The first quarter of 2025 brought a precipitous decline in U.S. lower middle market M&A activity. This deceleration is part of a broader contraction in dealmaking that echoes the nadir of the late-2000s. In fact, global M&A deal counts fell nearly 19% from the previous quarter, underscoring widespread uncertainty. April 2025 saw only 555 U.S. deals – the fewest in any month since May 2009, worse even than the Great Recession or early pandemic era. Such figures illustrate the depth of the current M&A malaise and set the stage for a careful examination of its root causes.
Multiple factors have converged to sap momentum from the lower middle market. Businesses and investors entered 2025 with optimism after a modest pickup in late 2024, but that confidence quickly ebbed amid new headwinds. From abrupt shifts in trade policy to tightening financial conditions and valuation volatility, dealmakers are facing a confluence of challenges not seen in over a decade. We explore the key drivers behind this downturn – and consider whether relief may be on the horizon.
Tariffs and Trade Uncertainty Raise Caution
A major factor in the slowdown has been resurgent trade policy uncertainty. Early 2025 brought unexpected tariff announcements that introduced significant volatility into the business climate. The U.S. imposed broad new tariffs on imports, provoking retaliatory measures abroad and rattling supply chains. Boardrooms reacted swiftly: many companies hit the “pause” button on acquisitions as they assessed how rising input costs and potential trade restrictions would impact their outlook. In the words of one industry observer, “Boardrooms are likely to put deals on hold as they assess the implications… adopting a cautious approach until the situation becomes clearer”.
The data bear out this wariness. Spooked by the sudden tariff shock, companies across the globe pulled the plug on deals, driving M&A activity to generational lows. April’s global deal volume plunged 34% below its historical average, and worldwide M&A sank to its lowest level in 20 years. U.S. dealmaking was especially hard-hit – one month’s deal count dropped to the lowest since 2005 globally and 2009 domestically. Such figures reflect how tariff-induced uncertainty can freeze strategic activity. Firms facing unpredictable costs for key inputs and fears of reciprocal trade barriers have understandably grown hesitant to commit to new expansions or cross-border acquisitions.
Notably, this policy whiplash comes at a sensitive time. The business community had been looking forward to 2025 as a year of stability after the U.S. elections. Instead, the new administration’s aggressive trade stance became a wildcard. The second Trump Administration’s trade and security policies signaled potentially sweeping changes – an intent “to significantly alter U.S. global trade… especially through tariffs,” creating an extremely volatile deal environment. Even though some of the initially announced tariffs were later paused or scaled back, uncertainty persists around future moves. This overhang of geopolitical risk is prompting many acquirers to wait for clarity rather than rushing into transactions.
Valuation Gaps and Market Volatility Erode Deal-Making
Another key drag on M&A activity has been the emergence of valuation gaps between buyers and sellers, compounded by market volatility and deteriorating performance metrics. As economic growth moderated and corporate earnings (EBITDA) in certain sectors began to soften, many prospective sellers found that the prices buyers were willing to pay had fallen below their expectations. Public market volatility – with equity markets weakening in early 2025 – has further muddied the waters for valuing businesses. This has led to a classic stalemate: sellers recall the high valuations of just a year or two ago, while buyers point to the new risks and require a discount.
Evidence of this valuation disconnect is widespread. Survey data show that valuation multiples in the lower middle market have begun to compress, ticking down by as much as a full turn in recent quarters. As interest rates surged in 2022–2023, “a significant gap between seller valuation expectations and buyer appetite developed,” causing many owners to shelve sale plans rather than accept lower pricing. These reluctant sellers – often disappointed by offers at only ~85% of their benchmark values – added to the slowdown by choosing to wait for a better market. Even in 2024, advisors noted an increasing prevalence of would-be sellers holding off due to unrealized price expectations. In the lower middle market, where businesses are often founder-owned and sentiment can be particularly sticky, this “valuation realism” lag has been pronounced.
Market volatility has amplified the issue. Rapid swings in stock prices and economic indicators make it harder for both sides to agree on a fair price. One consequence is that buyers demand wider margins of safety (i.e. lower multiples), especially for companies whose recent EBITDA has been trending down. For their part, owners are understandably reluctant to sell at what they perceive as a cyclical trough. The result is a widening bid-ask spread that has stymied deal closures. As one middle-market conference panelist observed, “gaps in pricing expectations [and] valuation uncertainty” are creating barriers to exit activity for private equity owners and entrepreneurs alike. Until the fog of volatility lifts and earnings stabilize, bridging this gap will remain a challenge.
