscription model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, as subscription revenue from new customers must be recognized over the applicable subscription terms.

If we make errors in our customers’ transaction tax determinations or when completing our customers’ returns or remit their tax payments late or not at all, our reputation, results of operations, and growth prospects could suffer.

The tax determination functions we perform for customers are complicated, time-sensitive, and dependent on the accuracy of the database of tax content underlying our solutions. Some of our processes are not fully automated, such as our process for monitoring updates to tax rates and rules, and, even to the extent our processes are automated, our solutions are not proven to be without possibility of errors. If we make errors in our customers’ tax determinations or when completing our customers’ returns or remit their tax payments late or not at all, our customers may be assessed interest and penalties. In addition, as a certified provider in the SST program, in some circumstances we may become liable to member states in the event of delinquent payment of taxes and may be responsible for certain tax liabilities. For certain of our solutions, we guarantee the accuracy or timeliness of the results or output provided by those solutions and could be liable under such guarantee for up to 12 months’ service fees for those solutions in the event of an error that results in uncollected or unremitted taxes, penalties, or interest. Although our agreements have disclaimers of warranties and limit our liability (beyond the amounts we agree to pay pursuant to our guarantee, if applicable), a court could determine that such disclaimers and limitations are unenforceable as a matter of law and hold us liable for these errors. Further, in some instances we have negotiated agreements with specific customers or assumed agreements in connection with our acquisitions that do not limit this liability or disclaim these warranties. Additionally, erroneous tax determinations could result in overpayments to taxing authorities that may be difficult to reclaim from the applicable taxing authorities. Any history of erroneous tax determinations or returns or failures to timely remit tax payments for our customers could also cause our reputation to be harmed, could result in negative publicity, loss of or delay in market acceptance of our solutions, loss of customer renewals, and loss of competitive position. In addition, our errors and omissions insurance coverage may not cover all amounts claimed against us if such errors or failures occur. The financial and reputational costs associated with any erroneous tax determinations or failures to timely remit tax payments may be substantial and could harm our results of operations.

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Cybersecurity and data security breaches may create financial liabilities for us, damage our reputation, and harm our business.

Our customers provide us with information that our solutions store, some of which is confidential information about them or their financial transactions. In addition, we store personal information about our employees and, to a lesser extent, those who purchase products or services from our customers. We have security systems and information technology infrastructure designed to protect against unauthorized access to such information, but we may not be successful in protecting against all security breaches and cyber-attacks. Threats to and breaches of our information technology security can take various forms, including viruses, worms, and other malicious software programs, or actions or omissions by an employee. Significant cybersecurity or data security breaches could result in the loss of business, litigation, regulatory investigations, loss of customers, and penalties that could damage our reputation and adversely affect the growth of our business.

In some cases, we must rely on the safeguards put in place by third parties to protect against security threats. These third parties, including vendors that provide products and services for our operations and our network of business application providers, could also be a source of security risk to us in the event of a failure of their own security systems and infrastructure, whether unintentionally or through a malicious backdoor. We do not review the software code included in third-party integrations in all instances.

Because the techniques used to obtain unauthorized access, or to sabotage systems, change frequently and generally are not recognized until launched against a target, we or these third parties have been and, in the future, may be unable to anticipate these techniques or to implement adequate preventative measures. With the increasing frequency of cyber-related frauds to obtain inappropriate payments, we need to ensure our internal controls related to authorizing the transfer of funds are adequate. We may also be required to expend resources to remediate cyber-related incidents or to enhance and strengthen our cyber security. Any of these occurrences could create liability for us, put our reputation in jeopardy, and harm our business.

Our platform, solutions, and internal systems, as well as external internet infrastructure, may be subject to disruption that could harm our reputation and future sales or result in claims against us.

Because our operations involve delivering a suite of transaction tax compliance solutions to our customers through a cloud-based software platform, our continued growth depends in part on the ability of our platform and related computer equipment, infrastructure, and systems to continue to support our solutions. In addition, in delivering our solutions to customers, we are reliant on internet infrastructure limitations. In the past, we have experienced temporary and limited platform disruptions, outages in our solutions, and degraded levels of performance due to human and software errors, file corruption, and first and third-party capacity constraints associated with the number of customers accessing our platform simultaneously. While our past experiences have not materially impacted us, in the future we may face more extensive disruptions, outages, or performance problems. In addition, malicious third parties may also conduct attacks designed to sabotage our platform, impede the performance of our solutions, or temporarily deny customers access to our solutions. If an actual or perceived disruption, outage, performance problem, or attack occurs, it could harm our reputation and the market perception of our solutions; divert the efforts of our technical and management personnel; impair our ability to operate our business; cause us to lose customer information; or harm our customers’ businesses. Any of these events may increase non-renewals, limit our ability to acquire new customers, result in delayed or withheld payments from customers, or result in claims against us.

Undetected defects in our solutions could harm our reputation or decrease market acceptance of our solutions, which would harm our business and results of operations.

Our solutions may contain undetected defects, such as errors or bugs. We have experienced such defects in the past in connection with new solutions and solution upgrades and we expect that such defects may be found from time to time in the future. Despite testing by us, defects may not be found in our solutions until they are deployed to or used by our customers. In the past, we have discovered software defects in our solutions after they have been deployed to customers.

Since our customers use our solutions for compliance reasons, any defects, disruptions in service, or other performance problems may damage our customers’ business and could hurt our reputation. We may also be required, or may choose, for customer relations or other reasons, to expend additional resources to correct actual or perceived defects in our solutions. If defects are detected or perceived to exist in our solutions, we may experience negative publicity, loss of competitive position, or diversion of the attention of our key personnel; our customers may delay or withhold payment to us or elect not to renew their subscriptions; other significant customer relations problems may arise; or we may be subject to liability claims for damages. A material liability claim or other occurrence that harms our reputation or decreases market acceptance of our solutions may harm our business and results of operations.

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We rely on third-party computer hardware, software, content, and services for use in our solutions. Errors and defects, or failure to successfully integrate or license necessary third-party software, content, or services, could cause delays, errors, or failures of our solutions, increases in our expenses, and reductions in our sales, which could harm our results of operations.

