UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K/A

(Mark One)

For the fiscal year ended December 31, 2021

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, 2021 was $13,670 million.

The number of shares of Registrant’s Common Stock outstanding as of February 17, 2022 was 87,486,573.

EXPLANATORY NOTE

In accordance with Rule 12b-15 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the following Items of our Annual Report on Form 10-K for the year ended December 31, 2021 (the “Form 10-K” or the “Original Filing”) have been partially amended and the complete text of those Items, as originally filed and as amended herein, is set out in this Annual Report on Form 10-K/A (this “Form 10-K/A”):

The other Items of the Original Filing have not been amended and, accordingly, have not been repeated in this Form 10-K/A.

Please note that the only changes to the Original Filing are those related to the matters described below and only in the items listed above. Except as described above, no changes have been made to the Original Filing, and this Form 10-K/A does not modify, amend, or update any of the other financial information or other information contained in the Original Filing. In addition, in accordance with Securities and Exchange Commission (“SEC”) rules, this Form 10-K/A includes updated certifications from our Chief Executive Officer and Chief Financial Officer as Exhibits 31.1, 31.2, 32.1 and 32.2, a new consent from the Company’s independent registered public accounting firm, and new inline XBRL tagging. Otherwise, the information contained in this Form 10-K/A is as of the date of the Original Filing and does not reflect any information or events occurring after the date of the Original Filing, except as discussed in Note 16 Subsequent Events.

Avalara, Inc. (the “Company”) is filing this Annual Report on Form 10-K/A for the year ended December 31, 2021, originally filed with the SEC on February 24, 2022 (the “Original Filing Date”), to make certain changes described below.

While preparing the financial statements for the first quarter of 2022, the Company discovered an error in its recognition of stock-based compensation expense for restricted stock units (“RSUs”).  As a result of the error, the Company under recognized stock-based compensation expense by $10.4 million in 2021, $6.1 million in 2020, and $1.7 million in 2019.

The Company’s accounting policy is to recognize stock-based compensation cost for RSUs on a straight-line basis over the period during which the participant is required to perform services in exchange for the award.  Almost all the Company’s RSU grants issued and outstanding through 2021 vest over a four-year period as follows:  20% of the shares vest on each of the one-year, two-year, and three-year anniversaries of the vesting commencement date, and the remaining 40% of the shares vest on the four-year anniversary.

The Company uses a third-party equity program administration software to track all stock awards. The Company also uses reports from this software to calculate the amount of stock-based compensation cost to recognize in each reporting period. The Company’s accounting team had selected reports that they believed were appropriate for straight-line basis expense recognition, when in fact, these reports were calculating stock-based compensation cost proportional to the vesting provisions of each RSU. Using this incorrect expense calculation resulted in the Company under-recognizing stock-based compensation cost during the first three years of the service period. In preparing the financial statements for the first quarter of 2022, the Company has determined the amounts necessary to correct previously issued financial statements to reflect stock-based compensation expense on a straight-line basis and has verified the expense reports generated from the software.

Management evaluated the quantitative and qualitative impact of this accounting error on the Company’s previously issued consolidated financial statements included in the Original Filing and concluded that the error was not material to its previously issued financial statements.

In addition, the Company re-evaluated the effectiveness of the Company’s internal control over financial reporting and identified a control deficiency associated with the accounting error, which the Company has

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concluded represents a material weakness in the Company’s internal control over financial reporting as of December 31, 2021.

Accordingly, the Company is filing this Form 10-K/A to amend management’s assessment of the Company’s internal control over financial reporting and its disclosure controls and procedures to indicate that they were not effective as of December 31, 2021. Further, included in this Form 10-K/A, the Company’s independent registered public accounting firm, Deloitte & Touche LLP (“Deloitte”), is amending its Report of Independent Registered Public Accounting Firm to reflect the identification of a material weakness in the Company’s internal control over financial reporting as of December 31, 2021.

As a result of the determination to file this Form 10-K/A, for the reasons outlined in the preceding paragraph, on May 4, 2022, the Audit Committee of the Board of Directors (the “Audit Committee”) of the Company, after discussion with management of the Company, determined that the Company will also revise its consolidated financial statements for the years ended December 31, 2021, 2020, and 2019, included in the Original Filing, to correct the accounting error for all periods presented. The correction of this accounting error does not impact the Company’s previously reported revenues or cash flows during any financial statement period and does not impact total assets, total liabilities, or total shareholders’ equity.

