As private equity (PE) firms look toward 2025, there is an air of cautious optimism about what evolving macroeconomic conditions might bring for M&A. With interest rate reductions, projected GDP growth, and political shifts—including potential regulatory changes by the Federal Trade Commission (FTC) and lower capital gains tax rates—there is increased opportunity for deal-making and fund raising.
While potential opportunities are on the horizon, there continues to be challenges such as a higher cost of capital and lingering valuation gaps. Additionally, proposed tariffs may encourage fund managers to focus on portfolio companies with more domestic supply chains due to ongoing uncertainties with foreign suppliers. PE firms are adopting creative strategies for deals and value creation to secure returns in an increasingly complicated market and stay competitive.
Here’s a look at five key trends expected to shape the PE landscape in the coming year.
1. Continued Surge in Deal Activity
There remains cautious optimism that the gap between buyer and seller expectations will close, resulting in more complete transactions in 2025. Various macroeconomic factors – including lower interest rates and a 2.5 percent GDP growth forecast for 2025 - are expected to help increase valuations.
A shift in administration could also allow for more fluidity in exit markets, as fund managers seek to exit investments after extended holding periods. Factors such as upbeat earnings calls and an increase in both private equity and investment bank stock prices signaled expectations for increasing IPOs and M&A activity. Additionally, expectations for reduced regulatory oversight and potential tax cuts on capital gains could prompt business owners to sell, especially after navigating higher inflation and borrowing costs.
2. Funds Using Add-On Deals to Boost Portfolio Company Valuations
Despite the optimism surrounding macroeconomic conditions, portfolio company valuations are still lagging. As PE firms await the effects of rate cuts and political shifts, funds are prioritizing the sale of assets with the strongest potential for return on investment and holding onto assets with lingering valuation issues—aiming to grow further portfolio companies before moving to sell. This is limiting the broader recovery of exit strategies, though the situation is expected to improve in 2025.
Add-on transactions will remain a key strategy for fund managers, particularly as they account for three out of every four buyouts in the U.S. PE market and represent over half of all deal value in the middle market. While add-ons may not grow their share of the overall deal market, they will continue to be a dominant force in PE activity in 2025. This strategy will be particularly useful for portfolio companies that have yet to close valuation gaps under current market conditions.
3. Corporations Will Continue to Be Active Sellers and Purchasers
Corporate buyers have accounted for nearly 44 percent of middle-market exit value (excluding public listings) as of Q3 2024. This trend is expected to persist in 2025. While lower interest rates will benefit the overall market, higher interest rates will be more challenging for PE firms, slowing the pursuit of deals that depend on multiple expansions to drive returns.
Corporate acquirers will likely maintain stronger buying power as the M&A market recovers. Additionally, corporations have also been active sellers, particularly through carve-outs and right-sizing initiatives, which will provide PE firms with significant opportunities in 2025. In the third quarter of 2024, sponsor-to-sponsor exits were still 17.4 percent below pre-pandemic levels, a trend expected to continue as PE firms wait for lower rates to take effect.
4. Creative Approaches to Deals, Value Creation, and Distributions
While the cost of capital remains high, PE firms are adopting innovative strategies to boost portfolio company valuations. Simpler buyouts are more difficult in the current environment, but larger firms capable of handling complex deals, such as carve-outs, take-privates, and cross-border transactions, are finding opportunities in these structures.
Refinancing will continue to be a key strategy for enhancing portfolio value in 2025, and PE firms will work to increase EBITDA through operational improvements and AI. These efforts aim to provide more immediate improvements to portfolio company performance without the need for major strategic shifts. Additionally, PE firms are exploring ways to return capital to investors, with secondary transaction volume projected to increase by 25 percent annually by the end of 2024.
5. Expanding Global Focus Amid Uncertainty
International deal activity is gaining momentum and aligning more closely with pre-pandemic levels, with global M&A activity rising by 27.6 percent in deal value and 13.3 percent by count YoY in the first three quarters of 2024. This trend is expected to continue into 2025, driven by stronger debt markets and associated pricing. Additional optimism stems from activity of over 20 European PE deals valued over €1 billion in H1 2024, which also occurred in H1 2019. An acceleration of deals valued at €1 billion has been a precursor to M&A recovery in prior M&A cycles.
North American PE firms are increasingly looking beyond domestic borders, finding success in international markets, particularly in emerging tech hubs outside the U.S. If the U.S. dollar continues to strengthen, we anticipate that more PE firms will turn to Europe and other international markets for opportunities in 2025.
What Lies Ahead?
The landscape for private equity in 2025 is filled with both challenges and opportunities. As the cost of capital remains elevated and geopolitical factors continue to shape global markets, agility, innovation, and a focus on emerging trends will be crucial for staying ahead of the competition.
If you would like to continue this discussion and learn how your company can navigate the complexities of 2025, please contact us.