Interest Rates, Cost of Capital, and the Private Equity Waiting Game
The rapid rise in interest rates over the past 18 months has cast a long shadow on M&A, particularly in the lower middle market where leveraged financing is often a linchpin of deal structures. By late 2024, the Federal Reserve’s monetary tightening had roughly doubled the cost of debt capital from its pandemic-era lows. This surge in the cost of capital has made acquisitions more expensive to finance, directly dampening deal appetite among both corporate and financial buyers. As one analysis noted, a persistently high interest-rate environment dampens dealmaking by squeezing would-be acquirers’ ability to leverage transactions and by making alternative uses of cash more attractive.
Private equity (PE) investors, a major force in the lower middle market, have been particularly sensitive to these dynamics. Many PE firms entered 2025 in a holding pattern, having watched borrowing costs climb and valuations decline through 2023. While there was hope for a rebound as interest rates began to stabilize and even tick down at the end of 2024, new political and economic uncertainties kept many firms on the sidelines. Rather than rush into pricey deals with expensive debt, sponsors have chosen to be patient – a “waiting game” until conditions improve. According to Boston Consulting Group, this dip in activity was anticipated: “weaker equity markets and rising policy uncertainty…[made] many companies more hesitant to pursue deals aggressively”.
Importantly, the delay is not due to lack of dry powder or interest – it’s about timing and price. PE funds are still sitting on record amounts of uninvested capital (more on that below), but are pacing their deployment prudently. Many financial buyers have spent recent quarters focused inward: working with portfolio companies to boost value, rather than chasing new acquisitions at high funding costs. When debt is costly, the bar for returns on new deals is higher, and only the most compelling opportunities clear that hurdle. This dynamic has contributed to fewer deals and longer holding periods. In fact, middle-market PE holding periods have reached all-time highs, with a significant share of assets held 5+ years, as firms postpone exits and wait for more favorable conditions.
There are early signs, however, that the interest-rate pressure may be abating. By Q1 2025, inflation had eased and the Fed had at least paused its rate hikes, with some rate cuts materializing in late 2024. This stabilization of the rate environment has started to improve financing terms. A more predictable (and slightly lower) cost of capital increases sponsors’ willingness to pursue acquisitions. Credit markets outside of traditional banks – the growing private credit and direct lending sector – have also stepped in to provide funding, partially offsetting banks’ tighter lending standards. These developments set the stage for a possible thaw in deal activity once broader confidence returns. As one industry leader observed in April, “as we get more clarity… I’d expect companies and funds that have been sitting on the sidelines to move decisively” when conditions turn.
Regulatory, Political, and Labor Headwinds Add to the Slowdown
Beyond tariffs and interest rates, several other headwinds have contributed to the M&A slump. Regulatory and political uncertainty has been a notable factor. In recent years, U.S. antitrust enforcement became more stringent, especially for larger deals, under an administration that increased scrutiny on consolidations. This heightened regulatory oversight meant some transactions were delayed or abandoned, and it likely weighed on middle-market sentiment as well. Now, with a new administration in 2025, there is a potential for shifts in policy – but initially, a period of uncertainty. Early signals suggest a contrasting approach: the incoming leadership has indicated it may relax certain regulations (for instance, easing capital requirements in banking and taking a more lenient stance on M&A approvals in some industries). Concurrently, it is also telegraphing aggressive moves in other areas (such as tariffs or national security reviews) that inject new unknowns. This mix of possible deregulation on one hand and unpredictable intervention on the other leaves dealmakers in a cautious position until the new rules of the game become clearer.
Political uncertainty can likewise create a “wait-and-see” approach in the deal market. Election years often bring a lull in activity as companies await the outcome; the contentious 2024 cycle was no exception. Now in 2025, questions remain around tax policy (e.g. will corporate tax rates change or investor taxes increase?) and around government spending or stimulus programs that affect corporate earnings. Moreover, unresolved geopolitical issues – beyond tariffs, issues like export controls, sanctions, or even conflict risks – continue to cloud the horizon. Each of these uncertainties on its own might not deter a strong strategic deal, but combined they contribute to a climate where caution prevails. As noted, many firms are explicitly taking a “wait-and-see” stance, pausing expansion plans and hiring until macro and policy signals improve.