For a more detailed impact of the correction of this accounting error, refer to Note 15 Correction of Previously Issued Consolidated Financial Statements to the consolidated financial statements of the Company included in Part II-Item 8 of this Form 10-K/A.

This Form 10-K/A includes (i) a new consent of Deloitte & Touche LLP, (ii) new certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 and Section 906 of the Sarbanes-Oxley Act of 2002, each of which is filed or furnished herewith, as applicable, and (iii) Exhibit 101 (Interactive Data Files) and Exhibit 104 (contained in Exhibit 101).

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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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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/A, 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 $135.6 million, $55.3 million, and $52.0 million in 2021, 2020, and 2019, respectively. We had an accumulated deficit of $702.9 million as of December 31, 2021. 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 $382.4 million in 2019, and $500.6 million in 2020 to $699.0 million in 2021. 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 rate 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 maintaining or upgrading their subscriptions, and if we fail to retain our customers at current or upgraded 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 rate.

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. In addition, the cost to attract new customers may increase as we market our existing and new solutions to different market segments and geographies. If we are unable to maintain effective sales and marketing activities and maintain

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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 will 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.

If we fail to attract and retain qualified personnel, our business could be harmed.

Our success depends in large part on our ability to attract, integrate, motivate, and retain highly qualified personnel at a reasonable cost on the terms we desire, particularly sales and marketing personnel, software developers, technical support, and research and development personnel. Competition for skilled personnel, particularly in the technology industry and in some countries and regions in which we operate, is intense and we may not be successful in attracting, motivating, and retaining needed personnel. We also may be unable to attract or integrate into our operations qualified personnel on the schedule we desire. We have from time to time experienced, and we expect to continue to experience, difficulty in attracting, integrating, motivating, and retaining highly qualified personnel, which could harm our business. In addition, dealing with the loss of the services of our executive officers, including our chief executive officer, or other key personnel and the process to replace any of our executive officers or key personnel may involve significant time and expense, take longer than anticipated, and significantly delay or prevent the achievement of our business objectives, which would harm our financial condition, results of operations, and business.

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, effective January 2021, SST payment rates decreased under a new contract with the SST Governing Board. 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

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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, which may result in such providers offering multiple solutions on their applications or 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. Certain large partners may negotiate, and in the past have negotiated, lower fees that may be charged to their end customers.

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.

In the past, we have pursued acquisitions of content, technology, and expertise to enhance the transaction tax compliance products and services we offer. We anticipate that we will continue to make 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

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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, financial services, 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. Larger customers may demand more integration services and customization as well as different product features and ongoing service expectations. In addition, 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 for underpayment of taxes, along with 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

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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 and financial condition.

Cybersecurity and data security breaches and ransomware attacks 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, as well as significant amounts of money for remittance to various taxing jurisdictions on their behalf. 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 and money, 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, ransomware, 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, sabotage systems, or otherwise access data and/or data backups 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, third-party data centers, 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.

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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.

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.

Our current cloud service infrastructure is run on AWS, GCP, and other third-party co-location leased data centers, and neither AWS, GCP, 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.

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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.

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.

Servicing our debt requires a significant amount of cash, and we may not have sufficient cash flow from our business to pay our substantial debt, settle conversions of the notes in cash, repurchase the notes upon a fundamental change, and meet other future capital needs.

Our ability to make scheduled payments of the principal of, to pay interest on, or to refinance our indebtedness, including our convertible senior notes due 2026 (the “2026 Notes”), depends on our future performance, which is subject to economic, industry, competitive, and other factors beyond our control. Our business may not generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt, or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.

Holders of the 2026 Notes have the right to require us to repurchase all or any portion of their notes upon the occurrence of a fundamental change at a fundamental change repurchase price equal to 100% of the principal amount of the notes to be repurchased, plus accrued and unpaid interest, if any. In addition, upon conversion of the

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notes, unless we elect to deliver solely shares of our common stock to settle such conversion (other than paying cash in lieu of delivering any fractional share), we will be required to make cash payments in respect of the notes being converted. However, we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of notes surrendered therefor or pay cash with respect to notes being converted. In addition, our ability to repurchase the notes or to pay cash upon conversions of the notes may be limited by law, by regulatory authority, or by agreements governing our current or future indebtedness. Our failure to repurchase notes at a time when the repurchase is required by the indenture governing the notes or to pay any cash payable on future conversions of the notes as required by the indenture would constitute a default under the indenture. A default under the indenture or the fundamental change itself could also lead to a default under agreements governing our current or future indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the notes or make cash payments upon conversions thereof.

