AVLR Avalara Inc

You are being asked by Avalara to adopt the Merger Agreement. It is a condition to the consummation of the Merger that Avalara’s shareholders adopt the Merger Agreement. For the reasons discussed below, we oppose the Merger and the adoption of the Merger Agreement. To that end, we are soliciting your proxy to vote AGAINST Proposal 1.

We recommend that you demonstrate your opposition to the proposed Merger and send a message to the Board that the proposed Merger is not in the best interest of Avalara’s shareholders by using the enclosed GOLD proxy to vote by telephone or internet today. Alternatively, you may sign, date and return the enclosed GOLD proxy card by mail.

Reasons to Vote Against Adopting the Merger Agreement:

We believe strongly in Avalara’s opportunity to create significantly more value for shareholders. Tax compliance is critical for all businesses, but despite increasing complexity and risk of exposure, many businesses continue to calculate taxes and file returns manually. We believe Avalara, by providing simple, automated transactional tax solutions in a market with limited competition, has a clear and long runway to continue to compound growth for many years, regardless of macroeconomic conditions. Avalara, in our view, is a fundamentally sound business, with a resilient business model, strong partnerships with leading companies and a compelling opportunity to be a part of every transaction in the world.^[2]

As Ross Tennenbaum, Avalara’s Chief Financial Officer, said this May:

“We’re addressing a large, low-penetrated market where we are a leader in the space, with competitive moats and a differentiated business strategy. We are positioning to capture a leader share of our market opportunity.”^[3]

And again, as recently as June 28, Mr. Tennenbaum expressed great enthusiasm for the prospects of Avalara:

“We remain in the early days of penetration in a big market and still believe we are a growth story where we can sustain strong growth for a number of years as we build a multibillion-dollar revenue company. We also believe we can do that with significant margin improvement.”^[4]

Avalara’s leadership team has taken great pains to explain that despite the difficult global economic environment, Avalara is positioned to succeed, stating that the Company is “a long and strong growth compounder and well-positioned to grow in good and in challenging times.”^[5]

It is dumbfounding to us that the Board would have chosen now to sell the Company. The management team has expressed confidence in the future, despite an uncertain macroeconomic environment that would surely cause any potential buyer to pause. Meanwhile, capital markets are volatile, private equity funds are proceeding very cautiously and the debt financing market for large buyouts, like that of Avalara, limits the ability of private equity firms to pay reasonable multiples. On top of this, the Company is on the verge of achieving operating profitability for the first time,^[6] which we believe will make it more attractive to a larger and different set of buyers. In light of these circumstances, this was simply the wrong time for the Board to look for a buyer for Avalara in our opinion.

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^[2] CEO Scott McFarlane, Avalara 2022 Analyst Day, June 28, 2022 (“First, we have a clear and unified vision to be part of every transaction in the world. And I am more confident than ever we can achieve this vision.”).

^[3] CFO Ross Tennenbaum, Q1 2022 Earnings Call, May 6, 2022.

^[4] CFO Ross Tennenbaum, Avalara 2022 Analyst Day, June 28, 2022.

^[5] CEO Scott McFarlane, Q1 2022 Earnings Call, May 6, 2022.

^[6] See Avalara Preliminary Proxy Statement, filed with the SEC on August 24, 2022, at 64, which shows Non-GAAP Operating Income at break-even in 2022 and $52 million in 2023, with Non-GAAP Operating Income projected to approximately double in each of the subsequent two years.

The Timing Is Wrong

Only one party made a final proposal to buy Avalara, despite the fact that Avalara is a company with very attractive long-term fundamentals and a “competitive moat.”^[7] This unfortunate and suboptimal outcome was the result, in our view, of a poorly timed and flawed sale process.

Macroeconomic factors like rising interest rates, inflation, supply chain disruptions and concerns over consumer spending have created significant economic dislocation and uncertainty in 2022. Avalara has certainly not been immune to these challenges. During the first quarter of 2022, sales and marketing capacity constraints led to slower than expected growth in new bookings and upsell bookings, and the Company’s international business faced some weakness attributable to a decrease in contract pricing with a large marketplace partner.

At the same time, volatile capital markets have lowered equity valuations and made financing of large buyout transactions difficult. The Russell 3000 was down 20% during the first half of 2022, its worst start to the year ever.^[8] For technology companies, these issues have been compounded by the normalization of growth and post-pandemic demand, rattling investor confidence in the sector. Not surprisingly, Avalara’s stock price was down approximately 23% during the first quarter of 2022 given these economic uncertainties and the “risk off” capital markets environment.