Labor market constraints represent another oft-cited challenge, especially in sectors like manufacturing and construction. Through 2024, the U.S. labor market was historically tight – unemployment hovered around ~4% and worker shortages were acute in skilled trades. For many mid-sized companies, growth has been throttled not by lack of demand but by lack of people (or by rising wage costs for the people they can find). This can indirectly slow M&A: an acquirer might be less inclined to buy a business if they know filling its job openings or expanding production will be difficult. Indeed, several Federal Reserve districts noted that a lack of workers with the right skills is constraining growth in key industries. Conversely, as the labor market shows some early signs of loosening in 2025 (improved worker availability in select regions), companies might gain more confidence to pursue acquisitions and expansions. For now, however, talent scarcity and wage inflation remain on the list of risk factors that deal participants weigh during due diligence, particularly in labor-dependent sectors like manufacturing, healthcare services, and construction.
Finally, the impact of sector-specific cycles cannot be overlooked. The slowdown has not been uniform across industries. For example, manufacturing and industrial companies – many exposed to input cost inflation and supply chain disruptions – have seen only modest deal volume declines in early 2025, whereas consumer-facing businesses and financial services firms (which are sensitive to interest rates) experienced more noticeable drops in M&A activity. On the other hand, certain sectors have proven relatively resilient or even buoyant. Technology, media, and telecom deals have ticked upward, likely driven by ongoing digital transformation needs and ample cash at big tech firms. Notably, healthcare has remained robust, with deal activity rising – healthcare M&A in Q1 2025 was higher than the previous quarter. This reflects the defensive, non-cyclical nature of many healthcare segments, as well as strong secular drivers (aging demographics, innovation in life sciences, etc.) that make the sector attractive even in uncertain times. Such divergence by sector suggests that while the overall M&A climate is cool, pockets of opportunity persist for well-positioned buyers.
Outlook: Dry Powder, Resilience, and the Path to a Rebound
Figure: Global Private Equity Dry Powder ($ Trillions) – Unspent capital has accumulated to record levels (over $2.6 trillion by mid-2024), reflecting substantial buying power waiting on the sidelines.
Looking ahead, there are reasons to believe that the current M&A doldrums in the lower middle market will eventually give way to a resurgence. History suggests that pent-up demand does not disappear – it builds. And by many measures, the latent capacity for dealmaking is formidable. Private equity firms and corporate acquirers have amassed unprecedented levels of cash reserves earmarked for acquisitions. Global PE “dry powder” reached a multi-year high of roughly $2.6 trillion in unspent capital by mid-2024. This mountain of liquidity is a double-edged sword: on one hand, it indicates that a lot of money has gone undeployed during the recent slowdown; on the other, it represents massive firepower that can be unleashed as soon as conditions improve. Deal professionals often quip that private capital “needs to be put to work” – limited partners expect their funds to be invested, and fund managers earn their keep by doing deals. Thus, the current lull may simply be setting the stage for a burst of activity once confidence returns. Indeed, many PE investors are under pressure from their own investors (LPs) to find exits for aging portfolio companies and to capitalize on their dry powder before fund investment periods close. This adds a sense of urgency to do deals once the window is open.
What might crack open that window? A few developments could act as catalysts. Greater clarity in policy – for example, if trade tensions stabilize or the new U.S. regulatory direction becomes more predictable – would remove a major psychological overhang. Similarly, continued easing of interest rates or credit conditions would directly lower the cost of financing deals. There are early indications of this: between late 2024 and early 2025, the Fed pivoted from tightening to holding rates steady, and market interest rates began to edge down, improving the outlook for leveraged buyouts. Fed officials have signaled that a soft landing (avoiding recession) remains likely, which, if achieved, provides a more favorable macroeconomic backdrop for M&A.
Crucially, buyer and seller expectations are slowly reconciling. The valuation gap that yawned open in 2022–2023 has shown hints of narrowing as more realistic pricing sets in. As time passes, memories of peak 2021 multiples fade and both parties adjust to new norms. Many founders who postponed sales in the past two years may decide that 2025–2026 is the time to act, lest market conditions shift again. In fact, advisors anticipate a wave of family- and founder-owned businesses coming to market, motivated by factors like retirement timelines and the desire to lock in gains during the next window of strength. Their entry could boost deal flow, particularly in the lower middle market.