We rely on computer hardware purchased or leased from, software licensed from, content licensed from, and services provided by a variety of third parties to offer our solutions, including database, operating system, virtualization software, tax requirement content, and geolocation content and services. Any defects in third-party hardware, software, content, or services could result in errors or a failure of our solutions, which could harm our business. For example, in the past, we experienced a period of higher than usual latency and outages that impacted some customers resulting from a third-party provider data center infrastructure failure. In the future, we might need to license other hardware, software, content, or services to enhance our solutions and meet evolving customer requirements. Any inability to use hardware or software could significantly increase our expenses and otherwise result in delays, a reduction in functionality, or errors or failures of our products until equivalent technology is either developed by us or, if available, is identified, obtained through purchase or license, and integrated into our solutions, any of which may reduce demand for our solutions. In addition, third-party licenses may expose us to increased risks, including risks associated with the integration of new technology, the diversion of resources from the development of our own proprietary technology, and our inability to generate revenue from new technology sufficient to offset associated acquisition and maintenance costs, all of which may increase our expenses and harm our results of operations.

We rely upon data centers and other systems and technologies provided by third parties to operate our business, and interruptions or performance problems with these centers, systems, and technologies may adversely affect our business and operating results.

We rely on data centers and other technologies and services provided by third parties in order to operate our business. If such data centers fail to operate properly or become disabled even for a brief period of time, there could be a failover recovery latency, and we could suffer financial loss, a disruption of our business, liability to customers, or damage to our reputation. In addition, our response to any type of disaster may not be successful in preventing the loss of customer data, service interruptions, and disruptions to our operations, or damage to our important facilities.

Most of our current cloud service infrastructure is run on AWS and neither AWS nor our other data center providers are obligated to renew their agreements with us on commercially reasonable terms, or at all, and it is possible that we will not be able to switch our operations to another provider in a timely and cost-effective manner should the need arise. If we are unable to renew our agreements with any of our data center providers on commercially reasonable terms, or if in the future we add data center facility providers, we may face additional costs or expenses or downtime, which could harm our business.

Any unavailability of, or failure to meet our requirements by, third-party data centers, technologies, or services, could impede our ability to provide services to our customers, harm our reputation, subject us to potential liabilities, result in contract terminations, and adversely affect our customer relationships. Any of these circumstances could adversely affect our business and operating results.

Incorrect or improper implementation, integration, or use of our solutions could result in customer dissatisfaction and negatively affect our business, results of operations, financial condition, and growth prospects.

Our solutions are deployed in a wide variety of technology environments and integrated into a broad range of complex workflows and third-party software. If we or our customers are unable to implement our solutions successfully, are unable to do so in a timely manner, or our integration partners are unable to integrate with our solutions through our integrations, customer perceptions of our solutions may be impaired, our reputation and brand may suffer, and customers may choose not to renew or expand the use of our solutions.

If we fail to effectively maintain and enhance our brand, our business may suffer.

We believe that continuing to strengthen our brand will be critical to achieving widespread acceptance of our solutions and will require continued focus on active marketing efforts. Our brand awareness efforts will require continued investment across our business and particularly as we introduce new solutions that we develop or acquire and as we continue to expand in foreign markets. Brand promotion activities may not yield increased revenue, and even if they do, any increased revenue may not offset the expenses incurred in building our brand. If we fail to promote and maintain our brand, or if we incur substantial expense in an unsuccessful attempt to promote and maintain our brand, our business could suffer.

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Economic conditions and regulatory changes resulting from the United Kingdom’s exit from the E.U. could adversely affect our business, financial condition, and results of operations.

On January 31, 2020, the United Kingdom (the “U.K.”) exited from the E.U., commonly referred to as “Brexit,” and immediately entered into a transition period during which all E.U. rules and trading agreements remained in effect through December 31, 2020. On December 24, 2020, the U.K. and E.U. announced they had entered into a post-Brexit deal on certain aspects of trade and other strategic and political issues. The impact of Brexit is uncertain, but it has the potential to significantly disrupt the free movement of goods, services, and people between the U.K., the E.U., and other nations, increase legal and regulatory complexities, increase costs of conducting business in Europe, and lead to global economic uncertainty. Because we have based our European operations in the U.K., any of these effects of Brexit, among others, could adversely affect our financial position, results of operations, or cash flows.

We may not be able to secure financing on favorable terms, or at all, to meet our future capital needs, which could harm our business, results of operations, financial condition, and prospects.

From time to time, we may need to engage in equity or debt financings. The success of any future financing efforts depends on many factors outside of our control, including market forces, investment banking trends, and demand by investors, and we may not be successful in raising additional capital. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly impaired, and our business may suffer.

Our ability to use our net operating loss to offset future taxable income may be subject to certain limitations.

As of December 31, 2020, we had U.S. federal net operating loss carryforwards, or NOLs, of approximately $902.3 million due to prior period losses. In general, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its NOLs to offset future taxable income. Our existing NOLs may be subject to limitations arising from previous ownership changes. Future changes in our stock ownership, the causes of which may be outside of our control, could result in an ownership change under Section 382 of the Code. Our NOLs may also be impaired under state laws. Furthermore, our ability to utilize NOLs of companies that we may acquire in the future may be subject to limitations. There is also a risk that due to regulatory changes, such as suspensions on the use of NOLs, or other unforeseen reasons, our existing NOLs could expire or otherwise be unavailable to offset future income tax liabilities. For these reasons, we may not be able to realize a tax benefit from the use of our NOLs, whether or not we attain profitability.

We need to continue making significant investments in software development and equipment to improve our business.

To improve the scalability, security, efficiency, availability, and failover aspects of our solutions, and to support the expansion of our solutions into other tax types, such as international VAT, additional excise taxes, or additional lodging taxes, we will need to continue making significant capital equipment expenditures and also invest in additional software and infrastructure development. If we experience increasing demand in subscriptions, we may not be able to augment our infrastructure quickly enough to accommodate such increasing demand. In the event of decreases in subscription sales, certain of our fixed costs, such as for capital equipment, may make it difficult for us to adjust our expenses downward quickly. Additionally, we are continually updating our software and content, creating expenses for us. We may also need to review or revise our software architecture and user experience as we grow, which may require significant resources and investments.

If economic conditions worsen, it may negatively affect our business and financial performance.

Our financial performance depends, in part, on the state of the economy. Declining levels of economic activity may lead to declines in spending and fewer transactions for which transaction tax is due, which may result in decreased revenue for us. Concern about the strength of the economy may slow the rate at which businesses of all sizes are willing to hire an outside vendor to perform the determination and remittance of their transaction taxes and filing of related returns. If our customers and potential customers experience financial hardship as a result of a weak economy, industry consolidation, or other factors, the overall demand for our solutions could decrease. If economic conditions worsen, our business, results of operations, and financial condition could be harmed.

