www.dress-for-less.com: Diesel trousers 35% off @ £64.90

LONDON, June 29 (Reuters) - Buyout firm Palamon Capital Partners is selling online fashion retailer Dress for Less as it looks to return money to investors ahead of a fundraising later this year, people familiar with the situation said.

The European mid-market firm has received approaches for the business, based in Germany, which it bought for an undisclosed sum at the end of 2007, the sources said. One said the business could fetch about 400 million euros ($488.2 million).

Palamon declined to comment.

Palamon is among a number of private equity firms hoping to raise a new fund towards the end of this year, sources have previously said.

With many investors squeezed by two years of poor returns from their portfolios, buyout firms have been told they need to sell companies and return cash before coming back for new funds.

Retail has been one of the hotspots for private equity activity this year after Bridgepoint sold pet goods retailer Pets at Home. Just last week, U.S. buyout house TPG [TPG.UL] agreed to pay about 300 million pounds ($451.9 million) for British fashion retailer Republic.

In line with the fast-growing online fashion retail space, Dress for Less has grown in excess of 20 percent a year and is likely to attract interest from rival private equity firms and other online retailers hoping to consolidate and build market share, one of the sources said.

"There is a shortage of companies of that size and so there should be interest from all quarters," the source said.

The company, which sells brands including Diesel and Tommy Hilfiger at a discount, is headquartered in Germany but also targets consumers in Eastern Europe, France, Spain, Britain, the Netherlands and Scandinavia.

Palamon, whose portfolio also includes German loyalty card provider Loyalty Partner and British independent financial adviser Towry, raised 670 million euros for its second fund in 2006. It is hoping to raise a similar amount for its third fund, a source previously said. ($1=.8194 Euro) ($1=.6638 Pound) (Additional reporting by Natalie Harrison; editing by Simon Jessop)