Over the past two years, the global mergers and acquisitions landscape has confronted a formidable adversary: rising borrowing costs. As central banks in the U.S., Europe and beyond tightened policy to rein in inflation, dealmakers found themselves navigating a more treacherous terrain. This article examines how elevated rates reshaped valuations, deal structures and financing strategies—and offers guidance for those seeking to thrive in this new environment.

Economic and Rate Environment

Since March 2022, the U.S. Federal Reserve has pushed its benchmark rate to levels unseen in over two decades. Similar moves by the European Central Bank, the Bank of England and others have meant that corporations face elevated real interest rates when they reach for debt financing.

Even modest rate cuts in late 2024 have left borrowing costs above pre-pandemic norms. As a result, many potential buyers paused deal negotiations, waiting to see if rates would fall further. Sellers, on the other hand, maintained price expectations set in a lower-rate world, giving rise to valuation gaps and stalled transactions.

M&A Activity and Deal Dynamics

With borrowing costs high, companies have become more selective. Many acquirers now demand deeper due diligence, focusing on cash flow resilience and earnings stability. Sellers, meanwhile, have had to align expectations with the new reality.

Some of the key headwinds include:

• significant valuation mismatches and delays as buyers and sellers negotiate harder;
• reduced appetite for highly leveraged buyouts, shifting toward equity-heavy structures;
• heightened scrutiny of interest coverage ratios and debt serviceability;
• increased deal renegotiations and, in some cases, withdrawals.

Despite these challenges, the market has not ground to a halt. Instead, it has gravitated toward larger, strategically compelling transactions. Deals above $1 billion accounted for a growing share of total deal value, highlighting a trend toward scale and consolidation.

Private Credit and Alternative Financing

As banks tightened lending standards, private credit funds and non-bank lenders stepped in to fill the void. These players often offer greater flexibility, albeit at higher pricing, and have become a critical source of capital for mid-market sponsors.

Key developments in this segment include:

• Higher usage of innovative alternative financing solutions, such as unitranche and mezzanine debt;
• A rise in sponsor-backed restructuring negotiations, driven by covenant pressures;
• Growing collaboration between private equity firms and direct lenders to share risk.

In leveraged buyouts, the proportion of equity contributions has increased as debt became more expensive. This shift underscores a broader recalibration in deal finance that prioritizes stability over pure leverage.

Macro Outlook and Scenarios

Looking ahead, consensus forecasts paint a nuanced picture. The base case for 2025 envisions flat M&A volumes in the U.S., with a possible uptick if inflation subsides and central banks ease further. Yet higher-for-longer rates could just as easily push volumes lower.

Market scenarios include:

• Optimistic: A 6% increase in deal volume, driven by rate cuts and stronger corporate confidence;
• Pessimistic: A 6% contraction, fueled by persistent inflation and policy uncertainty;
• Base case: Stable volumes, as selective deals and defensive restructuring offset broader slowdowns.

Cross-border activity adds another layer of complexity. While U.S. and European deals may stabilize, emerging markets remain sensitive to capital flow volatility and policy shifts, creating pockets of both opportunity and risk.

Navigating the New M&A Landscape: Strategies for Stakeholders

In this environment of higher costs and tighter financing, proactive strategies are essential. Companies and advisors should consider the following approaches:

• Enhance target screening by prioritizing businesses with strong free cash flow and low cyclical exposure;
• Structure deals with flexible financing terms, including earn-outs or seller financing to bridge valuation gaps;
• Leverage non-traditional lenders early in the process to diversify funding sources and secure pre-committed capital;
• Engage in pre-deal restructuring discussions to streamline post-acquisition integration and debt servicing.

By adopting these measures, acquirers can mitigate the impact of high borrowing costs and position themselves for growth when rates eventually normalize.

Conclusion

The current M&A slowdown is not a permanent stall but a recalibration. Elevated rates have prompted buyers and sellers to rethink valuations, deal structures and financing plans. Yet beneath the surface, strategic opportunities abound. Companies that embrace strategic resilience and adaptability—through rigorous due diligence, creative financing and targeted deal selection—will be best placed to capitalize on the next wave of transactions.

As markets adjust, the ability to execute decisive, well-funded deals will separate the leaders from the rest. In an environment defined by higher costs, those who innovate, remain disciplined and plan for multiple scenarios will unlock value and reshape industries for years to come.