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Beginning in 2020, the novel coronavirus (“COVID-19”) pandemic led to widespread disruptions across the world, including in the states and countries in which we operate. As a result of the COVID-19 pandemic, we experienced and, in the future, may experience decreased demand for our solutions from customers along with slower collections on accounts receivable. Because we recognize revenue over the subscription term, the effect of the pandemic may not be fully reflected in our operating results until future periods. While we are developing and implementing risk mitigation plans and have temporarily reduced our pace of hiring and delayed certain other non-essential expenditures, these measures may not be sufficient to prevent adverse impacts on our business and financial condition from COVID-19. The degree to which the COVID-19 pandemic may impact our results of operations and financial condition is unknown at this time and will depend on future developments, including the geographic spread of COVID-19, the severity and the duration of the pandemic, the success of vaccines, and further actions that may be taken by governmental authorities or businesses.

Sales to customers or operations outside the United States may expose us to risks inherent in international sales and could negatively impact our business and results of operations.

Historically, transactions occurring outside of the United States have represented a small portion of our revenue. However, we intend to continue efforts to expand our international sales, including through our sales operations in Europe, India, and Brazil. Operating in international markets requires significant resources and management attention and will subject us to regulatory, economic, and political risks that are different from those in the United States, and our international expansion efforts may not be successful. Potential risks and challenges associated with sales to customers and operations outside the United States include:

Any of these factors could negatively impact our business and results of operations.

Risks Relating to Legal, Compliance and Regulatory Matters

We hold significant amounts of money on behalf of our customers that we remit to taxing authorities, and this may expose us to liability from errors, delays, fraud, or system failures, which may not be covered by insurance.

We handle significant amounts of our customers’ money for remittance to various taxing jurisdictions on their behalf. If our banks’ or our own internal controls and compliance procedures regarding cash management fail, are hacked or sabotaged, or if our banks or we are the subject of fraudulent behavior by personnel or third parties, we could face significant financial losses. Our efforts to remit tax payments to applicable taxing jurisdictions only after receiving the corresponding funds from our customers may fail, which would expose us to the financial risk of collecting from our customers after we have remitted funds on their behalf.

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Additionally, we are subject to risk from concentration of cash and cash equivalent accounts, including cash from our customers that is to be remitted to taxing jurisdictions, with financial institutions where deposits routinely exceed federal insurance limits. If the financial institutions in which we deposit our customers’ cash were to experience insolvency or other financial difficulty, our access to cash deposits could be limited, any deposit insurance may not be adequate, we could lose our cash deposits entirely, and we could be exposed to liability to our customers. Any of these events would negatively impact our liquidity, results of operations, and our reputation.

Changes in tax laws and regulations or their interpretation or enforcement may cause us to invest substantial amounts to modify our solutions, cause us to change our business model, or draw new competitors to the market.

Changes in tax laws or regulations or interpretations of existing taxation requirements in the United States or in other countries may require us to change the manner in which we conduct some aspects of our business and could harm our ability to attract and retain customers. If our platform and solutions are not flexible enough to adapt to changes in tax laws and regulations, our financial condition and results of operations may suffer. In addition, depending on the content of any sales tax legislation, the role of third-party compliance vendors may change and we may need to invest substantial amounts to modify our solutions or our business model. We also could see a decrease in demand, we could see new competitors enter the market, or we could be negatively impacted by such legislation in a way not yet known.

Changes in the application, scope, interpretation, or enforcement of laws and regulations pertaining to our business may harm our business or results of operations, subject us to liabilities, and require us to implement new compliance programs or business methods.

We perform a number of critical business functions for our customers, including remittance of the taxes our customers owe to taxing authorities. Our electronic payment of customers’ taxes may be subject to federal or state laws or regulations relating to money transmission. The federal Bank Secrecy Act requires that financial institutions, of which money transmitters are a subset, register with the U.S. Department of Treasury’s Financial Crimes Enforcement Network and maintain policies and procedures reasonably designed to monitor, identify, report and, where possible, avoid money laundering and criminal or terrorist financing by customers. Most U.S. states also have laws that apply to money transmitters, and impose various licensure, examination, and bonding requirements on them. We believe these federal and state laws and regulations were not intended to cover the business activity of remitting transaction taxes that taxpayers owe to the various states. However, if federal or state regulators were to apply these laws and regulations to this business activity or if our activities are held by a court to be covered by such laws or regulations, we could be required to expend time, money, and other resources to deal with enforcement actions and any penalties that might be asserted, to institute and maintain a compliance program specific to money transmission laws, and possibly to change aspects of how we conduct business to achieve compliance or minimize regulation. Application of these laws to our business could also make it more difficult or costly for us to maintain our banking relationships. Financial institutions may also be unwilling to provide banking services to us due to concerns about the large dollar volume moving into and out of our accounts on behalf of our customers in the ordinary course of our business. As we continue to expand the solutions we offer and the jurisdictions in which we offer them, we could become subject to other licensing, examination, or regulatory requirements relating to financial services.

Our solutions involve the collection, dissemination, and use of certain personal information, which are subject to numerous laws and regulations. For example, the California Consumer Privacy Act, which became effective on January 1, 2020, provides a private right of action for data breaches and requires companies that process information of California residents to make disclosures to consumers about their data collection, use, and sharing practices and allow consumers to opt out of certain data sharing with third parties.  We also are subject to data security and privacy protection requirements in foreign jurisdictions. For example, in 2018 the E.U. adopted the General Data Protection Regulation, which imposes requirements on companies that receive or process personal data of European Economic Area residents and includes significant penalties for non-compliance. Other governments in the U.S. and internationally have adopted or are considering similar types of data protection laws and regulations. We may incur significant costs to comply with these laws and regulations. A security breach or other failure to safeguard consumer data could subject us to costs associated with notice and remediation, as well as potential regulatory investigations or enforcement actions, and possibly to civil liability. If governmental authorities were to expand their enforcement activities, or change their interpretation of the applicability of these laws, or if new laws were to be adopted, compliance burdens and costs could increase significantly, harming our results of operations and possibly the manner in which we conduct our business.

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Our ability to protect our intellectual property is limited and our solutions are, and may in the future be, subject to claims of infringement by third parties.

Our success depends, in part, upon our proprietary technology, processes, trade secrets, and other proprietary information and our ability to protect this information from unauthorized disclosure and use. We primarily rely upon a combination of confidentiality procedures, contractual provisions, copyright, trademark, and trade secret laws, and other similar measures to protect our proprietary information and intellectual property. We also use patents, including those of our acquired businesses, to protect certain of our intellectual property. Our trademarks and service marks include Avalara, the Avalara logo, AvaTax, the Avalara Compliance Cloud, and “Tax compliance done right,” marks for our acquired businesses, and various marketing slogans. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our solutions or to obtain and use information that we regard as proprietary, and third parties may attempt to develop similar technology independently. In addition, if unauthorized disclosure of our source code occurs through security breach, cyber-attack or otherwise, we could lose future trade secret protection for that source code, which could make it easier for third parties to compete with our products. Our means of protecting our proprietary rights may not be adequate.

