Key Highlights
- Mixed Bag for 2024: While overall M&A activity was down year-over-year, larger deals (over $25M) saw increased volume and value, signaling a potential turning point.
- Interest Rate Impact: Falling interest rates in late 2024 fueled the increase in larger M&A deals as the cost of debt financing decreased.
- Economic Headwinds: The Fed’s interest rate policy and the 2024 presidential election, particularly the resulting tariff policies, created headwinds for M&A activity going into 2025.
- US Economic Resilience: Despite global economic slowdowns, the US economy has shown remarkable resilience, although tariff policies present a new challenge.
- Focus on Quality: High-quality companies with strong financials and operational models will command premium valuations in the M&A market in a climate of uncertainty.
2024 Middle Market M&A: A Year of Mixed Signals
For most intermediaries, investment bankers, strategic buyers, and private equity firms in the United States, 2024 wasn’t a great year for M&A activity, but it wasn’t nearly as bad as in 2023. Year–over–year, M&A activity was still down in 2024, but the rate of decrease has moderated.
When comparing M&A activity year-over-year, the overall M&A activity (deal count) decreased in December 2024 compared to the same period in 2023. However, there is a bright spot. M&A deals greater than $25 million showed year–over–year increases, and as the overall number of deals increased, so did the aggregate transaction values. This is the first time we have seen a clear improvement in M&A activity since 2021.
Interest Rates and the Resurgence of Larger Deals
Falling interest rates can explain this increase in volume for larger M&A deal sizes. As discussed in prior year M&A updates, more significant M&A deals are often highly leveraged transactions where up to 60-80% of the deal value funded by debt is not uncommon. The Fed last raised interest rates in July 2023, and since then, the Fed has kept interest rates static until September 2024. In the fall of 2024, the Fed lowered interest rates in September and December, signaling that our worst fears of a recession may be behind us. As interest rates started to fall, the cost of debt also began to soften or, at a minimum, stopped increasing. This gave parties involved in larger M&A deals the clarity to get those deals done.
Although we did not see the same commensurate increase in M&A deal volume for deal sizes less than $25 million, we did see a lower rate of decrease in this category of deals. Comparing December 2024 to December 2023, M&A deal volume showed a modest 14-15% decrease. A year ago, M&A deal volume dropped by 18-40% in December 2023 compared to December 2022. As we stated in last year’s M&A update at the beginning of 2024, we expected to see M&A activity improve in 2024 compared to 2023. However, we were not expecting a considerable increase in M&A deal volume. The data for 2024 demonstrates just that.
Economic Crosscurrents: Navigating Uncertainty
Several headwinds kept M&A activity tepid throughout 2024. The first headwind came from the Fed’s monetary policy or, more specifically, its stance on interest rates. The good news is that the Fed dropped interest rates 100 basis points or 1% in 2024, but the bad news is that the decrease in interest rates did not happen until September 2024.
Since March 2022, the Fed raised rates eleven times. We have not seen this level of active monetary policy from the Fed since the Great Recession of 2008. For over 14 months (July 2023 to September 2024), the Fed held rates steady at 5.25% to 5.50%. During those 14 months, GDP was strong, unemployment was still near historic lows, and, most importantly, inflation started coming down. Inflation peaked at 9.1% in June 2022; by July 2023, inflation reached 3.2%. When the Fed began decreasing interest rates in September 2024, inflation had come down to 2.4%. Why did the Fed wait until September 2024 to start lowering interest rates? The Fed clearly was in a “wait and see” mode, giving the economy time to digest and stabilize while watching for any signs of weakness.
The Fed actively used monetary policy to bring the economy in for a “soft landing.” It has been over 15 years since the last “recession,” and we may not get one. Traditionally, a recession is technically defined as two consecutive quarters of economic contraction, typically measured by GDP. Initially, we saw negative GDP growth in Q1 and Q2 of 2022, but in 2024, the US Bureau of Economic Analysis (BEA) revised the historic 2022 GDP, resulting in negative GDP for only Q1 2022. Furthermore, we did not see the typical economic climate that would constitute a recession. There has not been a period from 2022 through 2024 with decreased economic output, rising unemployment, and lower consumer spending. Since COVID-19, the lowest unemployment rate was 3.4% in April 2023, and we finished in December 2024 with unemployment at a respectable 4.1%. The Fed defines full employment as having a 4% unemployment rate.
