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Avalara IPO | S-1 Breakdown

By 

Alex Clayton

May 15, 2018

Company Overview

Avalara, the leading provider of cloud-based solutions for tax compliance and automation, filed for a $150M IPO. The company plans to trade on the NYSE under the ticker “AVLR” and Goldman Sachs is leading the offering. Avalara is now the 10th SaaS/B2B company to file this year behind Pluralsight, Carbon Black, DocuSign, Smartsheet, Pivotal, Dropbox, Zscaler, Zuora, and Ceridian. Avalara’s motto is “tax compliance done right” and their mission is to enable companies to focus on their core business and not worry about tax compliance — their vision is to be part of every transaction in the world. There are thousands of local, regional, state, and federal taxing authorities in the U.S. and internationally that impose a variety of transaction taxes that businesses must comply with, which include tax obligation, collection, remittance, records of registrations, tax exemption certificates, and other compliance documents. Avalara’s core market are SMB to mid-market companies ranging from 20 → 500 full-time employees (FTEs) and in many cases these companies don’t have any software systems to track their tax compliance and/or file taxes. Moreover, the U.S. government collects many millions of dollars per year in fines from companies that don’t comply and/or make errors with their taxes. While regulation may be decreasing at the federal level, commerce is becoming more global and local and state regulations are increasing. For example, the company reveals that digital music downloads are currently taxable in New Jersey but tax exempt in Iowa. In New York City, a plain bagel, sliced and toasted is currently taxable, while a plain bagel to go is tax exempt.

The company’s core product offering, AvaTax, processes transaction tax determinations on average in under 60 milliseconds and in 2017 processed an average of over 16 million tax determinations per day, including 58+ million on Cyber Monday. Avalara was founded in 1999 under the name Advantage Solutions and changed their name to Avalara in December 2005. The company has 1,495 FTEs (full-time-employees) and is based in Seattle, WA.

Company Timeline Output

Source: Company S-1

Summary Metrics and GTM

Avalara did $213.2M of total revenue in CY’17, up 27% YoY from $167.4M in 2016. In Q1'18 the company did $61.4M of revenue, up 25% YoY. 92%+ of Avalara’s revenue is subscription or recurring in nature, and the company ended Q1'18 at $231.5M of implied ARR (quarterly subscription revenue * 4), up 26% YoY. The company is still losing money and had a (25)% and (17)% GAAP and non-GAAP operating loss margin in the most recent quarter, respectively. Their free cash flow margin improved from (45)% in CY’15 to (8)% in CY’17, but in the most quarter dipped to (28)%. Below are a few other stats and KPIs from the S-1;

  • As of March 31, 2018, the company had 7,760 core customers — a core customer is a uniquely identified company that spends at least $3,000 per year with Avalara. While core customers represent less than half of total customers, they account for more than 85% of total revenue. ARR / core customers represents a ~$30K average ACV. There is a long tail of SMB customers that are in Avalara’s self-serve segment.
  • Subscription and returns revenue accounted for 92%, 93%, 94%, and 94% of total revenue during 2015, 2016, 2017, and the three months ended March 31, 2018, respectively.
  • 95% of revenue is in North America.
  • In 2015, 2016, 2017, and for the three months ended March 31, 2018, commissions earned by partners amounted to approximately 7%, 6%, 7%, and 6% of total revenue, respectively.
  • The revenue churn rate for each of 2016 and 2017 was less than 5% and net revenue retention was 107% on average for the past 4 quarters. In Q1'18 net revenue retention was 109%.
  • No single customer represented more than 1% of total revenue since 2015.
  • The company has over 600 pre-built integrations that link the Avalara Compliance Cloud with other business applications used for accounting, ERP, e-Commerce, POS, recurring billing, and CRM systems. Avalara added over 100 new integrations in 2017.
  • There are over 12,000 regulations involving tax in the U.S. alone and they change frequently, are not consistent across geographies, vary with regard to tax incentives, time periods, and by product and price. There are also sales and use tax, VAT, excise tax, lodging tax, and communications tax. Each tax type has a different method for calculating and applying the tax, requiring different processes for compliance.