In addition, third parties have claimed, and may in the future claim, infringement by us with respect to current or future solutions or other intellectual property rights. The software and internet industries are characterized by the existence of a large number of patents, trademarks, and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. The outcome of any claims or litigation, regardless of the merits, is inherently uncertain. Any existing or future claims and lawsuits, and the disposition of such claims and lawsuits, whether through settlement or licensing discussions, or litigation, could be time-consuming and expensive to resolve, divert management attention from executing our strategies, result in efforts to enjoin our activities, lead to attempts on the part of other parties to pursue similar claims, and, in the case of intellectual property claims, require us to change our technology, change our business practices, pay monetary damages, or enter into short- or long-term royalty or licensing agreements. Any adverse determination related to any existing or future intellectual property claims or other litigation could prevent us from offering our solutions to others, could be material to our financial condition or cash flows, or both, or could otherwise harm our results of operations.

Indemnity provisions in our subscription agreements potentially expose us to substantial liability for intellectual property infringement and other losses.

In many of our subscription agreements with our customers, we agree to indemnify our customers against any losses or costs incurred in connection with certain claims by a third party, including claims alleging that a customer’s use of our solutions infringes on the intellectual property rights of the third party. Customers facing infringement claims or other indemnifiable claims may in the future seek indemnification from us under the terms of our contracts. If such claims are successful, or if we are required to indemnify or defend our customers from these or other claims, these matters could be disruptive to our business and management and harm our business, results of operations, and financial condition.

We use open source software in our platform and solutions, which may subject us to litigation or other actions that could harm our business.

We use open source software in our platform and solutions, and we may use more open source software in the future. In the past, companies that have incorporated open source software into their products have faced claims challenging the ownership of open source software or compliance with open source license terms. Accordingly, we could be subject to suits by parties claiming ownership of what we believe to be open source software or claiming noncompliance with open source licensing terms. Some open source software licenses require users who incorporate open source software as part of their software or services to publicly disclose all or part of the source code to such software or make available any derivative works of the open source code on unfavorable terms or at no cost. If applicable, such licenses could require us to release our proprietary source code, pay damages, re-engineer our applications, discontinue sales, or take other remedial action, any of which could harm our business. In addition, if the license terms for updated or enhanced versions of the open source software we utilize change, we may be forced to re-engineer our platform or solutions or incur additional costs.

Risks Relating to Ownership of Our Common Stock

Our stock price has been and likely will continue to be volatile and may decline regardless of our operating performance, resulting in substantial losses for investors in our common stock.

From June 15, 2018, the date that our common stock started trading on the New York Stock Exchange, through December 31, 2020, the trading price of our common stock has ranged from $28.09 per share to $184.41 per

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share. The market price and trading volume of our common stock may fluctuate significantly regardless of our operating performance, in response to numerous factors, many of which are beyond our control, including:

If we fail to maintain an effective system of disclosure controls and internal control over financial reporting, our ability to produce timely and accurate financial statements or comply with applicable regulations could be impaired.

As a public company, we are required to maintain internal control over financial reporting and to report any material weaknesses in such internal control.  Section 404 of the Sarbanes‑Oxley Act requires that we evaluate and determine the effectiveness of our internal control over financial reporting and provide a management report on internal control over financial reporting. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis.

As we reported in our Annual Report on Form 10‑K as of December 31, 2019, we had a material weakness in our internal control over financial reporting related to an absence of adequate controls to effectively design, implement, and operate process-level and information technology controls to sufficiently mitigate risks of material misstatement associated with certain complex business processes and changes in those processes or applicable accounting standards. We remediated this material weakness during 2020 and have concluded that our internal control over financial reporting was effective as of December 31, 2020. However, remediation of the material weakness does not guarantee that our remediated controls will continue to operate properly, or that we will not experience another material weakness, or that our financial statements will be free from error.

Our current controls and any new controls that we develop may become inadequate because of changes in conditions in our business. Further, a material weakness or weaknesses in our disclosure controls and internal control over financial reporting may be discovered in the future. Any failure to develop or maintain effective controls or any difficulties encountered in their implementation or improvement could harm our results of operations or cause us to fail to meet our reporting obligations and may result in a restatement of our financial statements for prior periods. Any failure to implement and maintain effective internal control over financial reporting also could adversely affect the results of periodic management evaluations and annual independent registered public accounting firm attestation reports regarding the effectiveness of our internal control over financial reporting that we are required to include in our periodic reports that will be filed with the SEC. Ineffective disclosure controls and procedures and internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, and could have a material and adverse effect on our business, results of operations and financial condition. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on the New York Stock Exchange.

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Provisions in our charter documents and under Washington law could make an acquisition of our company more difficult and limit attempts by our shareholders to replace or remove our current management.

Our Articles of Incorporation, our Bylaws, and Washington law include a number of provisions that may have the effect of deterring takeovers or delaying or preventing changes in control or changes in our management that a shareholder might deem to be in his or her best interest. In addition, because our Board is responsible for appointing our management, these provisions may frustrate or prevent any attempts by our shareholders to replace or remove our current management by making it more difficult for shareholders to replace members of our Board. These provisions include the following:

Item 1B. Unresolved Staff Comments.

Not applicable.

Item 2. Properties.

Our corporate headquarters are located in Seattle, Washington, where we occupy approximately 133,554 square feet of office space under a lease that expires in 2028. We maintain additional offices in the United States, Brazil, Europe, and India.

We lease all of our facilities, and we do not own any real property. We believe that our existing facilities are adequate for our current needs and that suitable additional or alternative space would be available to us to lease on commercially reasonable terms if and when we need it.

Item 3. Legal Proceedings.

From time to time, we may become involved in other legal proceedings or be subject to claims arising in the ordinary course of our business. Regardless of the outcome of any existing or future litigation, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors.

