Continuation fund investors eye payout in Leonard Green’s SRS Distribution exit

While Leonard Green’s transaction is giving cash-out LPs the benefit of both processes, the 'quick flip' issue remains controversial in continuation fund deals where assets are quickly exited.

Leonard Green & Partners’ agreed $18.25 billion exit of SRS Distribution, announced earlier this month, represents what could be a quick payout for investors in a continuation fund that closed at year-end.

The firm agreed to sell SRS Distribution, a wholesale distributor of building products, to Home Depot in a transaction valued at $18.25 billion, including debt, the company said earlier this week.

The deal, if it closes as expected by the end of fiscal 2024, according to a statement, would be a massively lucrative exit. Leonard Green acquired the company in 2018 for more than $3 billion, according to Reuters.

The agreed exit comes only a few months after Leonard Green closed a large secondary that moved stakes in SRS Distribution, ExamWorks, Veritext and Troon Golf out of older funds and into a continuation pool.

The continuation fund raised $2.2 billion and was led by AlpInvest Partners, with other investors participating, including Goldman Sachs. Evercore worked as adviser on the secondary process.

Existing LPs in both Funds VI and VII, which held the four assets, had the option to cash out of their interests in the companies or roll over on substantially the same terms they had in the older funds.

Pricing was around par as of the reference date, and around 90 percent of existing LPs chose to sell in the process, affiliate title Buyouts reported. Leonard Green rolled 100 percent of its carried interest in the assets into the continuation fund, Buyouts reported.

Leonard Green’s continuation fund deal closed at year-end. Generally, assets that are moved into a continuation fund are expected to be held longer as the term of the new vehicle extends for several more years. In the case of SRS, a full exit only a few months after the closing of the fund represents a fairly quick flip for a continuation fund asset.

According to sources familiar with this transaction: “A near-term exit was not contemplated at the time of the continuation fund transaction, as an IPO down the road was the expected path of exit.”

Some LPs have concerns of selling into a continuation fund process and potentially missing out on a more lucrative exit in the future. While the risk is always there when cashing out of an asset, a sale so soon after the closing of a secondary process that is expected to extend a firm’s hold over an asset can raise eyebrows with LPs.

However, if the deal closes as agreed, Leonard Green Fund VII LPs will be able to take advantage of both processes – they received distributions in the continuation fund deal, while still retaining exposure to SRS through the main fund, a source told Buyouts.

Here’s how it works: Leonard Green sold around 16 percent of its interest in SRS into the continuation fund, retaining its remaining stake through Fund VII, a source said.

This means Fund VII LPs who chose to cash out of their interest in SRS still retained ownership through the main fund, the source said. In this way, those cash-out LPs received distributions through the continuation fund and are poised to capture more value through the exit, the source said.

Leonard Green used the secondary as a way to deliver liquidity to Fund VII investors, the source said. It also used the process to balance the fund portfolio. SRS, through its performance, resulted in a position that was more than 25 percent of Fund VII’s NAV at the time, the source said.

While Leonard Green’s transaction is giving cash-out LPs the benefit of both processes, the “quick flip” issue remains controversial with secondary deals where assets are quickly exited, sources said.

“If the premise of the CV is to hold longer for value creation maximisation, etc, and then there is a quick flip, it can be a problem if the valuation of that quick flip is a material premium to the CV price,” said a secondaries market source.

Update: This story was updated with an additional quote about the transaction.