While Avalara’s share price declined as investors pulled back from higher-risk assets, there were no signs that the Company’s long-term prospects were fundamentally impaired. As noted above, in May and June, the Company’s executive officers continued to express great confidence in the Company’s prospects and batted away concerns that the economic slowdown would have much impact on the Company in the mid- to longer-term. Notably, on the May earnings call, for example, Mr. Tennenbaum said that Avalara’s broad customer diversity helps “insulate the [Company] from shock to e-commerce and the broader economy” and that its international business remains “a huge opportunity and green space” going forward.^[9]

The Company’s projections also reflect management’s confidence that the short-term economic disruptions would have only a marginal impact on the mid- and long-term prospects of the business. While the Company’s “May Projections” forecasted a Non-GAAP Operating Loss of $11 million in 2022 and Non-GAAP Operating Income of $55 million in 2023, the Company’s updated “July Projections” show the Company breaking even in 2022 (an improvement) and a Non-GAAP Operating income of $52 million in 2023.^[10]

Faced with uncertain economic times – but ones the executive team was confident the Company would weather successfully^[11] – a depressed stock market and a volatile financing market, it is incomprehensible to us that the Board would have thought the timing was optimal to maximize the value of the Company in a sale.

We believe there was no imperative for the Board to undertake a sale process amid a temporarily strained economic environment coupled with inhospitable financing markets.

By July, as proposals for Avalara were due under the Board’s process, high-yield corporate bond spreads to treasury yields had widened more than 200 basis points from January, significantly affecting the availability of financing and the cost of debt for any buyout. Notably, the number of announced private equity buyouts in the $5 billion to $10 billion range in Q2 was down more than 40% from a year earlier^[12] because of the turmoil in the economy and financing markets.^[13]

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^[7] CFO Ross Tennenbaum, Q1 2022 Earnings Call, May 6, 2022.

^[8] Source: FactSet.

^[9] Avalara Q1 2022 Earnings Call, May 5, 2022.

^[10] Avalara Preliminary Proxy Statement, filed with the SEC on August 24, 2022, at 63-64.

^[11] In May, the Board approved mid-term projections indicating that Avalara could achieve operating profitability as soon as 2023 for the first time. See Avalara Preliminary Proxy Statement, filed with the SEC on August 24, 2022 at page 63.

^[12] Source: Bloomberg.

^[13] Source: Aaron Kirchfeld and Michelle F. Davis, “Dealmakers Buckle Up as Records Give Way to Ruptures in M&A,” Bloomberg, June 30, 2022 (“Buyout firms, whose spending had been trending up year-on-year as recently as May, are all of a sudden finding it harder to secure the leveraged loans required to get big deals done.”).

We believe the Board’s timing for conducting the once-and-only sale of Avalara impacted the number of proposals and the competitive nature of the “auction.” Several potentially interested parties withdrew from the process, specifically citing unfavorable market conditions^[14] and an uncertain macroeconomic environment.^[15] Even Vista itself did not initially submit a proposal due in part to difficulty securing financing because of the “deterioration in the financial markets”^[16] and then came back with a lower indication of interest than what it had originally proposed, in part because of “the deterioration in the financial markets.”^[17]

The Sale Process Was Flawed

Having launched a sale process in the middle of market turmoil, we believe the Board should have expected that no bidder would provide an indication of interest that matched the Board’s view of intrinsic value. That is exactly what happened. In fact, no bidder was even able to submit a final bid on the Board’s timeline because of the lack of certainty regarding Avalara’s near-term business outlook and the inability to finance an attractive proposal.

When the deadline for making proposals came and went without the Company receiving any final proposals, the Board on July 16 rightly “decided to terminate the potential sale process.”^[18] That was the smartest thing this Board did during this “sale” process.

Unfortunately, it was not a decision that lasted.

Instead, the Board appears to have eagerly re-engaged with Vista when Vista came back to the table with a price that was almost 10% below its initial indication of interest. The Board’s engagement on that basis signaled to Vista, in our view, the Company’s unusual eagerness to complete a deal. Vista from then on, in our opinion, had the upper hand and was able to negotiate a deal very much in its favor.

And while this unusual negotiating move – agreeing to re-engage with a bidder at a significantly lower price to accommodate temporary financial market dislocation – may have been the most obvious and egregious process flaw that irreparably tainted the sale process, it certainly was not the only one in our view.