On October 22, 2018, PTP OneClick, LLC (“PTP”) filed a lawsuit against Avalara, Inc. in the United States District Court for the Eastern District of Wisconsin. The lawsuit alleges that making, using, offering to sell, and selling AvaTax, Avalara Returns, and TrustFile (the “Avalara Products”) infringe U.S. Patent No. 9,760,915 held by PTP and also alleges unspecified trade secret misappropriation, unfair competition, and breach of contract. PTP seeks judgments of willful patent infringement, willful trade secret misappropriation, unfair competition, and breach of contract. PTP requests preliminary and permanent injunctions to enjoin the Company from making, using, offering to sell, and selling the Avalara Products along with treble damages and attorneys’ fees. Based upon the

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Company’s review of the complaint and the specified patent, the Company believes that the Company has meritorious defenses to PTP’s claims. On November 7, 2018, the Company moved to dismiss the lawsuit and to have the patent held invalid, and also moved to transfer the matter to the United States District Court located in Seattle, Washington. On April 30, 2019, the United States District Court for the Eastern District of Wisconsin granted the Company’s motion to transfer, reserving resolution of the motion to dismiss for the United States District Court for the Western District of Washington. On October 7, 2019, the United States District Court for the Western District of Washington invalidated the patent and dismissed the patent and unfair competition claims with prejudice but did not dismiss the trade secret misappropriation or breach of contract claims. On March 5, 2020, we filed a motion for summary judgment. On May 27, 2020, the United States District Court for the Western District of Washington entered summary judgment in favor of Avalara, Inc. disposing of the remaining trade secret misappropriation and breach of contract claims. Plaintiff filed a notice of appeal but subsequently withdrew the notice. On July 7, 2020, the United States District Court for the Western District of Washington dismissed the appeal with prejudice. For a description of the risks of this and similar litigation, see the section titled “Risk Factors—Our ability to protect our intellectual property is limited and our solutions are, and may in the future be, subject to claims of infringement by third parties.”

Item 4. Mine Safety Disclosures.

Not applicable.

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information for Common Stock

Our common stock has been listed on the New York Stock Exchange, under the symbol “AVLR” since June 15, 2018. Prior to that date, there was no public trading market for our common stock.

Dividend Policy

We have never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not anticipate paying any dividends on our common stock in the foreseeable future. Any future determination to declare dividends will be made at the discretion of our Board of Directors and will depend on our financial condition, results of operations, capital requirements, general business conditions, and other factors that our Board of Directors may deem relevant.

Holders

As of December 31, 2020, we had 105 holders of record of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of shareholders, we are unable to estimate the total number of shareholders represented by these record holders.

Stock Performance Graph

The graph below compares the cumulative total return on our common stock with that of the S&P 500 Index and the RDG Software Composite. The period shown commences on June 15, 2018, and ends on December 31, 2020, the end of our last fiscal year. The graph assumes an investment of $100 in each of the above on the close of market on June 15, 2018. The stock price performance graph is not necessarily indicative of future price performance.

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Our common stock cumulative total return presented on the graph and table above is based on our closing stock price of $44.94 per share on June 15, 2018.

Recent Sales of Unregistered Securities

In December 2020, as partial consideration for the acquisition of the shares of Impendulo, we issued 7,009 shares of common stock to the sellers in connection with the closing in reliance on exemption from the registration requirements of the Securities Act of 1933 pursuant to Section 4(a)(2) thereof because the issuance of securities did not involve a public offering.

In November 2020, as partial consideration for the Business License Purchase, we agreed to an earnout provision with a maximum earnout payment of up to $20.7 million, to be paid in shares of the Company’s common stock following the achievement of certain Business Licenses performance metrics during the next four years. The agreement to issue shares of Company common stock was made in reliance on exemption from the registration requirements of the Securities Act of 1933 pursuant to Section 4(a)(2) thereof because the sale of securities did not involve a public offering.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

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Item 6. Selected Financial Data.

We derived the following selected consolidated statements of operations data for the years ended December 31, 2020, 2019, and 2018 and the selected consolidated balance sheet data as of December 31, 2020 and 2019 from audited consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. The consolidated statements of operations data for the years ended December 31, 2017 and 2016, and the selected consolidated balance sheet data as of December 31, 2018, 2017, and 2016, have been derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K. The selected financial data set forth below should be read together with the financial statements and the related notes to those statements, as well as the section of this report titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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The amortization of acquired intangibles included above was as follows:

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs and expectations that involve risks and uncertainties. Our actual results and the timing of events could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in the sections of this report titled “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”

Overview

We are a leading provider of tax compliance automation for businesses of all sizes. The Avalara Compliance Cloud includes calculation, returns, compliance document management, licensing and registration, fiscal representation, and tax content and insight solutions.  We sell our solutions primarily on a subscription basis through our sales force, which focuses on selling to qualified leads provided by our marketing efforts and by partner referrals. Revenue from subscriptions and returns represented 93% of total revenue in both 2020 and 2019.  

We focus on maintaining and expanding our partner network, which has been and will continue to be an essential part of our growth. We continue to increase the available number of partner integrations, which are designed to link the Avalara Compliance Cloud to a wide variety of business applications, including accounting, ERP, ecommerce, marketplace, POS, recurring billing, and CRM systems. Through marketing activities, we generate awareness from many businesses, both large and small, and enhance communications with our existing customers.

We make substantial investments by increasing headcount, investing in better software tools and technologies, and making strategic acquisitions to continuously improve the Avalara Compliance Cloud.  With these investments, we will continue scaling our platform for continued growth, adding new features and functionality, supporting new products and content types, and improving the user experience. Through acquisitions in 2020, we added tax content research and automation tools in the U.S., business license and registration compliance capabilities for companies of all sizes, and expanded product and content to offer insurance premium tax compliance solutions. We expect to continue to make significant investments, both organically and through acquisitions, to gain new and relevant content, technology, and expertise that best serve the transaction tax needs of our customers.

Our business is impacted by the COVID-19 pandemic, which has resulted in authorities implementing numerous preventative measures to contain or mitigate the extent of the impact, including travel bans and restrictions, limitations on business activity, quarantines, and shelter-in-place orders. These measures have caused, and are continuing to cause, business slowdowns or shutdowns in affected areas. Almost all our employees currently work offsite and most have been working from home since March 2020.  We expect these arrangements to continue for most of our workforce for a significant portion of 2021.  As the COVID-19 pandemic continues to evolve, the extent and timing of the broader impact of the pandemic on our results of operations, overall financial performance and operating cash flows remains uncertain, including the impact on our future revenue growth, the timing of the resumption of normal operating expenses, and the extent to which any incremental expenses associated with the preventative and precautionary measures will be necessary.