Avalara sells subscriptions and primarily targets SMB →mid-market companies in all industries and also has a team focused on larger enterprises. The very small businesses (i.e. spending less than $3K/year with Avalara) can buy solutions through self-serve in Avalara’s marketplace without sales or the onboarding team involvement. Most sales are done over the phone and contracts typically range from 12–18 months and Avalara charges customers in tiers based on their number of transactions and tax filings. Some revenue is driven by their partners too. The average core customer is at ~$30K in average ACV and pricing starts on the low end at $50/mo.

Product

Avalara offers a suite of products for transaction tax compliance and automation. They can be purchased individually or as a suite and most customers begin with a single product, typically their core product, AvaTax. The company offers a few main solutions;

  • AvaTax: Core tax compliance product that launched in 2004 that helps companies determine the appropriate transaction tax, and started with just sales tax. The product has broadened to include other types of tax such as VAT, excise tax, lodging, communications, and international tax, tariffs and duty rates.
  • Avalara Returns for tax returns, preparation, filing and remittance: Avalara offers a tax returns product that can be integrated into AvaTax or sold separately. It’s offered as an annual subscription or it can be purchased on a per returns basis. For smaller customers with less complex filing requirements, they offer 2 self-serve solutions 1) TrustFile that helps companies populate sales and use tax return forms 2) MyLodgeTax which prepares and files returns for lodging tax customers.
  • Avalara Compliance Document Management: Compliance document management solution for W-8, W-9, licenses, registrations and other tax forms. This product can be purchased separately and their offering is called CertCapture.

Additional Products

  • MatrixMaster: Product taxability database for retail that has classification rules for almost 20 million products.
  • Avalara CloudConnect: Hardware device for customers that want an on premise solution.
  • VAT Expert: SaaS product that checks customer and supplier VAT numbers and provides VAT determinations for the European market.
  • Brazilian tax compliance: Solution focused on tax determination for the Brazil market.
Source: Company S-1

Market Opportunity

Avalara believes their market size to be over $8B in the U.S. alone. They derive that figure by looking at U.S. Census data on businesses and applying an appropriate ACV to each segment based on their current customer base. The company also states that, according to the Organisation for Economic Co-operation and Development (OECD), there was an estimated $377B of sales tax collected in the U.S. in 2016 and AvaTax determined ~$5.8B during the same year, which represents ~1.5% market share for Avalara. There’s also another estimated $445B of other types of transaction taxes that were collected in the U.S. in 2016 which the company could theoretically help determine for customers. Moreover, there’s another $1.2T of estimated VAT taxes that were collected in Europe in 2016, a market where Avalara has more recently entered.

Competition

Avalara’s space is competitive and fragmented. The company competes with DIY (do-it-yourself) approaches which include Excel spreadsheets, tax tables or rate calculators, outsourced services and consulting firms, and other tax compliance software vendors like CCH Incorporated (a subsidiary of Wolters Kluwer), ONESOURCE Indirect Tax (division of Thomson Reuters), Sovos, and Vertex. Given how compliance is getting harder and harder for any company, and SMBs and mid-market companies lack the resources of large enterprises, the market trends are moving towards a solution like Avalara.

Investors and Ownership

According to Pitchbook, the company has raised $394.5M to date from investors including Warburg Pincus, Sageview, Battery, Technology Crossover Ventures (TCV), Pioneer Venture Partners, Arthur Ventures and others. 5%+ pre-offering VC shareholders include Sageview (27.1%), Warburg Pincus (24.4%) and Battery Ventures (9.9%). Scott McFarlane, CEO and co-founder, is at a 3.8% pre-offering stake. The company raised their last round of $96M from Sageview, Battery, and Warburg in September of 2016 at a $925M pre-money valuation, according to Pitchbook.

