Since the last two strategy notes focused on the macro and liquid market impact of the ever-evolving trade war, we thought it made sense to focus this note on its impact on private equity.
IPOs aren’t bouncing back—that’s good for secondaries
Let’s start with the largest undeniable negative impact on the ability of large and mega cap private equity managers to finally return capital to annoyed institutions: The complete lack of a reopening of the initial public offering (IPO) market.
As you remember, of all the expected improvements post-Trump reelection and pre-trade war, we were most suspicious of the expectations the IPO market would boom again. However, we did expect an issuance environment more robust than what had occurred from 2022 through 2024. We were generally rooting for such an environment to provide large and mega cap private equity managers and their investors more liquidity to potentially acquire middle market PE companies that had graduated from the middle market to upper middle market or large cap.
But unless the trade war is resolved soon (so far, we are making progress with recent steps taken by the Trump administration, but we’re still way offsides relative to the beginning of the year), it is clear this lack of reopening will deny long-awaited liquidity events for large and mega cap PE sponsors, which in turn will drive more volume in secondaries—both limited partner (LP) and general partner (GP). However, it is clear to me that GP secondary providers could be the biggest winners (with volume for both GPs and LPs up from last year’s record and GP secondary volume potentially eclipsing LP secondary volume) and with GP discounts more attractive than recent history. On top of this, the new potential dramatic tax increase on private college endowments (without religious exemptions and with greater than $2 million in assets per student and over 500 students) that was just added to the Tax Cuts and Jobs Act (TCJA) extension could drive further LP and secondary volume.
Let’s face it, if you haven’t monetized a private position in years 7 through 12 of ownership, you were probably waiting for an opportunistic public listing. So without IPO activity coming back, GPs will turn even more aggressively to continuation funds to cash out extended institutions. Thus, large and mega cap private equity lack-of-IPO-resumption pain should be LP and GP liquidity provider gain.
As a reminder, whether or not the secondary opportunity surprises to the upside in 2025, the most important statistic to focus on for secondaries is how much historical return has come from growth (EBITDA, monetizing at a higher multiple than entry, etc.) vs. marking the discount up to net asset value (NAV). If you invest in private equity secondaries, the most important question you can ask is what percentage of a manager’s total return has come from growth vs. the discount. If the number isn’t in their random access memory, chances are it might not be flattering.
Overallocation is driving volume in the secondary market
Source: Bloomberg Finance, L.P. Russell 2000 Index. Data as of March 31, 2025. Shaded areas indicate National Bureau of Economic Research (NBER)-declared U.S. recessions.
Discounts are still at attractive levels
Source: Bloomberg Finance, L.P. Data for U.S. middle market as of December 31, 2025, latest data available. S&P 500 and Russell 2000 constituent index data as of December 31, 2024. Russell 2000 constituent index excludes financials and companies with less than $25M EBITDA. The constituent population totals 792 companies.
Has activity in the equity part of the capital structure collapsed?
I am often asked to address the narrative that private market activity in the equity part of the capital structure has collapsed since 2021, the current trade war will make it worse and there is little hope for meaningful exits anywhere at any time.
I consider this narrative to be inaccurate.
As always, a picture tells 1,000 words. As you can see in the following chart, private equity transactions skyrocketed in 2021, when the Fed was still pumping in outrageous levels of liquidity, and fiscal stimulus was driving a powerful economic recovery (prior to the inflation hangover, of course). When the Fed tightened1 aggressively, private equity activity downshifted considerably over the subsequent few years, but importantly for the middle market, only back to levels that were still substantially higher than pre-pandemic.
Now it is fair to estimate private equity activity will be lower than expected coming into the year, but to extrapolate lower-than-expected activity to none is quite a reach. Additionally, there is no reason to expect the dominance of the middle market transaction count to ebb any time soon.
Steady supply of deals in U.S. middle market
Source: Pitchbook Q1 2025 PE Breakdown U.S. Buyout Deal Breakdown.
The middle market is resilient
Furthermore, when you zero in on the middle market, it is important to remember how resilient this sector is to market dislocations and economic landmines. This is primarily due to the emphasis on the economically and market condition resilient exit strategy of primarily selling to strategic acquirers and larger leveraged buyout (LBO) sponsors that still have massive cash piles to put to work.
The most amazing statistics from the following chart are not that 40%–60% of exits tend to be to strategic acquirers, or that 30%–50% of exits tend to be to larger private equity firms; it is that even in 2021 when the IPO market was rolling, only 7% of the exits were via IPO.
As per usual, all roads lead back to the middle market.
