The Middle Market’s Resilience to Rising Rates

The current macroeconomic environment has been categorized by a heightened level of forward-looking uncertainty. To combat rising inflation, the Fed has raised interest rates 5.00% since March 17, 2022, from a Fed Funds Rate low of 25 basis points to the current 16-year high of 5.25%.

As a result of these rate increases, lenders are much more cautious and have sought risk mitigation via tightened credit standards and a significant reduction in the amount of leverage they are willing to dish out per M&A transaction. Buyers have shifted from their Q4 2022 “wait-and-see” approach, returning to M&A as a means for inorganic growth. Concurrent with lenders, sponsors have fortified their diligence requirements and are much more selective. These factors have resulted in an overall reduction in the volume of deals getting done.

Despite this M&A slowdown, valuations have proven resilient. This has been supported by an unprecedented level of dry powder across private equity firms and strategic acquirers with strong balance sheets relative to prior recessionary periods.[1] The amount of dry powder in the PE space alone was estimated at $3.6 trillion at the end of H1-2022[2] and a large portion of this capital needs to be deployed into the market before firms can turn their focus towards raising their next fund. In addition to this dry powder, more capital is coming to market. In Q1-2023, private equity firms raised $146 billion, in-line with the total raised from Q1-2022 and on the back of a handful of very large vehicles.[3] The sheer number of closed funds, however, has been almost cut in half over the same time period, as both firms and LPs wait for the water to settle more before fully jumping back in.

Potential buyers have adjusted their M&A strategy to this new regime by refining due diligence workstreams, transaction structures, financing sources, risk management practices, and post-transaction implementation processes. Private equity firms in particular have reacted by further emphasizing the quality of revenue, strength of the management teams, cash flow management, and their own cadre of internal operating advisors to identify and unlock returns through operational improvement.[4] These developments have intensified the due diligence process – leading to longer diligence periods and demanding more data or assurance from sellers than historically observed.

The goal of such pre and post-transaction measures is aimed to select quality assets that can be improved by leveraging fundamental business-specific conditions and industry-specific trends. Firms eyeing M&A and capital raise initiatives in 2023 or H1-2024 should align and present themselves with the changing data-points and macroeconomic conditions in mind, highlighting their resiliency through recent cycles – COVID, recent banking crises, and the rising interest rate environment.

While the news cycle seems hyper-focused on the possibility of a recession and the correlated downturns that may ripple through the economy, it is far from the full picture. The demand for quality assets is strong, and sponsors are maintaining proactive relationships with their investment banking counterparts as a result. It is imperative for founders and executives to have a seasoned and knowledgeable advisor on their team as they venture out to choppy waters to secure their short-term and long-term goals.

If you wish to learn more about the current economic environment’s impact on lending and M&A, or if you would like to discuss how Falcon might help you and your business best achieve your objectives, please contact Mark Gaeto ( or Ted Stack (

[1] 2023 M&A Outlook | Morgan Stanley

[2] Global Private Equity’s record-breaking performance set to collide with economic turbulence as business cycle nears its end — Bain & Company Mid-year Private Equity (PE) Market Update | Bain & Company

[3] Private Equity’s First-Quarter Fundraising Dollars Hold Steady but Closings Fall

[4] Operating Executives Are Playing a Bigger Role in PE Firms (