We believe our 2020 operating results reflect the adaptability and resilience of our business. Total revenue for 2020 was $500.6 million, an increase of 31% from $382.4 million in 2019. The 2020 acquisitions accounted for $6.5 million of this increase.  This compares to an increase of 41% in 2019 from 2018.  Our revenue growth was attributable to adding new customers, expanding service offerings to existing customers, and increased SST fees. Total revenue for 2020 and 2019 generated outside the U.S. was 6% of total revenue. We intend to continue aggressively investing internationally to expand non-U.S. revenue.

We added approximately 2,740 core customers during 2020 and delivered a net revenue retention rate of 107% on average over the past four quarters. In 2020, our non-core customer revenue continued to grow faster than our revenue from core customers. We use net revenue retention rate to reflect the stability of our revenue base and to provide insight into our ability to grow existing customer revenues.

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Operating expenses increased to $419.4 million in 2020 from $323.0 million in 2019, as we continued to make significant investments in our future growth. Sales and marketing expenses were $204.5 million in 2020, or 41% of total revenue, compared to $168.6 million in 2019, or 44% of total revenue. The decrease in sales and marketing expenses as a percentage of revenue in 2020 is due primarily to temporarily reduced spending on in-person marketing events and customer-related travel costs.  During 2020, we vacated certain leased offices in the U.S. following the dislocation of our workforce because of the COVID-19 pandemic.  As a result, we recorded a charge of $0.8 million to write-down the related operating lease right-of-use assets and associated property and equipment, which was recorded in general and administrative expenses.

Operating loss was $62.0 million during 2020 compared to an operating loss of $55.9 million during 2019. Our net loss was $49.2 million during 2020 compared to a net loss of $50.2 million during 2019. Non-GAAP operating loss was $3.1 million during 2020 compared to non-GAAP operating loss of $14.4 million during 2019. During 2020, we generated positive free cash flow of $34.0 million compared to positive free cash flow of $12.0 million in 2019. See the section titled “Use and Reconciliation of Non-GAAP Financial Measures” for more information about our non-GAAP financial measures.

In August 2020, we completed a public offering of our common stock and sold 4.5 million shares for net proceeds of $556.3 million. As of December 31, 2020 and 2019, we had no borrowings outstanding. We ended the year with $673.6 million of cash and cash equivalents. We believe our strong balance sheet positions us well to continue to make additional investments to grow and expand both our products and services, along with the customers we serve.

Key Business Metrics

We regularly review several metrics to evaluate growth trends, measure our performance, formulate financial projections, and make strategic decisions. We discuss revenue and the components of operating results under “Key Components of Consolidated Statements of Operations,” and we discuss other key business metrics below.

Number of Core Customers

We believe core customers is a key indicator of our market penetration, growth, and potential future revenue. The small and mid-market customer segments have been and remain our primary target market segments for marketing and selling our solutions. We use core customers as a metric to focus our customer count reporting on our primary target market segments. As of December 31, 2020 and 2019, we had approximately 14,890 and 12,150 core customers, respectively.

We define a core customer as:

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Currently, our core customer count includes only customers with unique account identifiers in our primary U.S. billing systems and does not include customers that subscribe to our solutions through our international subsidiaries and certain legacy and acquired billing systems that have not yet been integrated into our primary U.S. billing systems (e.g., recent acquisitions and our lodging tax compliance solution). As we increase our international operations and sales in future periods, we may add customers billed from our international subsidiaries to the core customer metric.

We also have a substantial number of customers of various sizes that do not meet the revenue threshold to be considered a core customer. Many of these customers are in the emerging and small business segment of the marketplace, which represents strategic value and a growth opportunity for us. Customers who do not meet the revenue threshold to be considered a core customer provide us with market share and awareness, and we anticipate that some may grow into core customers. In addition, we have larger customers that are early in their adoption or only utilize our services for small segments of their business, providing opportunities over time for us to extend our relationship and make them core customers.

In addition to customers with whom we have a direct relationship, some of our customers are business application publishers (including ecommerce platforms) that include automated tax determination powered by Avalara. While those platform providers may be core customers to Avalara, their end-user customers generally are not.

Net Revenue Retention Rate

We believe that our net revenue retention rate provides insight into our ability to retain and grow revenue from our customers, as well as their potential long-term value to us. We also believe it reflects the stability of our revenue base, which is one of our core competitive strengths. We calculate our net revenue retention rate by dividing (a) total revenue in the current quarter from any billing accounts that generated revenue during the corresponding quarter of the prior year by (b) total revenue in such corresponding quarter from those same billing accounts. This calculation includes changes during the period for such billing accounts, such as additional solutions purchased, changes in pricing and transaction volume, and terminations, but does not reflect revenue for new billing accounts added during the one-year period.

Currently, our net revenue retention rate includes only customers with unique account identifiers in our primary U.S. billing systems and does not include customers who subscribe to our solutions through our international subsidiaries or certain legacy billing systems that have not been integrated into our primary U.S. billing systems. Our SST solution is not included in net revenue retention rate. This means that revenue expansion from existing customers adopting our SST solution is not included, while revenue contraction from customers replacing one or more of Avalara’s other solutions with SST is included. Our net revenue retention rate was 107% on average for the four quarters ended December 31, 2020.

Strategic Acquisitions

We have pursued and expect to continue to pursue acquisitions that align with our strategic objectives to build relevant content, technology, and expertise to best serve the transaction tax compliance needs of our current and future customers. Accordingly, the comparability of periods covered by our financial statements are, and in the future may be, affected by the impact of these acquisitions.

In December 2020, we signed a definitive agreement to acquire Inposia Solutions, GmbH for €30 million (approximately $37 million, using the exchange rate on December 28, 2020) subject to certain purchase price adjustments and closing conditions. We expect the transaction to close in the first half of 2021.

2020 Acquisitions

Transaction Tax Resources.  On October 5, 2020, we acquired all the outstanding equity of Transaction Tax Resources, Inc. (“TTR”) for total cash consideration of approximately $378.0 million. TTR is a leading provider of tax content, research, consulting, and automation tools in the U.S., with products that include software solutions for companies and governments. Approximately $57.6 million of the purchase price will be paid to TTR shareholders

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over the next three years. In addition, up to $26.4 million of the purchase price will be paid to TTR’s founder and shareholder if certain TTR performance metrics are achieved during the 2021 and 2022 fiscal years.

Business Licenses.  On November 5, 2020, we acquired substantially all of the assets of Business Licenses, LLC, (“Business Licenses”) for aggregate consideration of approximately $97.0 million. Business Licenses is a leading provider of business license and registration content, software, management, and services that automate and streamline license and registration compliance for companies of all sizes. Approximately $64.9 million of the purchase price was paid at the time of acquisition and approximately $11.4 million of the purchase price will be paid to Business Licenses’ shareholders after eighteen months. Up to $20.7 million will be paid, in shares of our common stock, to Business Licenses’ shareholders if certain Business Licenses performance metrics are achieved during the next four years.