Meaningful dry powder from up market sponsors
Source: Pitchbook, as of June 30, 2024. Mega-cap funds are defined as having $5B in AUM or more.
More exit optionality for middle market as IPOs fall
Source: Pitchbook U.S. Private Equity Middle Market Report as of 12/31/2024.
How will macro headwinds impact the U.S. middle market?
Now, turning our attention to the timeless investment thesis of GARP or growth at a reasonable price, the question I often receive is: How will the trade war, a slowdown in economic growth and a potential recession impact the definition of GARP in middle market private equity?
Starting on the revenue side, it is pretty clear slower economic growth and a potential recession should lead to lower revenue and EBITDA growth rates relative to the past four years’ exceptional growth rates. As you can see from the chart below, historically, middle market private corporations grew revenue meaningfully faster than the mighty S&P 500 (and the far less than mighty Russell 2000, MSCI World ex-U.S. and MSCI EM indexes). There is no rational reason to expect this dynamic to change any time soon. Forward revenue growth expectations for the S&P, almost by definition, have to decline given the slowing revenue growth of the most important mega cap tech stocks that have made up the majority of recent revenue growth—and the dearth of other listed equities that can compound revenue growth significantly above nominal gross domestic product (GDP).
As discussed at length in previous strategy notes, the Russell 2000 is an adverse selection bias index: When over 40% of index constituent companies cannot make money in a north of 5% nominal GDP growth environment like the past four years, you have big problems.
Don’t get me wrong, I’m rooting for the new German stimulus measures to quicken the pulse of the European economy; and Japan finally has achieved sustained above-zero inflation; and we all know the rather dire situation the Chinese economy was in before the trade war and how they and other emerging markets countries could be the biggest losers from the reordering of global trade—so who’s kidding who? It is hard to imagine an environment where international sources of revenue growth surpass the S&P 500 anytime soon, let alone middle market private corporations.
Secular growth trends offset economic stress
The other important factor to focus on in the chart below is the relatively impressive resilience of middle market private corporations in the darker quarters of the pandemic.
Remember, it is not just the massive, growing and resilient economic opportunity that U.S. middle market private companies provide, but also the economically resilient secular growth trends like picks and shovels for data centers, near shoring and onshoring manufacturing production, domestic migration (and the infrastructure tied to it), the blocking and tackling of health care services and therapeutics—the list goes on.
Thus, in more economically stressful times, these secular growth trends have the potential to offset lower nominal GDP growth rates.
Greater opportunity for growth in the middle market
Source: National Center for the Middle Market, Bloomberg Finance L.P., as of December 31, 2024.
The Russell 2000 continues to show negative earnings
Source: Bloomberg Finance, L.P. Russell 2000 Index. Data as of March 31, 2025. Shaded areas indicate National Bureau of Economic Research (NBER)-declared U.S. recessions.
Middle market PE: The definition of GARP
Source: Bloomberg Finance, L.P. Data for U.S. middle market as of December 31, 2025, latest data available. S&P 500 and Russell 2000 constituent index data as of December 31, 2024. Russell 2000 constituent index excludes financials and companies with less than $25M EBITDA. The constituent population totals 792 companies.
How to pick a manager in private equity? Find a deep alpha proposition
The devil is always in the details. As an investor for private equity evergreen or drawdown strategies, one of the keys is to focus on what level of revenue growth you must achieve to generate your longer-term return targets.
If, for example, the middle market private corporate asset class needs to generate 10% revenue growth, in order for a middle market private equity firm to generate 10% revenue growth and 12%–15% EBITDA growth, for you to hit your return goals, you are probably already behind the eight ball.
As one can see from the chart above, recent north of 10% middle market private corporate revenue growth is well above the pre-pandemic growth rates and is partially a function of the tremendous above-trend line nominal GDP growth (real GDP + inflation) we enjoyed from mid-2021 through the end of last year.
As discussed in prior strategy notes, a nominal GDP growth rate of 4%–6% is a much more rational expectation going forward than 6%–9%. In the aforementioned hypothetical situation, the investor would be more likely to receive 8% revenue growth and 9.5%–12% EBITDA growth—and the return goals would fail to be achieved.
If, however, an investor had achieved north of 20% revenue and 30% EBITDA growth over the past almost four years, there should be ample room for nominal GDP and middle market private corporate revenue growth to drop and still eclipse return targets.
As discussed in prior strategy notes, there is ample room for alpha generation in private equity and middle market private equity in particular. However, investors still need to choose their investment managers carefully and make sure there is empirical evidence of a deep alpha proposition that can help overcome any short-term hits to the economy.