The US Economy: Resilience Amidst Global Headwinds
The chart above shows that the last period the US had negative GDP was in the first quarter of 2022. In June 2022, the Fed started increasing interest rates; however, GDP did not slow down; instead, it stayed resilient throughout the “high-interest rate environment.” Many economists have speculated why this occurred, as traditional economic theory suggests that the economy slows down when interest rates increase. We did not see a slowdown in US GDP when interest rates increased. In comparison, we saw a slowdown in other countries worldwide when they raised their interest rates to fight inflation. While the US economy enjoyed a healthy 2-3% GDP growth rate, many industrialized countries and trading partners worldwide did not.
The G7 countries of the UK, Japan, and the European Union (EU) experienced GDP of 0%, 1.2%, and 1%, respectively, as of the end of the third quarter of 2024, compared to the US GDP of 3.1% for the same period. In other words, the US economy is poised to grow more than the UK, Japan, and Eurozone economies combined. Almost all global economies have faced inflationary pressures, just like the US. Still, the US economy is truly showing its resiliency, even after the Fed raised interest rates higher and faster since the Great Recession of 2008 the US Economy continues to grow.
When the US started raising interest rates in June 2022, the UK and the EU also started raising their key interest rates around the same time. However, The Bank of Japan (BoJ) did not begin raising interest rates until March 2024, and it appears the BoJ will continue to increase interest rates to fight inflation. In January 2025, the BoJ raised its key short-term interest rate by 25 basis points to 0.5%, the highest level in 17 years. Although the UK and EU started raising interest rates around the same time as the US, they experienced severe slowdowns in their respective economies, showing less than 1% GDP growth and sometimes negative GDP growth since 2022.
Tariffs: A New Landscape for Middle Market M&A
The second headwind in 2024 that slowed down M&A activity came from the 2024 presidential election. It was another heated battle between the two dominant parties in the US, but the election was decided, and the country is moving forward. With a new administration comes new economic policies. A discussion about the latest economic policies is far more detailed than the purpose of this article. Still, I want to point to tariffs as one economic policy that may greatly impact M&A activity.
The chart above shows that tariff revenue as a percentage of total federal receipts has been negligible for the last 80 years. The last time there was meaningful tariff revenue was around World War II. President Trump’s Executive Order on February 1, 2025, imposes an additional 25% tariff on imports from Mexico and Canada and 10% on Chinese imports. Oil from Canada will see a 10% tariff. Traditional economic theory states that tariffs drive prices for goods and services higher. Whether this administration considers tariffs a tool to bring parties to the negotiating table or a first strike to level the current trade imbalance, the short-term effect will likely cause higher prices for goods from Mexico, Canada, or China. In other words, inflation. As we have seen since 2022, the Fed has been closely monitoring inflation and has made monetary policy changes based on the prevailing inflation data.
As we have seen in recent years, the Fed Funds Rate’s outlook signals the direction in which the volume of M&A deals will go. We have seen that a higher Fed Funds Rate negatively impacts M&A deal volume, and a lower Fed Funds Rate positively impacts M&A deal volume. While we do not see any signs of an increase in the Fed Funds Rate soon, there are inflationary pressures that we need to keep an eye on. On February 11, 2025, in his testimony in front of the Committee on Banking, Housing, and Urban Affairs, Fed Chair Jerome Powell addressed tariffs, debanking, and interest rate cuts. Powell stated, “The economy grew 2.5% last year. The labor market is also substantial. Unemployment at 4% is quite a low level. Inflation last year was 2.6% for the year, so we’re in a pretty good place with this economy. We want to make more progress on inflation, and we think our policy rate is in a good place. We don’t see any reason to be in a hurry to reduce it further.”
The Fed is in “wait and see” mode and not planning to make significant interest rate cuts until they understand the impact of the current administration’s tariff policy on the US economy. In Fed Chair Jerome Powell’s February testimony in Congress, he stated that someone has to pay the tariff. It can be the exporter, the importer, or the middleman. “It’s not the Fed’s job to make or comment on tariff policy. That’s for elected people, and it’s not for us to comment,” he said. “Ours is to try to react to it in a thoughtful and sensible way and make monetary policy so we can achieve our mandate,” Powell said.
The impact of increased inflationary pressure from tariffs is not limited to the Fed Funds Rate but also the underlying profitability of businesses. Under President Trump’s Executive Order, the US importer is responsible for payment of the tariff. In the near term, the increased cost of intermediate and finished goods hurt profitability and demand for goods impacted by tariffs. The businesses that may be affected the most by tariffs are those that import intermediate goods for final assembly in the US, commodities such as lumber and oil & gas, and consumer goods. The top 3 importers to the US are China, Mexico, and Canada. We generally see consumer goods from China, intermediate goods from Mexico, and oil and raw materials from Canada.