From the start, the Company’s financial advisor, Goldman Sachs, appears to have failed to conduct a robust sale process. It initiated contact with just three potential buyers. The few other firms in the process had all been engaging with the Company for several months about providing growth capital for the Company’s promising international expansion opportunities. Later, when a rumor of a sales process appeared in the media, and Goldman fielded additional in-bound interest from “a variety of parties,”^[19] Goldman appeared to pay little attention to those potential buyers and sources of financing; in fact, as far as we can tell from reviewing the Company’s public disclosures, no substantive discussions took place with any of these parties.

The Board’s process, it appears based on its disclosures was to interact with the limited number of firms that had indicated some interest in a transaction with the Company in March and April, and to make outbound phone calls to just three additional firms. We believe this process was woefully inadequate, especially in the face of challenging market conditions. Compounding this process that we regard as deficient was the Board’s willingness to accept a “no-shop” provision, severely limiting the Company’s ability to solicit or encourage other proposals once the deal was announced.

It appears to us that Vista may have been the preferred buyer all along. Goldman has longstanding ties to Vista, after all, including by earning more than $80 million^[20] in fees during the last two years from Vista and its affiliates and portfolio companies. It is also not lost on us that Avalara director Marcela Martin serves on a board of a Vista-controlled company with four Vista professionals, including the Vista partner that was responsible for the Avalara deal. And Avalara director Rajeev Singh has also served on the board of a company that Vista acquired.

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^[14] Avalara Preliminary Proxy Statement, filed with the SEC on August 24, 2022, at 39 (“Party G informed Goldman Sachs that they had determined not to explore a potential transaction involving Avalara because of challenging market conditions,” while “Party C informed members of Avalara’s senior management that they would not submit an indication of interest because of market conditions…”).

^[15] Id. at 41.

^[16] Id.

^[17] Id. at 49.

^[18] Id. at 41.

^[19] Id. at 40.

^[20] Id. at 60.

However, whether Vista was the preferred party all along, or not, it should have been obvious to this Board in our opinion that, between Goldman’s lucrative relationship with Vista and its outsized success fee for this transaction, Goldman had extraordinary financial incentives to recommend a transaction and that nearly any available transaction would be good enough.

The egregious conflicts of interest that incentivized management and Goldman to advocate for the transaction raise serious and troubling questions as to whether the Board followed a reasonable and prudent process. Avalara management stands to receive a $60 million payday as a result of the deal^[21] (not including the $2.7 million the non-employee directors will receive^[22]). Two of the Company’s directors are serving or have served on the boards of Vista affiliates. Goldman has a close working relationship with Vista and its affiliates, for which it received approximately $80 million in fees over the past two years (not including another $43 million from Vista equity holders and their affiliates^[23]), and stands to receive $70 million contingent upon closing of the transaction^[24] (plus a net gain of an estimated $5 million with respect to capped call transactions^[25]). These conflicts of interest and the absence of truly independent financial advice, in our view, made for a biased and flawed process which, unsurprisingly, led to a great deal for Vista and Goldman but a disappointing outcome for Avalara shareholders.

The Board could very easily have obtained a second opinion from an independent financial advisor – a firm without a strong financial incentive for getting a deal done or maintaining a mutually beneficial relationship with the would-be buyer. So, why didn’t the Board engage a second, unconflicted financial advisor to objectively review the timing, process and terms of this important transaction? We suspect the Board was concerned that any such independent financial advisor would question the suboptimal timing and flawed approach used by the Board and Goldman to arrive at the deal.

The Price Is Inadequate

The Board’s unexplained haste to sell the Company could perhaps be excused had what we regard as an ill-designed and poorly executed sale process nevertheless maximized value for Avalara shareholders. The negotiated transaction, at $93.50 per share, falls far short in our view.

¹ Source: FactSet. (NYSE: AVLR) Data as of July 6, 2022, the last trading day prior to media reports speculating on the proposed merger. “Vista Initial Indication of Interest” calculated as the midpoint of the range of $97.00 and $101.00 per share of Avalara common stock as disclosed on page 39 of Avalara’s Preliminary Proxy Statement.

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^[21] Id. at 68.

^[22] Id. at 68.

^[23] Id. at 60.

^[24] Id. at 62.

^[25] Id. at 62.