Impendulo.  On December 1, 2020, the Company acquired the shares of Impendulo Limited (“Impendulo”). The total consideration transferred related to this transaction was $13.6 million, consisting of $11.7 million paid in cash at closing, $1.2 million paid in the Company’s common stock, and an additional $0.7 million that was accrued for cash payable to the sellers in the first quarter of 2021 based on final revenue metrics achieved up to the date of the acquisition. Impendulo is a London-based provider of insurance tax compliance software and services, specializing in support for multi-national insurance companies.

2019 Acquisitions

Compli.  On January 22, 2019, we acquired substantially all the assets of Compli, Inc. (“Compli”) for $17.1 million, consisting of $11.8 million paid in cash at closing, an additional $1.6 million of cash to be paid out after twelve months, and an earnout provision fair valued upon acquisition at $3.8 million. Compli is a provider of compliance services, technology, and software to producers, distributors, and importers of beverage alcohol in the United States.

Indix.  On February 6, 2019, we acquired substantially all the assets of Indix Corporation (“Indix”) for $9.1 million, consisting of $5.5 million paid in cash at closing, an additional $1.4 million cash to be paid after eighteen months, and an earnout provision valued upon acquisition at $2.2 million. Indix is an artificial intelligence company providing comprehensive product descriptions for more than one billion products sold and shipped worldwide.

Portway. On July 31, 2019, we acquired substantially all the assets of Portway International Inc. (“Portway”) for $24.3 million, consisting of $13.0 million paid in cash at closing, an additional $2.0 million of cash to be paid after eighteen months with an acquisition date fair value of $1.9 million, and an earnout provision fair valued upon acquisition at $9.4 million. Portway is a provider of Harmonized System classifications and outsourced customs brokerage services.

Key Components of Consolidated Statements of Operations

Revenue

We generate revenue from two primary sources: (1) subscription and returns; and (2) professional services. Subscription and returns revenue are driven primarily by the acquisition of customers, customer renewals, and additional service offerings purchased by existing customers. Revenue from subscription and returns comprised approximately 93% of our revenue for 2020, 2019, and 2018.

Subscription and Returns Revenue. Subscription and returns revenue primarily consist of fees paid by customers to use our solutions. Subscription plan customers select a price plan that includes an allotted maximum number of transactions over the subscription term. Unused transactions are not carried over to the customer’s next subscription term, and our customers are not entitled to any refund of fees paid or relief from fees due if they do not use the allotted number of transactions. If a subscription plan customer exceeds the selected maximum transaction level, we will generally upgrade the customer to a higher tier or, in some cases, charge overage fees on a per transaction or return basis. Customers purchase tax return preparation on a subscription basis for an allotted number of returns. Fees paid for subscription services to tax content vary depending on the volume of tax information accessible to the customer.  

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Our standard subscription contracts are generally non-cancelable after the first 60 days of the contract term. Cancellations under our standard subscription contracts are not material, and do not have a significant impact on revenue recognized. We generally invoice our subscription customers for the initial term at contract signing and upon renewal. Our initial terms generally range from twelve to eighteen months, and renewal periods are typically one year. Amounts that have been invoiced are initially recorded as deferred revenue or contract liabilities. Subscription revenue is recognized on a straight-line basis over the service term of the arrangement beginning on the date that our solution is made available to the customer and ending at the expiration of the subscription term.

Currently a small component of our total revenue, we offer SST services to businesses that are registered to participate in the program. We earn a fee (SST revenue) from participating state and local governments based on a percentage of the sales tax reported and paid, and as a result, we generally provide SST services at no cost to the seller.

Subscription and returns revenue also include interest income generated on funds held for customers. In order to provide tax remittance services to customers, we hold funds from customers in advance of remittance to tax authorities. These funds are held in trust accounts at FDIC-insured institutions. Prior to remittance, we earn interest on these funds.

Professional Services. We generate professional services revenue from providing tax analysis and services, including tax registrations, voluntary disclosure agreements, nexus studies, and backfiling services. We also provide configurations, data migrations, integration, and training for our subscriptions and returns products. Our 2020 acquisitions of TTR and Business Licenses expanded the scope of professional services we offer to include business licenses and registration services and tax refund claims and recovery assistance.  We bill for service arrangements on a fixed fee, milestone, or time and materials basis, and we recognize the transaction price allocated to professional services performance obligations as revenue as services are performed and are collectable under the terms of the associated contracts.

Costs and Expenses

Cost of Revenue. Cost of revenue consists of costs related to providing the Avalara Compliance Cloud and supporting our customers and includes employee-related expenses, including salaries, benefits, bonuses, and stock-based compensation and the amortization of capitalized software development costs. In addition, cost of revenue includes direct costs associated with information technology, such as data center and software hosting costs, tax content maintenance, and certain services provided by third parties. Cost of revenue also includes allocated costs for certain information technology and facility expenses, along with depreciation of equipment and amortization of intangibles such as acquired technology from acquisitions. We plan to continue to significantly expand our infrastructure and personnel to support our future growth, including through acquisitions, which we expect to result in higher cost of revenue in absolute dollars.

Research and Development. Research and development expenses consist primarily of employee-related expenses for our research and development staff, including salaries, benefits, bonuses, and stock-based compensation, and the cost of third-party developers. Research and development costs, other than software development expenses qualifying for capitalization, are expensed as incurred. Capitalized software development costs consist primarily of employee-related costs, and are amortized as cost of subscription and returns revenue. Research and development expenses also include allocated costs for certain information technology and facility expenses, along with depreciation of equipment.

We devote substantial resources to enhancing and maintaining the Avalara Compliance Cloud, developing new and enhancing existing solutions, conducting quality assurance testing, and improving our core technology. We expect research and development expenses to increase in absolute dollars.

Sales and Marketing. Sales and marketing expenses consist primarily of employee-related expenses for our sales and marketing staff, including salaries, benefits, bonuses, sales commissions, and stock-based compensation, integration and referral partner commissions, costs of marketing and promotional events, corporate communications, online marketing, solution marketing, and other brand-building activities. As a result of the current COVID-19 pandemic, we have suspended in-person promotional and customer events and have converted many of these activities to virtual events, which has temporarily reduced these types of marketing expenses. We expect to resume in-person marketing activities when conditions allow. Sales and marketing expenses include allocated costs for certain information technology and facility expenses, along with depreciation of equipment and amortization of intangibles such as customer relationships, customer lists, and backlog from acquisitions.