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

As of December 31, 2021, we had U.S. federal net operating loss carryforwards, or NOLs, of approximately $1.1 billion due to prior period losses. NOLs generated in 2017 and prior will begin to expire in 2025. NOLs generated after 2017 do not expire but are limited to 80% of taxable income when utilized. Furthermore, 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 some or all our NOLs, whether or not we attain profitability in the U.S.

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

To improve the scalability, security, performance, 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.

Beginning in the first quarter of 2020, the 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

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the pandemic may not be fully reflected in our operating results until future periods. While we have implemented risk mitigation plans, 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 emergence of new variants, 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 current sales operations in Europe, India, and Brazil, as well as other countries and regions identified for expansion. Operating in international markets, particularly when entering new countries and regions, 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. As we expand our international operations, we currently do not have the breadth of partners like that which we have established in the U.S., making us more reliant on the initial partners that we have established to date. For example, a single partner accounts for a significant portion of our European revenue and any failure to retain or expand this relationship could harm our business and results of operations. Other 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 of these funds 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 cash financial losses, including but not limited to significant financial penalties

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imposed by taxing jurisdictions for late remittances calculated as a percentage of tax payment amounts due. Furthermore, our efforts to remit tax payments to applicable taxing jurisdictions only after receiving the related 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.

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 financial condition and liquidity, results of operations, and our reputation.

We also invest a portion of our funds held for customers in liquid, investment-grade marketable securities, money market securities, and other cash equivalents. Such investments are subject to general market, interest rate, credit, and liquidity risks. We follow an established investment policy to monitor and mitigate our exposure to liquidity and credit risks. These risks could be more significant, individually or together, during periods of unusual financial market volatility.

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 taxing jurisdictions. 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 significant 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.

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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.

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, internal theft, 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. See “Legal Proceedings” in Part I, Item 3 of this Annual Report on Form 10-K for more information regarding recent litigation. 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.

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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 and Convertible Notes

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, 2021, the trading price of our common stock has ranged from $28.09 per share to $191.67 per 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:

Future sales of our common stock or equity-linked securities in the public market could lower the market price for our common stock and adversely impact the trading price of the 2026 Notes.

In the future, we may sell additional shares of our common stock or equity-linked securities to raise capital. In addition, a substantial number of shares of our common stock is reserved for issuance upon the exercise of stock options, vesting of restricted stock units and performance stock units, and under our employee stock purchase plan. We cannot predict the size of future issuances or the effect, if any, that they may have on the market price for our

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common stock. The issuance and sale of substantial amounts of common stock or equity-linked securities, or the perception that such issuances and sales may occur, could adversely affect the trading price of the notes and the market price of our common stock and impair our ability to raise capital through the sale of additional equity or equity-linked securities.

The capped call transactions may affect the value of the 2026 Notes and our common stock.

In connection with the pricing of the 2026 Notes, we entered into capped call transactions with certain financial institutions (the “option counterparties”). The capped call transactions cover, subject to customary adjustments, the number of shares of our common stock initially underlying the 2026 Notes. The capped call transactions are expected to offset the potential dilution as a result of conversion of the notes.

The option counterparties or their respective affiliates may modify the hedge positions they established in connection with entering into the capped call transactions by entering into or unwinding various derivative transactions with respect to our common stock and/or purchasing or selling our common stock or other securities of ours in secondary market transactions (and are likely to do so on each exercise date of the capped call transactions, which are expected to occur during the 40 trading day period beginning on the 41st scheduled trading day prior to the maturity date of the notes, or following any termination of any portion of the capped call transactions in connection with any repurchase, redemption, or early conversion of the notes). This activity could also cause or avoid an increase or a decrease in the market price of our common stock or the notes.

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.

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.

We have identified a material weakness in our internal control over financial reporting that resulted in immaterial errors in our financial statements. If we fail to remediate this material weakness or if we experience additional material weaknesses in the future, we may be unable to accurately and timely report our financial results or comply with the requirements of being a public company, which could cause the price of our common stock to decline and harm our business.

We identified a material weakness over controls to correctly recognize stock-based compensation cost for RSUs. The control deficiency relates to the ineffective design of controls to verify the appropriate methodology selected for expense recognition when utilizing system-generated reports. For a more detailed description of the impact of the correction of this accounting error, see Note 15 to the accompanying consolidated financial statements of the Company.

