In this article, I discuss two major financial outlooks for 2025, the first being the projected economic growth expected and its proposed impact on the private equity market. The second is the expected trends in the M&A market. It is unclear how the recent election will change the forecasts and estimates outlined below.
Private Equity Outlook
The general consensus is that the Feds have recently lowered the interest rate by 0.25% and the rise in the stock market are positive trends for 2025. Only time will tell. In mid-September, then the Federal Reserve lowered the federal funds target rate 50 basis points from 5.5% to 5.0%. Economists predict the Fed will continue to drop rates into 2025.
At this point in 2024, experts expect the global outlook for 2025 will be approximately 2.8 percent. Economists predict the economy is poised to slow into 2025, driven by monetary policy and increased costs, and conflict in the middle east. which will impact private sector activity. However, as I noted earlier, the domestic outlook, indicates lower inflation and interest rates and a more balanced labor market which should set the stage for more sustainable economic domestic growth in 2025.
The Census Bureau is projecting that 28,865 new business startups with payroll tax liabilities will form within 4 quarters of application from all the business applications filed during September 2024. This indicates new client business for private equity firms.
In addition to the initial funding, Private equity often requires long investment holding periods, because it takes a while before projects like turning around a troubled firm or launching an initial public offering (IPO) can garner positive returns. In many cases, private equity funds hold investments for around three to five years.
The funds themselves normally have a lifespan of about 10 years; this means the equity investment is a long-term commitment. While we are looking at 2025, it is likely that the financing potential will follow for the next 5 years with reliable cash flows or failing companies that need to be restructured.
Mergers & Acquisitions Outlook
The Fed’s goal has long been to keep inflation at or below 2%, which is predicted to be the optimal inflation rate to maximize employment and ensure stability in consumer prices. Following the coronavirus outbreak, inflation began to skyrocket, getting as high as 9.1% in mid-2022. Last month (October 2024), inflation dropped to just above this 2% mark, and economists predict it will hit the Fed’s goal by early 2025.
What does this mean for the M&A market?
Historically, as inflation falls, merger and acquisition activity rise and that’s because:
- Loans are less expensive. As inflation falls, financing tends to get less expensive, encouraging individuals to consider new investment opportunities.
- Businesses are looking to expand. In times of prosperity, businesses are looking to grow and acquire other companies.
- Deals are accelerated. When inflation and interest rates are higher, businesses tend to hold off on mergers or acquisitions. But once inflation and interest rates drop, the pent-up demand for M&As will ensure that businesses carry out buy/sell agreements quickly.
But there’s one thing we need to know: even though the inflation rate is falling, investors might not see changes to borrowing rates right away.
How long do borrowing rates lag behind monetary policy?
In mid-September, the Federal Reserve issued its first interest rate cut in over a year. It dropped the Federal Funds target rate 50 basis points, from a max of 5.5% down to 5.0%. Economists predict that it will continue to slash interest rates into 2025, ending the year at a projected 3.1%. When will businesses see this new monetary policy reflected in spending patterns and prices?
There is a long-held belief that there is a 12- to 18-month lag between monetary policy changes and changes in the market. Lowering the Federal Funds rate has always been seen as a way to fine-tune inflation. But recently, economists have been questioning that theory. Experts today believe monetary policy serves less as “a mechanical lever to control inflation” and more as a method to “affect the public psychology and bolster confidence in the institution.”
We have noticed that artificial intelligence (AI) and other smart technologies can also help in the M&A process itself. Many businesses use generative AI to support the dealmaking process, by drafting documents, summarizing paperwork, developing due diligence strategies, and so much more.
If you’re considering using M&As to acquire new technologies or if you just happen to be acquiring a company that has smart technologies embedded in their operations and processes, take your time during the due diligence process. Here are a few potential snags:
- Valuations could be high. Companies that have implemented AI could be overvalued. In a report issued by The Carlyle Group last year, the authors showed a comparison of electric companies in the 1920s to AI-embracing companies of today. Like what happened in the 1920s, it is possible that investors will aggressively bid up the valuations of AI-enabled companies simply because there is a desire to be an early-stage investor in these new technologies. That premium price may be worth it but be cognizant of the role AI plays in those valuations.
- New security risks could develop. Whenever you implement new technology, you need to reassess your security risks. Smart technology used by a target company can expose the buyer to security risks they aren’t prepared to deal with. This includes both in-house developed AI tools and the use of publicly available AI tools.
Today, many see M&A transactions as a more effective way to accelerate growth and transform their business than organic growth. Organic growth can be difficult to achieve when the political landscape is so uncertain and when AI technology adoption can feel so risky. Instead of chasing after organic growth that relies on tenuous governmental policies, businesses may instead choose to grow by acquiring other businesses.
Conclusion
Looking forward to Q4 2024 and into 2025, the deal landscape may continue to evolve, and new structures develop, it is likely that the deal flow will increase compared to 2024. This being the case, the private equity investors will look for ways to significantly improve each portfolio.
Statista projects that the number of deals in the private equity market will reach approximately $12.9k by 2025, while S&P Global projects that private markets will reach more than $15 trillion by 2025. Furthermore, CFO.com reports that 41% of private equity firms polled expect an M&A surge in 2025.: Elevated interest rates and rate uncertainty are the biggest perceived hurdles for future deals.
There will always be reasons for delays and uncertainties won’t disappear. A strong and successful strategy factors them in, allowing you to make the best decisions with the available information. By mastering the art of strategy in M&A and private equity, companies can achieve their objectives with precision, purpose and strategic success.