Certain sectors are poised to lead the rebound. Healthcare, for instance, continues to enjoy strong demand and investor interest – a trend likely to persist given its immunity to trade disputes and its demographic tailwinds. Tech and digital economy businesses, which drove M&A in the past decade, remain attractive as larger players seek growth via innovation acquisition. And even industrial companies, many of which delayed deals due to tariff and supply chain worries, could see renewed activity if they pursue domestic acquisitions to circumvent trade barriers (a strategy already being considered in light of tariff threats). Furthermore, any easing of regulatory stringency on mergers (e.g. a more permissive antitrust environment) would particularly benefit mid-sized transactions that had been skittish about legal approval. Early indications from Washington – such as potential tax incentives and a generally pro-business cabinet – suggest the pendulum could swing toward a more deal-friendly climate in certain respects.
Finally, the sheer resilience of the middle market should not be underestimated. Even in the first quarter’s trough, not all was doom and gloom. As noted, several industries managed to increase deal volume despite the headwinds, and many deals did get done, often with creative structures and financing. For example, continuation funds and secondary transactions have emerged to provide liquidity when traditional exits were challenging. Such adaptability is a hallmark of the middle market and bodes well for its recovery. Dealmakers at a major industry conference (ACG’s DealMAX) in April 2025 struck a cautiously optimistic tone: while acknowledging the rocky start to the year, the majority maintained a bullish outlook for an M&A pickup in the latter half of 2025, fueled by abundant capital and the sense that the worst of the uncertainty would pass. In their view, the current slowdown, however steep, is a temporary waystation rather than a new normal.
Conclusion
In an intellectually sober analysis reminiscent of former Fed Chair Alan Greenspan’s economic musings, one might say that the lower middle market M&A arena is experiencing a period of significant disequilibrium, born of both cyclical and exogenous forces. Tariff-induced turmoil, valuation conundrums, and the higher cost of capital have together engineered a marked cooling of activity – the kind that surfaces perhaps once in a generation. Yet, in this nuanced landscape, there are also the seeds of a revival. Markets adapt: prices find their level, capital finds its outlet, and confidence returns as uncertainties clarify.
At IIB, we are already witnessing early signs that the tide could turn. The fundamental drivers for mid-sized dealmaking – entrepreneurial dynamism, strategic transformations in industries, and the relentless availability of investment capital – remain intact. When the current headwinds abate, the accumulated dry powder and strategic need for growth will likely trigger a resurgence in M&A activity. Indeed, history shows that periods of M&A lull are often followed by bursts of catch-up growth, as pent-up demand is finally released. Should interest rates continue to ease and trade/regulatory clouds lift, 2025 may yet close on a much stronger note than it began.
In summary, while the steep slowdown of early 2025 has been the most severe in well over a decade, it is best viewed not as a harbinger of permanent decline, but as a moment of recalibration. The lower middle market is navigating a rare intersection of headwinds, but it remains fundamentally sound and inherently resilient. As Greenspan himself once noted in a different context, when we are faced with uncertainty, we do well to remember that “history is replete with instances of markets regaining their footing”. The coming months will test that premise. For now, prudence and patience are paramount – yet optimism for a revival in M&A, grounded in ample liquidity and enduring economic forces, is entirely justified. The stage is set for those poised to act when the clouds part, and we foresee that the M&A winds will shift again, rewarding the diligent and the prepared when the next opportunity cycle arises.
Sources:
- PYMNTS – Tariff Worries Plunge M&A to Lowest Level Since 2009
- S&P Global Market Intelligence – Global M&A by the Numbers: Q1 2025
- The CFO Magazine – M&A activity slows as tariffs and uncertainty weigh on deals
- Keene Advisors – Q1 2025: M&A Activity Stalling Amid Market Uncertainty
- ACG Middle Market Growth – Dealmakers Anticipate M&A Uptick in H2 2025
- Federal Reserve Beige Book – April 2025 (labor market commentary)
- PMCF Investment Banking – 2025 M&A Outlook: Five Factors Shaping the Middle Market
- PwC – US Deals 2025 Outlook
- IBBA Market Pulse Survey – Q1 2025 Highlights (Lower Middle Market valuation trends)
- BCG/Willis Towers Watson – Quarterly Deal Performance Monitor (as cited in The CFO)
