Overall M&A Market Commentary
Uncertainty is corrosive to the M&A market and deals because acquiring a business is risky. Anything that cannot be identified, anticipated, measured, and mitigated in the purchase or sale of a company can have a dramatic negative impact on the deal’s outcome. After the election in November, there was great optimism in the deal community that 2025 would be a great year for M&A transactions. The legions of investment bankers, M&A attorneys, due diligence providers, and other M&A facilitators were all gearing up for elevated deal activity because of the anticipated more business and a more deal-friendly market.
As they suggested in the campaign, the new Trump presidential administration hit the ground running. It rapidly rolled out, on multiple fronts, the agenda he said he would employ once elected. Many citizens consider the goals of streamlining the federal government, addressing the large influx of undocumented people, changing immigration policy, and considering the fairness of global trade and tariffs as worthy projects—doing all of them at once during the first 100 days of the new administration was an unanticipated shock to the system.
While having a four-year term, any U.S. president must work with two-year election cycles for the House and the Senate. Hence, getting things accomplished requires a deliberate plan and a rapid rollout to achieve the administration’s agenda before risking losing its allies in Congress. President Trump learned from his first term as the 45th President how hard it was to move an agenda forward with these political limitations. This time, his new administration was better prepared and planned to hit the ground running. Aided by senior Republicans, lawyers, and business leaders, the Trump team was ready to implement their strategy from day one.
The frenetic pace and resulting “shock and awe” were not wholly expected and created uncertainty, stalling the early 2025 M&A market. The M&A market expected the slower pace of “politics as usual” change to be the more rapid pace of change offered by the new administration. The country expected a more business-friendly administration with less regulation, lower taxes, and a pro-growth agenda. However, the participants in the deal market likely did not expect this amount of rapid change in the first 100 days of the Trump administration.
While the Department of Government Efficiency (“DOGE”) and Immigration and Customs Enforcement (“ICE”) efforts were controversial, candidate Trump campaigned and won an election with these as part of his strategy and implemented these efforts quickly. In addition, these activities have produced initial results and appear to grow in acceptance, as recent polls indicate.
However, the added “project” of reordering world trade through tariffs in March and on Liberation Day in April ramped up market volatility and business and consumer uncertainty. According to NFIB’s March Small Business Economic Trends report, the NFIB Small Business Optimism Index fell 3.3 points to 97.4, its lowest level since October 2024 and well below the market expectation of 101.3. This was the most significant decline in the index since June 2022 and was partly due to business concerns over tariffs. In addition, according to the Michigan Consumer Sentiment survey, sentiment fell for the fourth straight month, declining 11% from March. Sentiment has decreased more than 30% since December 2024 because of growing worries about the expanded trade war.
As indicated earlier, all this activity occurred rapidly and in the first 100 days of the new administration. In fairness, it will take at least an equal amount of time to begin to see the results of these changes. The tariffs could boost M&A activity as U.S. companies begin to “reshore” their supply chains in the U.S. Additionally, foreign companies may look to acquire domestic companies and manufacturing operations to produce products in the U.S. and thus avoid tariffs. While acknowledging the uncertainty in the current market, Larry Fink, the Chairman of Blackrock, stated in an interview on CNBC’s Squawk Box, “This is an opportunity to look for opportunities.” The tariff rollout is very dynamic. Changes and adjustments to the strategy will likely be made as negotiations with our global trade partners continue over the next 90 days.
Private equity (“PE”) firms have abundant, time-limited investment capital to put to work. Strategic buyers are well-capitalized and still looking for growth opportunities. The demand for deals outstrips the number of willing sellers with good quality companies. Due to market uncertainty, this is a “flight to quality” market where buyers are keenly interested in high-quality acquisition opportunities. In this environment, well-prepared companies with sound business fundamentals can still command broad buyer interest.
Due to the extended period over which private company M&A market data is collected, our information has a one-quarter lag. As a result, the market commentary reflected below is generally limited to the data through 4Q24. Any 1Q25 data included in this edition to expand trend lines is still preliminary and will be reviewed in detail in the next quarterly newsletter.
M&A Market Activity
Post-COVID, the M&A market bounced back significantly in 2021, likely compensating for the collapse in deals during the pandemic. The market started a slow ebb downwards in 2022 and stalled at low activity levels measured by deal number and annual dollar value in 2023 and 2024.
Business owner optimism is essential when considering the sale of a business or taking on the risks associated with acquiring businesses. Even with a relatively strong and improving U.S. economy in 2023 and 2024, business optimism has been tepid, induced partly by stubborn inflation, elevated interest rates, increased regulatory scrutiny, and political uncertainty. The change in the presidential administration significantly improved consumer and business optimism in late 2024 and early 2025, but the new administration’s tariff policies negatively impacted business optimism in March. The change in tariffs has just been implemented, so it is too early to tell the long-term effects on the deal market.