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We cannot assure you that the measures we have taken to date, and are continuing to implement, will be sufficient to remediate this material weakness or to avoid potential future material weaknesses. Moreover, we cannot be certain that we will not in the future have additional material weaknesses in our internal control over financial reporting, or that we will successfully remediate any that we find. Accordingly, there could continue to be a reasonable possibility that the material weakness we have identified, or other material weaknesses or deficiencies, could result in a misstatement of our accounts or disclosures that would result in a material misstatement of our financial statements that would not be prevented or detected on a timely basis or cause us to fail to meet our obligations to file periodic financial reports on a timely basis. Any of these failures could result in adverse consequences that could materially and adversely affect our business, including an adverse impact on the market price of our common stock, potential action by the SEC against us, shareholder lawsuits, delisting of our stock, and general damage to our reputation.

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:

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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/A. 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/A, 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, 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 91% of total revenue in 2021 and 93% of total revenue in 2020.  

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. We have made multiple acquisitions in the last few years to augment our tax content, serve the needs of customers in different geographies or industries, and improve additional aspects of 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 continued to be impacted by the COVID-19 pandemic during 2021, which over the last two years 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. Even though we began to re-open certain of our office locations in 2021, the vast majority of our employees continue working from home. We expect these arrangements to continue for most of our workforce for an undetermined portion of 2022. During 2021, some of the geographic areas we serve and work from began to loosen travel bans and restrictions, and, where it is safe to do so, we have resumed some in-person customer activities and events. However, we continue to host many customer activities and events virtually and continue to limit employee travel. As the COVID-19 pandemic continues to progress, 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.

Total revenue for 2021 was $699.0 million, an increase of 40% from $500.6 million in 2020. Excluding the $55.7 million of revenue growth from recent acquisitions, total revenue for 2021 increased by 29%. This compares to an increase in total revenue of 31% in 2020 from 2019, or an increase of 29% excluding acquisitions. Revenue growth from our international operations, excluding acquisitions, increased $15.9 million, an increase of 51% from 2020. While we intend to continue aggressively investing internationally to expand non-U.S. revenue, as base revenue increases for our international operations, we expect the pace of revenue growth to moderate.

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Total revenue for 2021 and 2020 generated outside the U.S. was 8% and 6% of total revenue, respectively.  

Under the revised calculation methodologies, we added approximately 3,250 core customers during 2021 and delivered a net revenue retention rate of 115% on average over the past four quarters. In 2021, 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. See the section titled “Key Business Metrics” for more information.

We maintained a total gross margin of 70% in 2021, despite an increase in the proportion of revenue generated from professional services, which has a lower gross margin. Revenue from subscription and returns comprised approximately 91% of our revenue for 2021 compared to 93% of our revenue for 2020.

Operating expenses increased to $609.6 million in 2021 from $424.9 million in 2020, as we continued to make significant investments in our future growth. As a percentage of total revenue, operating expenses in 2021 were consistent with 2020. Sales and marketing expenses were $298.5 million in 2021, or 43% of total revenue, compared to $206.0 million in 2020, or 41% of total revenue reflecting our continued investments to grow and expand our business.

Our net loss was $135.6 million during 2021 compared to a net loss of $55.3 million during 2020. Operating loss was $116.9 million during 2021 compared to an operating loss of $68.1 million during 2020. Operating loss increased due primarily to a $44.2 million increase in stock-based compensation expense. Non-GAAP operating income was $5.5 million during 2021 compared to a non-GAAP operating loss of $3.1 million during 2020. For the year ended December 31, 2021, net cash provided by operating activities was $34.1 million compared to net cash provided of $42.6 million for the year ended December 31, 2020. During 2021, we generated free cash flow of $12.7 million compared to free cash flow of $34.0 million in 2020. See the section titled “Use and Reconciliation of Non-GAAP Financial Measures” for more information about our non-GAAP financial measures.

In August 2021, we completed a private offering of $977.5 million of convertible senior notes. The convertible senior notes are unsecured obligations and bear interest at a fixed rate of 0.25% per annum, payable semi-annually. The net proceeds from the sale of the convertible senior notes were $959.9 million after deducting the issuance costs. The convertible senior notes will mature on August 1, 2026, unless earlier converted, redeemed, or repurchased. We used $75.3 million of the net proceeds from the convertible senior notes offering to pay for the cost of the capped call transactions which are intended to offset potential dilution to our common stock or offset any cash payments we are required to make in excess of the principal amount.