Several sell-side analysts and the investors they cover^[26] openly expressed doubt about the deal price:

In addition to analyst and investor sentiment, there are five objective measures of value that all suggest the deal price is inadequate and that a fair deal would be priced well over $110 per share:

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^[26] Permission to use analyst quotes neither sought nor obtained.

^[27] Source: FactSet. Data refers to weighted average based on disclosed transaction value.

^[28] Source: FactSet and Company filings. Comparable transactions refer to those in the “Selected Transactions Analysis” of the Company’s financial advisor and include Ping Identity (Thoma Bravo), Zendesk (Permira & H&F), SailPoint (Thoma Bravo), Datto (Kaseya / Insight), Anaplan (Thoma Bravo), Mandiant (Google), Medallia (Thoma Bravo), Proofpoint (Thoma Bravo), Pluralsight (Vista), Slack (Salesforce), Tableau (Salesforce), Ultimate Software (Hellman & Friedman), Apptio (Vista), SendGrid (Twilio), Adaptive Insights (Workday), MuleSoft (Salesforce), Netsuite (Oracle), Demandware (Salesforce), Marketo (Vista), Cvent (Vista), Solarwinds (Thoma Bravo), Concur (SAP) and Sourcefire (Cisco).

^[29] Source. FactSet. See supra at Footnote 35 for a list of comparable transactions.

^[30] Source: FactSet. Data refers to weighted average based on disclosed transaction value.

Conclusion

We are proud to have owned Avalara for nearly twenty years. And based on the Company’s strong competitive position and promising future, we are perfectly content to continue to own Avalara as an independent entity for years to come. We understand there has been a deceleration in revenue growth for the first time in Avalara’s history as a public company. But the Company’s modestly slower revenue growth over one or two quarters is not a fundamental business issue, nor do we believe that it will persist.

The Board, in the face of this macroeconomic adversity unrelated to the market for tax compliance software, should have insisted that the Company execute through the economic trough, with a plan to emerge stronger and create value in the future. If the Company is to be sold, it should be sold from a position of strength, in a robust financing market and only after a well-run, competitive process. This is not that time in our view.

The proposed transaction appears to us to be the product of bad timing and a flawed process. The price in our view reflects pessimism and transient market dynamics and not the Company’s intrinsic value. We are convinced that, in the near-term, Avalara can deliver value to shareholders far in excess of the $93.50 per share that Vista is offering, and in the longer-term, Avalara can compound that value as it executes its profitable growth strategy.

Shareholders Should Vote AGAINST the Merger

In our view, there is no reason to sell the Company now, and certainly not at this price. We therefore urge all shareholders to join us in voting AGAINST the Merger on the GOLD proxy card.

Vote Required.

According to the Company’s Proxy Statement, the approval of the Merger Agreement Proposal requires the affirmative vote of the holders of a majority of all of the issued and outstanding shares of Common Stock entitled to vote at the Company’s Special Meeting. An abstention vote will have the same effect as if the shareholder voted “AGAINST” the Merger Agreement Proposal. Nevertheless, we urge shareholders to vote “AGAINST” the Merger Agreement Proposal to make sure their voices are heard and that there can be no doubt that the Company’s shareholders stand in opposition to the Merger.

We urge you to vote today using our GOLD proxy card. If you have already voted using the Company’s white proxy card, you have every right to change your vote by using the enclosed GOLD proxy card to vote again by telephone or by Internet. In light of ongoing delays in the postal system, we encourage all shareholders to submit their proxies electronically. If you do not have access to a touch-tone phone or Internet, please sign, date and return the enclosed GOLD proxy card in the postage-paid envelope provided. Only the latest validly executed proxy that you submit will be counted; any proxy may be revoked at any time prior to its exercise at the Special Meeting by following the instructions under “Can I change my vote or revoke my proxy?” If you have any questions or require any assistance with voting your shares, please contact our proxy solicitor, MacKenzie Partners, toll free at 1-800-322-2885 or email at proxy@mackenziepartners.com.

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^[31] “Comparable public companies” refer to those in the “Selected Public Company Comparables Analysis” of the Company’s financial advisor and include Alteryx, BigCommerce Holdings, BlackLine, Coupa Software, Datadog, Elastic, HubSpot, MongoDB, Okta, PagerDuty, Paylocity, Shopify, Smartsheet and Zscaler.

^[32] Source: FactSet. Data from July 6, 2022 to August 5, 2022. Data refers to weighted average based on market value at the beginning of the measurement period.

^[33] See supra at Footnote 35 for a list of comparable transactions.