Eventually, private equity (“PE”) funds and strategic buyers with ample resources to make deals will need to ramp up their deal-making efforts and enter the M&A market to deploy their resources and earn a return. Additionally, the business owner population is beginning to “age out” and will need to seek liquidity by selling their businesses. Furthermore, the need for PE funds to exit their older portfolio companies will add additional deal supply to the M&A market. Because of the strong demand for deals and the anticipated growth in the supply of salable companies, there are indications that M&A market growth will increase in late 2025 once the tariff situation is sorted out.
We are seeing a temporary dip in business optimism, which has reduced the number of owners considering business sales. However, the number is expected to increase, perhaps significantly, once the uncertainty created by the imposition of new tariffs has passed and the economic results are better known.
- In 4Q24, $28.0 billion in middle-market deals were recorded, a substantial decrease from the value recorded in 3Q24. In quarter-over-quarter comparisons, 4Q24, the dollar value of deals was down 24.3% compared to 3Q24.
- Similarly, on a quarter-over-quarter comparison, the number of middle-market deals closed in 4Q24 decreased significantly from those closed in 3Q24. On a year-to-date basis, the number of deals closed in 2024 increased by 4.5% compared to the total number of deals closed in the same period last year.
- The average middle-market deal size of $56.0 million in 4Q24 was 5.9% larger than the average $52.9 million deal size closed in 3Q24 and larger than the average $ 50.9 million recorded in 2023. The 2024 M&A market was gradually shifting towards larger deals. Even with deal valuations of $50 million, these companies are still considered add-ons to existing companies with a lower business risk profile and an easier path to attract financing.
PE exit information reflects a similar pattern, albeit on a reduced scale, to the overall M&A market deal activity. PE exit activity in 4Q24, measured by the dollar value, was down 9.7% from 3Q24. In contrast, the number of PE exits was slightly less, 6.4% from 3Q24. While PE exit activity in the last three quarters was elevated from 1Q24, there was a declining trend towards the year-end. PE funds continue to be significantly behind in returning cash to their limited investors, which is giving rise to temporary measures like dividend recapitalizations and continuation fund investments. At some point, PE exit activity must increase to provide meaningful cash returns to the PE fund investors.
The PE funds are the “professional buyers and sellers” of businesses and must pursue deal activity in all types of markets. As such, they tend to provide leadership in the M&A market. PE funds strategically pursue both the buying and selling of portfolio companies, both at the portfolio company level, when the asset is most saleable, and at the fund management level, when the fund needs a realization to return capital to its investors. PE funds generally have limited time frames over which they must invest their committed capital and “harvest” these investments to return cash to the funds’ limited partners. Typically, these timeframes are 10 to 12 years, creating urgency in PE fund management.
According to Pitchbook information, the median holding period for a PE portfolio company reached an all-time high of 7.0 years in 2023 but declined to 5.9 years in 2024. This decline was promising, but many PE funds will need to continue to work down their portfolios of company investments and return capital to their investors, providing a near-future boost to M&A volume.
Even with lower M&A market activity, tariff uncertainty, and more cautious buyers, strategic and financial buyers continue to look for deals in the M&A market. Since the COVID recovery period, buyers across the spectrum have been more diligent in making acquisitions. Sellers with quality companies and good financial performance are receiving strong buyer attention. Preparation is key for business sellers to achieve appropriate enterprise valuations, manage a competitive sales process, and withstand more rigorous due diligence scrutiny.
Middle Market Deal Valuations
The post-COVID low-water mark for M&A deal valuations occurred in 2023, with valuation levels rising slightly in 2024. Valuation information may be skewed higher because higher-quality, clean deals with the highest valuations are closing in the current market.
- Deal valuation multiples for the sub-$25.0 million category in 2024 were 6.4x, above the long-run average of 6.2x for this size category and equaling the 5-year market peak for this size category.
- Deal valuation multiples for the large middle-market, the above $50.0 million category, came in at 8.3x in 2024, slightly above the long-run average for this category.
- Finally, the 2024 valuations in the $25.0 to $50.0 million middle segment were recorded at 6.8x, slightly below the five-year average of 6.9x.
PE funds have abundant committed capital, and strategic buyers continue to cautiously seek growth through acquisitions. The reduced volume of M&A activity has produced a smaller pool of new deals, leaving the demand for quality acquisitions unsatisfied. This supply-demand imbalance provides sellers with an opportunity to maximize their valuations. However, with the tariff uncertainty, acquirers are very cautious. As a result, only the better-quality companies can push for higher valuations. The tariff situation makes estimating valuations very difficult. The tariff situation has widened the spread between seller expectations and buyer offers, making deal negotiations more protracted. While sellers recognize the change in market dynamics, there is a limit to which they will lower their valuation expectations. Until the tariff situation has been largely resolved, the M&A market will continue to be muted.
