M&A Deal Count in 2025 Expected to Rebound Following Tepid Q1

Deal volume and market uncertainty entering 2025

2024 deal volume fluctuated from quarter to quarter but was relatively consistent between the 1^st quarter of 2024 with 100 deals and 98 deals in the 4^th quarter of 2024. Entering into 2025, there was high uncertainty surrounding both political and economic factors. This uncertainty led to a tepid deal count in the 1^st quarter of 2025 with DealStats reporting 59 completed transactions, a 40% drop in deal count from Q1 2024.

Key points

• Deal volume decline and market uncertainty: The beginning of 2025 has seen a significant decrease in deal activity. This reduction is attributed to heightened political and economic uncertainty, making both buyers and sellers more cautious in their approach to mergers and acquisitions.
• Premium valuations for strong assets and increased leverage: Despite lower transaction volume, high-quality companies continue to attract premium valuations. Add-on investments are becoming more prevalent compared to platform deals.
• Cautious Financing Environment and Outlook: Private equity and middle-market buyers are relying more on private credit and alternative financing tools as banks restrict lending, particularly for smaller companies. High interest rates and extended diligence periods are leading to more complex deal structures, including earnouts and deferred payments. The outlook for 2025 remains cautious, with improvements depending heavily on potential interest rate cuts.

Business valuation and leverage increasing

While deal count decreased, the average purchase price multiple, TEV/EBITDA (generally based on an Adjusted EBITDA), rose to the highest quarterly average since the middle of 2022 at 7.6x. Given the increased level of certainty related to interest rates (as compared to previous years), the Total Debt/EBITDA increased to 4.2x as well, indicating an increase in use of leverage and allowing for an increased purchase price for quality assets. Per GF Data, quality assets continue to earn a premium while discounted assets suffer the consequences of a drawn-out sales process and increased scrutiny through diligence. Regarding the rest of 2025, the outlook is expected to remain consistent in that strong companies will continue to get strong valuations with no structure and struggling companies will get depressed valuations with structure getting tossed to the side.

Additionally, the environment continues to remain consistent with an increased percentage of add-on investments with 41% of deals observed by GF Data being add-on investments rather than platform investments in Q1 2025. Anecdotally, the deals our Keiter Transaction Consulting team assisted with or completed followed this trend in that a majority of assets sold were add-ons rather than platform investments.

While many sectors experienced an increase in multiples during the 1^st quarter, including business services such as accounting firms, law firms, dental practices, and health care services, other sectors that are highly cyclical and impacted by interest rates and tariffs such as manufacturing suffered a decline in transaction multiples. See below for TEV/EBITDA by industry over the historical period:

Financing tools and deal structure

According to GF Data, there are multiple opportunities that lie ahead in 2024 for private equity firms and other middle-market buyers including continuation vehicles, private credit, and earnouts. Continuation vehicles were a useful tool for funds that had a finite life and will continue to be an option for funds that need to distribute liquidity to investors. Additionally, private credit continues to provide alternative options to lending from a traditional bank as banks have pulled back on cash flow lending for deals involving companies with less than $15MM in EBITDA. This has forced smaller transactions to be financed by private debt where the spreads over SOFR are 3-5% higher than traditional bank financing. The high interest rates in the debt markets will lead to increased earnouts or a deferred purchase price are attractive to create incentives for sellers that match the goal of the buyer. In fact, if financial thresholds and earnouts are satisfied, this creates a higher return for sellers than the original sale with the earnout not included.

A cautious outlook for 2025

While the outlook for 2025 is seen as optimistic by multiple service providers as exit opportunities arise, dry powder increases as liquidity is returned to investors, new dry powder entering the market for investment opportunities, and an opportunity for investors to look at foreign markets for add-ons and platform deals, the facts do not share the optimism. The market remains similar to the environment coming out of the Great Recession where many sellers will continue to wait for the overall M&A environment and their specific company metrics to improve before initiating a process. The middle market is and will continue to remain in an environment where diligence is more protracted and any company-specific issues are more closely scrutinized such as customer/vendor concentrations, and any lapses in performance which might suggest problems with sustainability. The M&A outlook is especially dependent on interest rate cuts which have not yet occurred in 2025 and may not occur throughout the fiscal year leading to a depressed 2025.

Have questions about the current or expected M&A environment? Contact your Keiter Opportunity Advisor or Email our Transaction Consulting Team| Call: 804.747.0000