Will President Trump’s Executive Order issuing tariffs get international parties to the negotiating table? On February 3, 2025, one day after the Executive Order was issued, Mexico agreed to send 10,000 troops to the US/Mexico border in exchange for a one-month delay until March 2025 for tariffs to be imposed upon Mexican imports. On February 12, 2025, Canada’s premiers arrived at the White House for tariff negotiations with senior Trump advisers as the Trump administration paused tariffs on Canada for 30 days.
Like most developed countries in the world, both Canada and China lacked strong economic growth in 2024. Although the full-year 2024 GDP appears to be headed to 1.8% GDP Growth, the near-term headwind caused by tariffs, the future outlook leans towards further interest rate cuts from the Bank of Canada. Falling interest rates could negatively impact the Canadian dollar. A weaker Canadian dollar would make Canadian exports less expensive for other countries to import, but not when there is a tariff on Canadian goods. In 2024, the US represented over 62.2% of total imported goods into Canada and more than 76% of its total exports into the US. The proposed tariff will have a significant negative impact on Canada’s already weakened economy. Canada has already retaliated against US goods imported into Canada through tariffs. US businesses that have historically traded freely with Canada may now be subject to a tariff whenever goods are sent to Canada. This negatively impacts the profitability of US companies doing business with Canadian companies unless prices increase (inflationary pressure) to offset the tariff impact.
Similarly, China has struggled with its economy in 2024, with GDP growth at 5%. From its peak of more than 14% in 2007, China’s GDP growth has decreased by almost 2/3rds since then. Although China met its GDP growth target of 5% in 2024, many are skeptical of the data given the slowing economic momentum, demographic challenges, and trade tensions with the US. Since the 2018 tariffs imposed by then-President Trump, the Biden administration expanded tariffs on Chinese imports by increasing the existing tariffs to 100% on electric vehicles, 50% on solar cells, and 25% on electric vehicle batteries, critical minerals, steel, and aluminum. These tariffs took effect on September 27, 2024. US businesses that rely on Chinese imports for finished or intermediary goods face more trade headwinds that could impact profitability and growth. After President Trump’s Executive Order issued tariffs against China, China retaliated with 10% to 15% tariffs for crude oil, liquefied natural gas, farm machinery, and other products from the United States.
What does all this mean for middle market M&A? In reviewing several surveys, finance professionals believed 2025 would be a bounce-back year for M&A activity with meaningful increases in deal volumes across the spectrum of deal sizes. This may not be the case due to recent economic data and current events. The headwinds in global trade pose significant risks to the US financial and business climate.
The outlook for the US economy is currently positive, with strong projected GDP (adjusted annual rate) in the first quarter of 2025 coming in at 2.9% as of February 14, 2025, according to the Atlanta Federal Reserve GDPNow Estimate. We ended 2024 with US Inflation at 2.9%. The lowest inflation rate in recent years was 2.4% in September 2024. Unemployment is still low at 4.1% as of December 2024. While inflation is not quite at the target 2% rate, the US economy is still poised to grow and appears relatively more substantial than other first-world countries.
The Flight to Quality: Preparing for a Successful Transaction
However, as we have noted in prior years, there is a flight to quality when there is uncertainty. Should quality, domestic US companies in desirable industries come to market, they will transact with strong valuations. With over $2 trillion of private equity dry powder globally waiting to be deployed on M&A deals and about half of that dry powder being in the US alone, there is plenty of M&A capital looking for quality companies. Because interest rates are still considered “high,” the cost of debt capital is high, and M&A deals seeking strong valuations must demonstrate their quality. Suppose companies prepare in advance for the scrutiny of due diligence by cleaning up their books and getting their financial, operational, and management models firmed up. In that case, the quality of these M&A opportunities will shine, and the bid/ask spread will converge to get these deals done. We experienced this in our own deal flow. Between 2023 and 2024, because of the quality of the underlying business and strong financial performance combined with early deal preparation and a strong Quality of Earnings Analysis, we closed most of our deals ranging between 8x to 15x.
Will 2025 be a banner year for M&A deals? It will depend on how trade negotiations turn out and the impact of tariffs on middle-market companies. Should negotiations find a new normal for international trade under the current administration’s tariff policy or the current administration find reasons to eliminate tariffs, the US economy and, subsequently, middle-market M&A deal volumes will undoubtedly increase.
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