As of December 31, 2021, we had $977.5 million in borrowings outstanding related to the convertible senior notes, with a net carrying value of $961.3 million. We ended the year with $1.5 billion 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.

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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.

⁽¹⁾ During the second quarter of 2021, we revised the methodology for calculating core customers to include revenue from SST (see Number of Core Customers below for details). The table above includes the number of core customers using both the legacy and the revised methodologies.

⁽²⁾ During the second quarter of 2021, we revised the methodology for calculating net revenue retention rate to include revenue from SST. In addition, professional services revenue is no longer included in the revised calculation methodology, as these services tend to be more one-time in nature (see Net Revenue Retention Rate below for details). The table above includes the net revenue retention rate using both the legacy and the revised methodologies.

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 segment. During the second quarter of 2021, we revised our core customer calculation methodology to include revenue from our Streamlined Sales Tax solution (“SST”), which results in additional customers being included in reported core customers. Under the revised calculation methodology, as of December 31, 2021, and 2020, we had approximately 18,270 and 15,020 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 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.

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As noted above, we revised our core customer calculation methodology during the second quarter of 2021. Under the prior methodology, revenue from SST was not included in our calculation of total revenue during the previous 12 months. This meant customers that would have otherwise met the definition of a core customer, with inclusion of attributable SST revenue, were excluded from our core customer count as well as our disclosures on the percentage of total revenue attributable to core customers. The revised methodology for core customers includes revenue from SST.

We believe these changes improve the usefulness of this key business metric, which is to measure both the growth of existing customers into core customers and the acquisition of new customers of a certain size.

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 numerous enterprise-level customers that 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 subscription and returns revenue in the current quarter from any billing accounts that generated revenue during the corresponding quarter of the prior year by (b) total subscription and returns 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.

During the second quarter of 2021, we revised our net revenue retention rate calculation methodology. Under the prior methodology, revenue from our SST solution was not included in net revenue retention rate. This means that revenue expansion from existing customers adopting our SST solution was not included, while revenue contraction from customers replacing one or more of Avalara’s other solutions with SST was included. The revised calculation methodology for net revenue retention rate includes revenue from SST. In addition, professional services revenue is no longer included in the revised calculation methodology, as these services tend to be more one-time in nature. Under the revised calculation methodology, our net revenue retention rate was 116% for the quarter ended December 31, 2021, and on average has been 115% over the last four quarters ended December 31, 2021. Under the legacy calculation methodology, our net revenue retention rate was 113% for the quarter ended December 31, 2021, and on average has been 110% over the last four quarters ended December 31, 2021.

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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.

2021 Acquisitions

Inposia. On April 1, 2021, we acquired the outstanding equity of INPOSIA Solutions, GmbH (“Inposia”), under a Share Purchase Agreement. Inposia is a German software company that delivers e-invoicing, digital tax reporting, and system and data integration to support digital transformation efforts and address real-time compliance requirements for businesses. Inposia will build upon Avalara’s existing e-invoicing capabilities in Brazil and India to support customers worldwide with real-time compliance. The total consideration transferred related to this transaction was €31.8 million (or approximately $37.4 million using the exchange rate on April 1, 2021), consisting of net cash consideration of $14.5 million and 164,416 shares of the Company’s common stock paid at closing with an acquisition date fair value of $23.0 million.

Davo. On April 20, 2021, we acquired substantially all the assets of DAVO Technologies LLC (“Davo”) under an Asset Purchase Agreement. Davo helps emerging small businesses automate the daily and ongoing requirements for sales tax. As a result of the acquisition, Davo extends Avalara’s ability to provide integrated sales tax compliance processes to alleviate the burden of compliance on small businesses. The total consideration transferred related to this transaction was $56.7 million, consisting of $23.5 million cash paid at close, a $0.3 million cash deposit paid in the first quarter of 2021, an acquisition holdback with a fair value upon acquisition of $2.6 million, and an earnout provision with a fair value upon acquisition of $30.3 million.

3CE. On September 7, 2021, we acquired substantially all the assets of 3CE Technologies, Inc. (“3CE”) under an Asset Purchase Agreement. 3CE is a Canadian company that provides software and services for Harmonized System code classifications and verifications, primarily to government entities and logistics services providers. The acquisition will expand and improve our Harmonized System code classification content and provide a new self-service model to sell to the Company’s customers. The total consideration related to this transaction is $11.2 million, consisting of $9.9 million cash paid at close and an acquisition holdback with a fair value upon acquisition of $1.3 million.

