Why LBO firms will survive credit crisis

LONDON (CNNMoney.com) -- The golden age of private equity may be over, but don't count on the new kings of Wall Street to relinquish their throne easily.

Sure, money isn't as cheap is used to be and new deals have slowed to a trickle.

Private equity firms will survive the credit crisis because they are more diversified and can borrow from nontraditional lenders.

But the booming private equity business is cyclical and has endured pullbacks before. What's more, this time around the industry is better positioned to ride out the credit storm.

For one, firms have become financial behemoths. The biggest ones now have access to capital from sources other than banks. That bolsters their ability to withstand a downturn in the credit cycle.

"Some of the big private equity houses have become integrated financial firms," said Anne Gales, who heads the European division of C.P. Eaton Partners, a global firm that helps investment funds raise money from institutional investors.

"They're no longer dependent on certain financing vehicles and can draw upon their own facilities," she said.

Powerhouse firms like Carlyle Group, which operates venture, real estate and asset-management funds, have extended their reach beyond pure buyouts.

And publicly traded Blackstone Group LP (Charts) resembles an investment bank more than anything else. In addition to its flagship private equity portfolio, Blackstone operates an advisory business and manages a variety of funds.

Diversification will help the private equity firms find capital at a time when tighter credit markets are constraining the ability of big banks like Citigroup Inc. (Charts, Fortune 500) and J.P. Morgan Chase & Co. (Charts, Fortune 500) to lend huge amounts for corporate buyouts.

"Some of the banks are feeling quite bruised, and they probably won't be as aggressive with their lending over the next 12 months," said Rob Donaldson, head of private equity and M&A at accounting firm Baker Tilly.

The banks' reluctance to lend has put the brakes on new deals. Private equity deals, which are typically financed by borrowing, accounted for only 13 percent of worldwide merger transactions in August and September - the lowest monthly levels this year, according to Thomson Financial.

It's not just the mega-funds like Blackstone, Carlyle and Kohlberg Kravis Roberts & Co. that are adapting to survive. Smaller private equity firms, which aren't able to draw on their own resources to finance deals, haven't been left out to dry.

A growing number of nontraditional players have been getting into the business of financing buyouts, according to Brett Barragate, a commercial finance lawyer at Jones Day.

"There's definitely been an expansion in the universe of people involved in the process," he said.

For example, private equity firms like Cerberus Capital Management have established their own lending arms. Mid-tier investment bank Jefferies Group Inc. (Charts) has also built up a direct lending business.

These non-traditional lenders don't have as many constraints as regular banks do. Since they don't hold deposits from customers, they don't have to maintain a minimum amount of reserves. That gives them more flexibility at a time when big banks are getting squeezed.

The bulk of buyout deals - especially the mega-sized ones - will still be financed through money center banks. But the new players in the lending world are increasing their role, Barragate said.

The shift in the credit cycle may be triggering doomsday predictions now, but some, like Gales, expect the private equity beat to keep on going.

"It's just one of the dislocations that happens from time to time. I don't think this will have a long-lasting effect on private equity," she said.