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We defer the portion of sales commissions that is considered a cost of obtaining a new contract with a customer in accordance with the revenue recognition standard and amortize these deferred costs over the period of benefit, currently six years. We expense the remaining sales commissions as incurred. Sales commissions are earned when a sales order is completed. For most sales orders, deferred revenue is recorded when a sales order is invoiced, and the related revenue is recognized ratably over the subscription term. The rates at which sales commissions are earned varies depending on a variety of factors, including the nature of the sale (new, renewal, or add-on service offering), the type of service or solution sold, and the sales channel. At the beginning of each year, we set group and individual sales targets for the full year. Sales commissions are generally earned based on achievement against these targets.

We defer the portion of partner commissions costs that are considered a cost of obtaining a contract with a customer in accordance with the revenue recognition standard and amortize these deferred costs over the period of benefit. The period of benefit is separately determined for each partner and is either six years or corresponds with the contract term. We expense the remaining partner commissions costs as incurred. Our partner commission expense has historically been, and will continue to be, impacted by many factors, including the proportion of new and renewal sales, the nature of the partner relationship, and the sales mix among partners during the period. In general, integration partners are paid a higher commission for the initial sale to a new customer and a lower commission for renewal sales. Additionally, we have several types of partners (e.g., integration and referral) that each earn different commission rates.  

We intend to continue to invest in sales and marketing and expect spending in these areas to increase in absolute dollars as we continue to expand our business. We expect sales and marketing expenses to continue to be among the most significant components of our operating expenses. Because we began to defer a portion of the sales and partner commission costs in 2019, our sales and marketing expense will not be comparable to prior periods in which we expensed these costs.

General and Administrative. General and administrative expenses consist primarily of employee-related expenses for administrative, finance, information technology, legal, and human resources staff, including salaries, benefits, bonuses, and stock-based compensation, professional fees, insurance premiums, and other corporate expenses that are not allocated to the above expense categories. General and administrative expenses include amortization of intangibles such as tradenames and noncompetition agreements from acquisitions.

We expect our general and administrative expenses to increase in absolute dollars as we continue to expand our operations, hire additional personnel, evaluate and integrate acquisitions, and incur costs as a public company. Specifically, we expect to continue to incur increased expenses related to accounting, tax and auditing activities, legal, insurance, acquisition evaluation and execution, SEC compliance, and internal control compliance.

Total Other (Income) Expense, Net

Total other (income) expense, net consists of interest income on cash and cash equivalents, quarterly remeasurement of contingent consideration for acquisitions accounted for as business combinations, foreign currency gains and losses, and other nonoperating gains and losses.

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Results of Operations

The comparability of periods covered by our financial statements is impacted by acquisitions (see Strategic Acquisitions above) and the impact of the adoption of new accounting standards. We adopted the revenue recognition standard ASC 606 effective January 1, 2019 on a modified retrospective basis. Our results of operations presented in the following tables include financial results for reporting periods during 2020 and 2019, which are reported in compliance with the revenue recognition standard ASC 606. Historical financial results for reporting periods prior to 2019 have not been retroactively restated and are presented in conformity with amounts previously disclosed under the prior revenue recognition standard ASC 605. Our Annual Report on Form 10-K for the year ended December 31, 2019 includes a discussion and analysis of our financial condition and results of operations comparted to the year ended December 31, 2018 in Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The following sets forth our results of operations for the periods presented.

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The amortization of acquired intangibles included above was as follows:

The following sets forth our results of operations as a percentage of our total revenue for the periods presented.

Year Ended December 31, 2020 as compared to the Year Ended December 31, 2019

Revenue

Total revenue for the year ended December 31, 2020 increased $118.1 million, or 31%, compared to the year ended December 31, 2019. Subscription and returns revenue for the year ended December 31, 2020 increased by

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$110.6 million, or 31%, compared to the year ended December 31, 2019. Professional services revenue for the year ended December 31, 2020 increased by $7.5 million, or 28%, compared to the year ended December 31, 2019.

Growth in total revenue was due primarily to increased demand for our services from new and existing customers. The increase in total revenue for the year ended December 31, 2020 compared to the same period in 2019, was due primarily to $50.8 million from existing U.S. customers, $29.4 million from new U.S. customers, $24.3 million from SST revenue growth, $6.5 million from 2020 acquisitions, and $7.9 million from revenue growth in our international operations, partially offset by $2.4 million lower interest earned on funds held from customers.  During 2021, we expect significantly lower revenue growth from SST services due primarily to a reduction in the fee we earn from these transactions.

Cost of Revenue

Cost of revenue for the year ended December 31, 2020 increased by $27.8 million, or 24%, compared to the year ended December 31, 2019. The increase in cost of revenue was due primarily to an increase of $20.4 million in employee-related costs from higher headcount, an increase of $2.7 million in software hosting costs, an increase of $2.6 million in allocated overhead cost, an increase of $2.5 million in third-party purchased software, an increase of $1.1 million in depreciation expense, and an increase of $0.3 million in amortization expense, partially offset by a $1.3 million decrease in outside professional service expenses.

Cost of revenue headcount increased approximately 27% from December 31, 2019 to December 31, 2020. Excluding the impact of 2020 acquisitions, cost of revenue headcount increased approximately 13% due to our continued growth to support our solutions and expand content. Employee-related costs increased due primarily to a $16.0 million increase in salaries and benefits (including $2.5 million from 2020 acquisitions), a $2.8 million increase in stock-based compensation expense, a $1.6 million increase in compensation expense related to our bonus plans, and a $1.1 million increase in contract and temporary employee costs, partially offset by a $1.0 million decrease in travel costs.

Software hosting costs have increased due primarily to higher transaction volumes. Allocated overhead consists primarily of facility expenses and shared information technology expenses, both of which were higher in total compared to the prior period due primarily to higher headcount throughout our operations. As a result of the COVID-19 pandemic, almost all our employees worked from their homes during most of 2020. Despite being unable to safely access our facilities, we were not able to materially reduce our lease expenses and related committed costs. Third-party purchased software costs have increased due primarily to an increase in the number of user licenses purchased and higher subscription fees for key applications. Depreciation expense increased due primarily to an increase in leasehold improvements and an increase in capitalized software costs for projects placed into service in 2020. Amortization expense increased due primarily to acquired intangible assets from our 2020 acquisition of TTR. Outside professional service expenses decreased due to declining use of third-party consulting firms to support service offerings in our European operations.

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Gross Profit