Multiple factors are aligning to create a dynamic M&A environment for closely held businesses in 2025. Declining interest rates, a surplus of private equity capital, and a wave of generational transitions are converging to fuel deal activity.
These factors, paired with increased confidence in the post-election economy, point to a dynamic and competitive M&A landscape in 2025 for the lower middle market – businesses in the $5m to $50m annual revenue range.
Let’s take a more detailed look at each factor impacting the 2025 M&A market.
Declining Interest Rates
Currently, the prime rate is at 7.5%, down from its peak of 8.5% 18 months ago. Lower interest rates create a ripple effect for the lower middle market.
For sellers, the increased affordability of financing means a larger pool of potential buyers with greater purchasing power. For buyers, reducing borrowing costs improves cash flow models, making acquisitions more attractive and feasible. Rate projections indicate further decreases, meaning those borrowing costs should only improve – driving more M&A activity for small businesses.
According to the Federal Open Market Committee (FOMC) Projections released in December 2024, the federal funds rate is expected to decline steadily over the next three years. The median federal funds rate is projected to decrease to 3.9% in 2025, 3.4% in 2026, and 3.1% in 2027, compared to the current level of 4.4%.
Historically, the prime rate maintains a margin of approximately three percentage points above the federal funds rate, meaning buyers could see prime drop below 7% by late 2025. Rate reductions significantly enhance affordability for acquisitions, allowing buyers to finance transactions at lower borrowing costs and allocate more capital toward higher valuations.
For example, a buyer borrowing today at 7.5% compared to 2023 at 8.5% saves $10,000 per $1 million financed annually — over a 10-year term, that’s a significant reduction in costs. Even a modest decrease in the prime rate can profoundly impact deal structuring, translating to substantial savings over the life of a deal.
The FOMC’s projections also highlight a gradual return to the Federal Reserve’s inflation target of 2.0% by 2027, with Personal Consumption Expenditures (PCE) inflation expected to ease to 2.5% in 2025 and then stabilize. This projection reflects confidence in a controlled economic environment where monetary policy can support growth without the sharp rate increases of recent years.
As we move through 2025, the projected decline in interest rates represents a compelling opportunity for both buyers and sellers in the M&A market. The Federal Reserve’s cautious yet optimistic approach, as outlined in the December 2024 FOMC projections, suggests that this favorable borrowing environment will persist, providing a strong foundation for robust deal activity in the lower middle market.
Private Equity ‘Dry Powder’
Buyers have access to abundant funding in 2025, making them more willing to pay top dollar for desirable businesses. One of the key factors propelling this activity is the staggering amount of “dry powder” that Private Equity Groups (PEGs) have amassed.
For those who’ve heard the term “dry powder” but haven’t been sure of its meaning, it basically refers to available, unallocated capital that is being earmarked for future deals.
Here’s how it works… PEGs have committed funds from individual and institutional investors. The capital that is unallocated and reserved for future investments is commonly called dry powder — and usually, it must be deployed within a certain amount of time.
The Wall Street Journal reports that globally, as of March 2024 (the latest available data), private equity firms still had more than 500 billion dollars of dry powder sitting in funds from 2020 and 2021 alone. It reports that North America-focused funds from those two years had over $300 billion of dry powder capital and are facing growing pressure to invest it in 2025.
So, PEGs are eager to deploy these funds, creating fierce competition for quality businesses. Approximately one-third of Viking M&A’s buyers are PEGs, making our team well-qualified to guide business owners through this competitive selling environment.
Generational Transitions
For years, studies have projected a wave of small businesses will change hands in the U.S. as a “silver tsunami” of aging baby boomer entrepreneurs retire. We discussed the phenomenon and its implications in 2020 in The Silver Tsunami is Coming.
High inflation, rate hikes, and other economic disruptions and uncertainty have slowed the anticipated wave, but the post-election environment has created a surge in activity. Viking Mergers & Acquisitions celebrated a highly successful Q4 in 2024, closing 19 deals on behalf of its clients — many of whom are baby boomers — with a total transaction value of $115 million.
Typically, Viking sees an uptick in inquiries from business owners in mid-January and February as New Year’s resolutions take effect, but in the fourth quarter of 2024, inbound inquiries increased substantially after the election results.
The election reassured many entrepreneurs with regard to long-term capital gains taxes, which were at risk of rising from 20% to 39.6%. With the tax policy stabilized, their confidence has been restored. Many are saying, “If I’m ever going to exit, I should do it in the next four years.”
This renewed confidence will drive the wave of businesses entering the market, creating opportunities for buyers and premium valuations for sellers.
The combination of stable tax policies, lower interest rates, and a robust buyer pool creates an optimistic outlook for 2025. Buyers remain aggressive, and well-positioned businesses are commanding premium valuations. Sellers who act within the next four years are likely to capitalize on favorable conditions, while buyers benefit from abundant financing options and market opportunities.
For many business owners, now is the time to seriously evaluate their exit strategies. It doesn’t cost anything to talk to a professional and gather the essential data to make an informed decision. Contact Viking today to request a confidential consultation.