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Buyout barons aim to buy each other out

It’s survival of the fattest in private equity-land, and the new dynamic may force more M&A among investment firms.

The barons of the buyout industry may need to buy one another out next.

KKR, the private equity firm co-founded by Henry Kravis, reportedly sought to tuck lender and investment firm HIG Capital under its growing corporate credit wing. That would mean adding about $20 billion in assets to Kravis' company. Neither firm responded to a request for comment.

That's not all; HarbourVest Partners, perhaps looking to take advantage of the discounted pound in the U.K., submitted a bid to buy SVG Capital, a British firm, but was rebuffed late last week. SVG Capital told HarbourVest, which is based in Boston, that it felt the bidder's offer came up short — and revealed it has had talks with other "credible parties," as well.

For some, it's the right move, in order to beef up assets under management.

Public markets haven't been too friendly to private equity firms' initial public offerings, and as their senior leaders consider ways to exit long-held positions in their companies, options to net a return are dwindling. Tacking on other businesses could at least help juice management fees for buyers.

But for other private equity firms, it may be the only other option, beyond becoming zombie funds or winding down in the long run.

"The bloom has come off the rose for many big private equity firms," said Richard Farley, chair of the leveraged finance group at law firm Kramer Levin.

Henry Kravis, co-chairman, co-chief executive officer and co-founder of KKR & Co., arrives for a session of the Allen & Co. Media and Technology Conference in Sun Valley, Idaho, July 6, 2016.
David Paul Morris | Bloomberg | Getty Images
Henry Kravis, co-chairman, co-chief executive officer and co-founder of KKR & Co., arrives for a session of the Allen & Co. Media and Technology Conference in Sun Valley, Idaho, July 6, 2016.

The urge to merge in the private equity industry should be growing, and it comes at a tough time for the private equity industry. Funding could become scarcer, as general partners leading top leveraged buyout firms are weighing whether to do deals. Some of their primary sources of cash public pensions are withdrawing from the business, in part because of abusive fee practices at certain firms.

Beyond the secular industry pressures faced by private equity firms, their returns have been compressed by a number of legislative and regulatory measures in the U.S.

In the wake of the global financial crisis, Washington regulators forced banks that fall under the purview of the Treasury Department and the Federal Reserve to scale back how much they lent to private equity buyers' deals, relative to the earnings before taxes, depreciation and amortization of those companies. Broadly speaking, banks are not permitted to lend more than six times a company's Ebitda to get a deal done.

Further, leading up to this election there has been a great deal of hand-wringing by private equity executives that carried interest taxation, which allows them to be taxed at around half the going rate ordinary Americans face, may rise in coming years, further crimping profits. One legislative expert, asking to not be quoted, suggested it will remain difficult to pass legislation targeting carried interest, in part because other financial services sector businesses beyond private equity count on the tax break.

"Washington probably isn't private equity's biggest enemy," the source said. "The real pressures are that the industry can't generate the same kinds of returns their investors got used to."