The Impact of Reduced Interest Rates on PE and M&A

The last two years have seen decreased deal activity, largely due to incompatible valuation expectations between investors and management teams, as well as economic and geopolitical uncertainty.

Across the board, we at Aalto have seen longer processes and greater hesitation from investors and acquirors. According to Mergermarket, many M&A deals have been put on hold either because of valuation mismatches or because of concerns over long-term profitability. This has also led to PE firms holding onto larger companies for longer, as the IPO market has been weak and current valuations do not provide investors with the necessary exit multiples – particularly considering the significant valuation cooling that has occurred over the last few years (see last week's article on European vs North American valuation premiums). Moreover, investors and acquirors have been pickier with the companies they pursue as a means of managing their resources more effectively. This results in less competition during fundraising and sale processes and feeds further into the valuation discrepancy.

As interest rates continue to decrease in Europe and the US, however, financial sponsors who rely on debt to finance buyouts will face a lower cost of capital, resulting in greater activity and hence, more competition and a smaller valuation gap.

This will not happen overnight though, since in many cases, investors must first find a solution for their existing portfolios. Additionally, continued geopolitical turmoil such as the war in Ukraine and rising tensions in the Middle East, as well as economic tension between China and the US, will further impede PE and M&A recovery.

Investors and acquirors are also still wary of the potential for a recession and will likely need more solid evidence of a successful soft landing and economic recovery before we see activity rise back up.

Assuming we do see signs that the rate cuts have worked over the coming months, we expect to see the PE and M&A markets recover in the first half of 2025.