Private Equity versus Strategic Valuations
Strategic buyers are significant factors in the M&A market, comprising almost two-thirds of all deals closed over the last decade. PE portfolio companies that make add-on acquisitions are grouped in the strategic category because these companies have many of the same characteristics as other strategic acquirers. Synergistic cost savings, access to new customers, and other revenue enhancement opportunities provide strategic buyers with the ability, but not the need, to pay more than the typical financial buyer. Since 2020, the size of the strategic premium has declined almost to zero, with a substantial strategic premium returning for unknown reasons in 2023. That trend reversed in 2024 when the strategic premium declined again to nearly zero.
- In the post-pandemic years of 2021 and 2022, strategic buyers, on average, paid little strategic premium over the PEs for their acquisitions. However, that trend reversed in 2023, when strategic valuations jumped to 8.5x above the 5-year trend level of 8.0x.
- Over the last five years, EBITDA multiples paid by PE buyers have remained in a range centered around 7.3x. The annual 2024 valuation data indicates that PEs are paying slightly more than the long-term trend level for new deals.
- The quarterly information in 2024 has been somewhat volatile because of the low number of M&A deals. Our data shows that the strategic premium has declined slightly throughout 2024.
- Prairie estimates that, for deals below $50.0 million, middle-market valuations are between one and two multiples of EBITDA lower than the levels in the chart below.
Middle Market Leveraged Buy Out Capitalizations
In 2024, as the U.S. economy continued to show resilience, the equity markets set new records in late 2024. However, in early 2025, the President’s strategy to reorder global trade through new tariff policies created uncertainty throughout the economy, including the stock markets, the lending, and the M&A markets. The implementation of these policies has just commenced, so it is too early to determine the long-term positive and negative effects. Most of the tariff increases have been delayed 90 days so that negotiations with the trading partners can occur, so the next 90 days will be critical for the markets. This uncertainty leads to reduced deal volume and more conservative behavior by lenders.
Commercial bank lenders are still cautious but are aggressively pursuing more creditworthy borrowers and forcing lesser-quality lending opportunities to other lenders. Fortunately, the private credit markets (including business development corporations, asset-based lenders, and other lending-oriented private credit funds) are picking up the slack. These private credit lenders are moving to a more “risk-on” lending profile and providing slightly more aggressive lending terms for lesser-quality issuers. While private credit and asset-based lending (“ABLs”) are becoming more active in the market, their loans are more expensive and have a more significant debt service cost. The growing private credit participation in the current lending market leads to improved overall debt availability, forcing more aggressive lending terms, and, in some cases, lower credit spread s across the lending market. Even with better terms, a deal’s maximum total debt component is around 50.0% of a typical leveraged capital structure, which remains conservative.
The Fed reduced interest rates by 100 basis points in 2024, 50 basis points in September, and 25 basis points in November and December. This shifted the short-term secured overnight financing rate (“SOFR”) lower, leading to lower borrowing costs. In addition, credit spreads narrowed, resulting in better issuer debt service coverage, and could lead to more debt in a typical capital structure.
Mezzanine funds are active in leveraged transactions. This capital has a high interest rate that can stress a company’s cash flow. Mezzanine is increasingly critical to a middle-market buyout capital structure when senior debt capital is harder to find. Interest-only and payment-in-kind (“PIK”) structures still dominate the markets, but in the current environment, equity co-investment structures help match mezzanine returns with the deal risk profile.
Overall Comment on the Financing Markets
The financing markets ended 2024 and started 2025 with growing demand for loans and financing as borrowers looked to expand and grow their businesses. Loans were made for working capital growth and capital expenditures by companies in all business sectors. The new presidential administration was expected to reduce regulations and be more business-friendly, which was expected to increase borrowing to fund the expected M&A activities and lead to more loan growth. Optimism was in the air.
The new administration hit the ground running and quickly established DOGE to improve the efficiency and reduce the costs of the federal government, and also expanded the ICE program to prioritize the removal of undocumented immigrants, particularly those with criminal convictions. When the new administration’s strategy to reorder international trade through new tariff policies was implemented in March and April, it created market uncertainty, a dramatic movement in the stock market, and a slowdown in the M&A markets. While the market expected change from the new administration, it was not prepared for the rapid pace of change that was employed.
The aggregate demand for loans and financing had been muted for several years but started to recover in mid-2024 and continued into 2025. The tariff uncertainty will likely temporarily reduce loan volume until the effects of these tariffs are better understood. The financing market, like the M&A market, abhors uncertainty, and until the tariff changes are sorted out, we will continue to see muted demand for new loans.