Acquisitions

It’s worth noting that significant portions of Avalara’s business have been built through acquisition, such as their tax return and preparations / filing product, their compliance document management solution, and since 2014 have acquired their excise tax, lodging tax, communications tax, and pieces of their Brazil and European VAT tax solutions. Some more information on a few they disclose since 2015 below (totaling ~$75M in total transaction value and mostly in cash);

  • September 2016 Acquisition of Gyori in Brazil — $21.7M
  • June 2015 Acquisition of VAT Applications — $16.5M
  • June 2015 Acquisition of EZtax — $28.1M
  • February 2015 Acquisition of HotSpot — $9.1M

Financials and Other Metrics Outputs

Avalara grew their implied ARR 26% YoY last quarter to $231.5M and has averaged 29% YoY ARR growth for the past 5 quarters. Subscription gross margins are ~75% and services gross margins are positive and were at 23% last quarter. In terms of efficiency, their implied ARR grew 1.26x over the past year, sales and marketing grew 1.23x, but their CAC (sales and marketing / new core customer logos) grew ~2x while their average ACV was relatively flat, implying it’s becoming more expensive to acquire similar-sized customers as they scale. With that said, sales and marketing as a % of revenue has stayed relatively constant in the 60's. Given they don’t disclose all customers (and just customers over $3K in annual revenue), the CAC could be off but probably in line with their trend line. The product itself is very sticky, and given Avalara had less than 5% revenue churn over the past 2 years and net retention of almost 110%, customers are likely quite profitable over time. Unfortunately, the company did not disclose any cohort data in their S-1. Avalara also only has $12.6M in cash so it’s a good time to raise money in an IPO. Outputs of other financials and metrics are below.

Annual Historical P&L & Metrics (000's)

Source: Company S-1

Quarterly Subscription and Returns Revenue ($M)

Source: Company S-1

Implied Ending ARR ($M)

Avalara has added $48.1M of net new ARR over the past year and $15M in the last quarter.

Source: Company S-1

Core Customers and Annual Contract Value (ACV)

While the company only discloses core customers ($3K+ in annual revenue), they make up most of total revenue and the chart below uses them as a proxy for average ACV (ARR / core customers). The company has been adding a similar amount of logos QoQ while average ACVs are increasing moderately. Given the increase in CAC, it’s likely the company has been adding many more large customers recently and have a long tail on the lower end, keeping the average down.

Source: Company S-1

Net Revenue Retention

Source: Company S-1

CAC (Customer Acquisition Cost) and Payback Periods

Avalara’s business is lumpier making their efficiency metrics harder to look at QoQ, but the chart below has CAC (sales and marketing / net new core customers) and their implied months to payback (implied net new ARR * gross margin / sales and marketing spend of prior quarter). Their median months to payback has been~40 months over the past 7 quarters. You can see medians for other companies here. As I mentioned they are probably moving up market given the higher CAC but it doesn’t show up in their average ACV.

Source: Company S-1

GAAP Operating Expenses as a % of Revenue

Source: Company S-1

GAAP Operating Margins and Free Cash Flow Margins

Source: Company S-1

Annual Cash Flows (000's)

Source: Company S-1

Quarterly P&L / Metrics (000's)

Source: Company S-1. Non-GAAP is less SBC.

Full-Time-Employee Breakdown

Avalara had 1,495 FTEs at the end of Q1'18. Their geographical breakdown is below;

Source: S-1

Valuation

Similar to other high-growth software companies that are unprofitable, Avalara is likely to be valued on a multiple of forward revenue. The output below uses NTM (next-twelve-months) revenue as a proxy based on an illustrative range of growth rates. Additionally, below is an ARR multiple range based on other high-growth public SaaS companies as a frame of reference. Avalara will need to show a plan for continued growth and improving margins, and a target model for profitability.

Note: Enterprise value ranges and growth rates are illustrative.

Avalara is solving a critical business and compliance problem (that is getting harder) for SMBs and mid-market companies. While the market is fragmented, it’s a massive opportunity and Avalara is barely penetrated. The international market is even bigger. It’s refreshing to see a company re-imagining a back-office function through software that has historically been a manual or outsourced process for many years, particularly in the SMB segments. Cloud-based software is permeating every business process and Avalara is a great example of a company that started in what probably looked like a niche market, and now the business is almost at $250M in ARR and going public. Avalara is a strategic asset and leader in SaaS tax automation for mid-market companies — congrats to the company and team and looking forward to seeing them as a public company.

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