In late spring 2024, we published a mid-year M&A update describing the state of the market at the time. Therein we highlighted the flight to quality we noticed among private equity and corporate buyers: they were generally more conservative on valuations but bidding aggressively on companies with the strongest business fundamentals.
That was still the case as 2024 came to a close and 2025 opened. The GF Data Third Quarter 2024 M&A Report, the latest available as of this writing, even noted that 40% of Q3’s PE deals were for companies with above-average financial health.
Setting expectations for 2025
M&A activity has been slowly ramping up, but we’re still a long way from the fast pace of 2021. In all candor, it may be some time before we return to that level, as the post-COVID activity was a rare season of deal euphoria. For PE, Q3 2024 was a bit slower than either Q1 or Q2, showing that the recovery hasn’t been, and likely won’t become, perfectly linear.
PE firms have also been hesitant to exit portfolio companies at lower than historical returns from businesses they acquired when the economy appeared invincible and valuations were at their peaks. This situation could be fueling some of their acquisition-related foot-dragging, as it puts pressure on fundraising and internal capacity.
We continue to see a large gap in interest between best-in-class businesses and average (or below average) performers. We’ve experienced in many of our processes a feeding frenzy for top-tier companies. In fact, we have been told several times recently that the multiples paid for our clients’ highly desirable companies were top of the market.
Another positive note, the Fed has started to ease interest rates and will likely keep doing so. This could benefit both sides of a transaction—sellers might have a slightly better chance to attract PE interest (at higher valuations) because debt is a bit cheaper for PE buyers. In addition, many corporations are flush with cash and looking to acquire companies.
Anecdotally, as we talk with buyers and advance our own deals, we are seeing a strengthening of M&A activity and a desire to put capital to work. We recently met with a PE partner who shared that their target is to make four to five acquisitions per year. In 2024, they stalled at two—all this while their portfolio exits slowed and return of capital to LPs fell behind schedule.
Looking to outside forces, there seems to be a post-election loosening as we gain more clarity on the political environment and the expectations for the next administration. While questions still remain, the uncertainty across various fronts—from the macroeconomic to the geopolitical—that impeded M&A over the past few years, now appears to be normalizing to healthier levels.
At Class VI, we are entering 2025 with cautious optimism, anticipating that market recovery will persist and be validated as Q4 M&A data comes in soon.
Due diligence remains challenging
As we always advise, you should share a credible growth plan backed by hard data to attract investment. Demonstrate how you’ll perform at or above expectations in every metric that is important to your business.
But once you have garnered investor interest, don’t expect that lower Fed rates and eager strategic buyers will let you off the hook regarding preparations before going to market. For the foreseeable future, due diligence will be more unforgiving than in the past, especially for companies suffering from volatile financial performance.
We’ve seen firsthand how grueling due diligence has become compared to even a few years ago. Not only are buyers digging deeper, but they’re less willing to overlook any problems they identify. Buyers now commonly ask for valuation reductions or special indemnities or escrows to protect against contingent liabilities or issues identified in due diligence.
The political talk of tariffs could also mean that diligence periods grow even longer. Buyers will want to understand how any tariff regime affects the profitability of potential acquisitions, such as by increasing the cost of raw materials. Sellers will need to focus on business performance for the entirety of the exclusivity period—this is a big part of why due diligence is so challenging. A deal can easily fail if results fall off at a key moment.
Go forth and transact
The takeaway for business owners entering a deal process is this: you must be ready to maintain or improve growth, even while answering the seemingly endless rounds of questions you receive from the buyer throughout the due diligence period. The more prepared you are, the easier it will be to juggle company leadership and transaction-related stresses.
Telling a convincing growth story and preparing for due diligence have always been good ideas. Now they’re non-negotiable necessities. Keep this in mind and let’s hope our optimism about the M&A market is warranted!