The Fed reduced interest rates by 100 basis points thrice in the last four months of 2024. These reductions led to a decrease in the Prime Rate of 100 basis points and a shift lower in the SOFR curve. These interest rates are the base rates to which a credit spread is added to develop the borrower’s interest rate. Even with the tariff uncertainty, credit pricing is holding steady currently. According to the Senior Loan Officer Survey, future tightening may occur in the following months. Lower interest rates will decrease financing costs and increase potential debt capacity in new deals. This could support higher M&A valuations and increase loan demand once tariff uncertainty has passed.
Banks and non-bank lenders, insurance companies, SBIC funds, Business Development Companies (“BDC”), and the rapidly emerging Private Credit Funds all have abundant capital and are anxious to make new loans. Refinancing transactions and a limited number of growth capital and capital expenditure loans have been the only options these groups have been able to pursue. If the M&A market ramps as expected, this could lead to a very active capital market and even more loan growth later in 2025.
Preparation is key in any market, but even more important in the emerging economic environment. All borrowers should have thoughtful business plans that show lenders how the Company will react to inflation, lower margins, changes to revenues, tariffs, and other business issues, including changes in interest rates. Lenders want to be repaid, so borrowers must detail how they will make that happen. With proper preparation, good-quality, creditworthy issues will be able to attract capital. Borrowers must be prepared for an extended financing process and potentially more conservative and expensive capital structures.
Total U.S. Middle Market Loan Issuance
- U.S. Leveraged Loan issuance in 2024 increased significantly to $1663.0 billion, exceeding all the annual volume tallies of the post-COVID years and even the last few years before COVID.
- Recessionary fears declined in 2024, and there was growing optimism that the new administration would be more business-friendly and focus on economic growth. The Fed’s 100 basis point interest rate reduction in 2024 was accomplished through three moves in September, November, and December, leading to lower borrowing rates. The lower rates have made borrowers more comfortable with the current interest rate environment and increased their demand for new credit to refinance higher-cost debt, fund growth, and capital expenditures. Although M&A activity financing is still muted, the deal flow in the credit markets has started to return to more normal year levels at the end of 2024 and into 2025.
- Bank lenders continued to focus on relationship banking, corporate borrowers’ lines of credit, and areas where they have a competitive advantage, such as operating business needs (including payroll and checking accounts). Due to the current tariff-induced economic environment, banks are cautious when making new loans and very selective when executing new leveraged transactions. Private credit funds have taken up the slack, but even this sector is focused on better-quality loan situations.
Interest Rate Environment
The Fed began its interest rate cuts with a robust 50-basis-point reduction in September 2024 and followed up with two additional 25-basis-point reductions in November and December, totaling a 100-basis-point reduction in the Fed Funds rate for 2024. The focus in 2025 became on the number and timing of the Fed’s next rate cuts.
The March Consumer Price Index (“CPI”) fell more than expected to 2.4%, down from an annual inflation rate of 2.9% in February. The Fed’s preferred measure, the Core PCE, showed a 2.8% annual increase, down from 3.2% in December. While inflation is somewhat tamed, it is still above the Fed’s goal of 2.0%. The tariff situation will likely affect the inflation picture and make future interest rate reduction activity more complicated.
The interest rate environment has finally normalized in late 2024. The yield curve in normal times is usually upward-sloping, reflecting normal inflation expectations. The 2-year to 10-year Treasury differential was a positive 79 basis points at the end of 2021. However, due to the Fed’s inflation-fighting action in raising short-term rates, the yield curve 2-year to 10-year differential moved negatively in mid-2022 and remained negative until late 2024. Usually, a negative 2-year to 10-year differential signals an impending recession, but because of the Fed’s manipulation of short-term rates, that predictive signal was spoiled. At the end of 2024, the 2-year to 10-year differential was a positive 33 basis points and a positive 34 basis points on March 31, 2025. Progress toward a more upward-sloping yield curve indicates a normal interest rate environment, even with the added initial effects of the tariffs on the economy.
Middle Market Debt Multiples
- The average total debt leverage in middle-market deals increased slightly in 2024 to 3.7x from the 3.6x average in 2023.
- Mezzanine capital continues to play a key role in leveraged capital structures. While mezzanine is more expensive capital than senior debt, its return structure matches the risk profile of companies operating in the current uncertain economic environment.
- Over the past five years (2018-2023), mezzanine debt averaged 0.7x EBITDA in the typical capital structure. During 2024, mezzanine leverage declined to 0.6x EBITDA, slightly lower than the long-run average.
- The senior debt markets improved in 2024, but because our market data lags by a quarter, we are still evaluating the 1Q25 market. The lending market appears to have navigated tariff uncertainty and continues to write new loans.
- Like in the M&A market, we anticipate tariff-driven changes in the lending markets in 1Q25 (to be covered further in the Summer PMMP) that will continue into the rest of 2025.
Terry Bressler is a Managing Director and can be contacted at 312.348.1323 or by email, tbressler@prairiecap.com.
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