Track1099. On October 1, 2021, we acquired substantially all the assets of Track1099 LLC (“Track1099”) under an Asset Purchase Agreement. Track1099 provides online software and services for cost-effectively managing, e-filing, and e-delivering Internal Revenue Service forms, including Forms 1099, W-2, and W-9. The total consideration related to this transaction is $48.8 million, consisting of $35.0 million cash paid at close, an acquisition holdback with a fair value upon acquisition of $5.0 million, and an earnout provision with a fair value upon acquisition of $8.8 million.

CrowdReason. On October 18, 2021, we acquired substantially all the assets of CrowdReason Limited Liability Company, a Texas limited liability company, and CorrelationAdvisors LLC, a Texas limited liability company (together, “CrowdReason”) under an Asset Purchase Agreement. CrowdReason is a technology services company that provides software applications, solutions, and services for property tax compliance, along with consulting services related to property valuation and property tax compliance. The total consideration related to this transaction is $36.4 million, consisting of $8.3 million cash paid at close, an acquisition holdback with a fair value upon acquisition of $1.7 million, and an earnout provision with a fair value upon acquisition of $26.3 million.

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2020 Acquisitions

Transaction Tax Resources. On October 5, 2020, we acquired all the outstanding equity of Transaction Tax Resources, Inc. (“TTR”), 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. The total cash consideration related to this transaction was approximately $378.0 million. Approximately $57.6 million of the purchase price will be paid to TTR shareholders 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”), 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. The total consideration related to this transaction was approximately $97.0 million. 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 18 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”), a London-based provider of insurance tax compliance software and services, specializing in support for multi-national insurance companies. The total consideration 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.

2019 Acquisitions

Compli. On January 22, 2019, we acquired substantially all the assets of Compli, Inc. (“Compli”), a provider of compliance services, technology, and software to producers, distributors, and importers of beverage alcohol in the United States. Total consideration related to this transaction was $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 12 months, and an earnout provision fair valued upon acquisition at $3.8 million.

Indix. On February 6, 2019, we acquired substantially all the assets of Indix Corporation (“Indix”), an artificial intelligence company providing comprehensive product descriptions for more than one billion products sold and shipped worldwide. Total consideration related to this transaction was $9.1 million, consisting of $5.5 million paid in cash at closing, an additional $1.4 million cash to be paid after 18 months, and an earnout provision valued upon acquisition at $2.2 million.

Portway. On July 31, 2019, we acquired substantially all the assets of Portway International Inc. (“Portway”), a provider of Harmonized System code classifications and outsourced customs brokerage services. Total consideration related to this transaction was $24.3 million, consisting of $13.0 million paid in cash at closing, an additional $2.0 million of cash to be paid after 18 months with an acquisition date fair value of $1.9 million, and an earnout provision fair valued upon acquisition at $9.4 million.

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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 is driven primarily by the acquisition of customers, customer renewals, and additional service offerings purchased by existing customers. Revenue from subscription and returns comprised approximately 91% of our revenue for 2021 and 93% of our revenue for 2020 and 2019.

Subscription and Returns Revenue. Subscription and returns revenue primarily consists 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.  

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 12 to 18 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. During the first quarter of 2021, we renewed our agreement with the SST Governing Board to provide SST services at a lower percentage rate than we previously earned.

Subscription and returns revenue also includes interest income generated on funds held from 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 back filing 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 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.

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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, software hosting costs for research and product development activities, and the cost of third-party developers. Research and development costs, other than software development costs qualifying for capitalization, are expensed as incurred. Capitalized software development costs, which consist primarily of employee-related costs, 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 suspended in-person promotional and customer events and converted many of these activities to virtual events, which temporarily reduced these types of marketing expenses. We began to gradually resume limited in-person marketing activities in the second half of 2021 where it was safe to do so. 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. During 2022, we expect to continue to increase in-person marketing activities as conditions allow.

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 estimated period of benefit, generally 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 and update targets during the year as appropriate. Sales commissions are generally earned based on achievement against these targets.

We defer the portion of partner commissions 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. Integration partners may be 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.

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.

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We expect our general and administrative expenses to increase in absolute dollars as we continue to expand our operations (in the U.S. and internationally), hire and train 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 quarterly remeasurement of earnout liabilities for acquisitions accounted for as business combinations, interest income on cash and cash equivalents, interest expense related to our 2026 Notes, foreign currency gains and losses, and other non-operating 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).

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

⁽¹⁾The stock-based compensation expense included above was as follows:

The amortization of acquired intangibles included above was as follows:

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