Stated another way, don’t fall for the mere brand awareness prevalent in large and mega cap private equity, smoke and mirrors math equating internal rates of return (IRRs) to compound rates of return (CRORs), or a sugar high from an overreliance on marking up discounted secondaries to NAV.
Outperformance: Middle market vs. large caps
The last point to highlight when considering the “G” in GARP is the comparison of middle market private equity growth to large cap growth. The following chart shows the compelling recent past outperformance of revenue and EBITDA growth for middle market private equity vs. those larger companies.
I have been asked over the past several years what could possibly change this phenomenon going forward and I am still at a loss to figure it out. If anybody has any ideas, please let me know.
Weighted average changes from sponsor entry to exit
Source: Morgan Stanley Investment Management as of June 30, 2023.
Are middle market private companies more fragile than large/mega cap?
One thing I have heard about a lot lately is how middle market private companies are fragile and thus an investor should emphasize large or mega cap in this environment (I suspect the idea has been promulgated by large and mega cap private equity sales teams).
Look, we are the first to admit that smaller companies can be more fragile than larger companies. However, I would push back on this narrative in two ways.
1. Lower balance sheet leverage
As you can see in the chart below, middle market private equity corporations have balance sheets that have close to 40% less debt. As you remember from prior strategy notes, the most important advantage this provided over the past three years in a higher interest rate environment has been that less precious free cash flow has had to be diverted to debt service costs than investing in future growth. This should remain an advantage even if the Fed ever takes rates back to zero. However, in a heightened recession risk scenario, the other benefit of lower balance sheet leverage shines brightly: A lower probability of default risk and losing money and control of the company in the event of a bankruptcy or an investment loss due to a dilutive equity injection.
2. Investment manager specific loss rates
From a bottom-up standpoint, the typical loss rate for private equity investments on every dollar invested (which is volume dominated by large and mega cap companies) has been $0.12–$0.15, depending on the study. If you can identify middle market private equity firms that have lower loss rates than the industry, that would empirically suggest the alpha propositions of those firms’ investment processes have clearly exceeded any additional fragility of smaller corporate entities vs. larger ones.
Middle market characteristics have driven outperformance: Comparing middle market vs. large-cap buyout transactions
| Significant opportunity | Attractive pricing | Less reliance on leverage | Greater exit opportunities |
| 140,000 U.S. middle market companies2 | 40% Lower average purchase multiple3 | 37% Lower average company leverage4 | $466B Dry powder in large-cap funds5 |
Note: Historical characteristics are not indicative of future results.
At a reasonable price
Onward to the “ARP” (at a reasonable price) in the middle market private equity GARP investment thesis!
This is another area where post-trade war reality could be meaningfully different than what we had anticipated coming into this year but basically should lead to less calendar year upside in 2025 than we had expected.
If you focus on the three charts below, you can see a few remarkable highlights.
Public market valuations are still within spitting distance of 2021 valuations (remember those days of money supply growth dwarfing nominal GDP growth and the most recent special purpose acquisition company (SPAC) craze) with the notable exception being the Nasdaq. This is the case for the S&P 500 and the Russell 2000, despite all of the uncertainty of the trade war and that, for the S&P 500 in particular, large multinational corporations could be one of the biggest losers (see the last strategy note, The Galactic Mean Reversion Part II)—and the fact that bottom-up earnings forecasts have barely budged downward at all, which could artificially depress the forward price-to-earnings (P/E) ratio! I guess if you are an optimist, you might say that at least valuations are below spitting distance of the dot-com bubble like they were in February before the trade war heated up!
All private market valuations are down substantially and also did not budge upward post-election outcome.
Large and mega cap valuations are sustainably and sometimes significantly higher than the middle market—which is partially driven by far more capital coming into that segment of the market in comparison to deal activity.
Even though public EV/EBITDA ratios have come down a bit recently, the Russell 2000 is still over 50% more expensive than middle market private companies. Holy cow!
Valuations in private equity are still below 2021 levels
Source: Bloomberg Finance L.P., as of April 30, 2025.
For the public markets…not so much
Source: Pitchbook. Data as of December 31, 2024. Middle market private equity consists of multiples on deals between $500 million and $1 billion. Large cap private equity consists of multiples on deals between $1 billion and $5 billion. Mega cap private equity consists of multiples on deals of $5 billion or more.
Large/mega cap fundraise outpaces deal volume
Source: Pitchbook. Data as of June 30, 2024.
Comparing EV/EBITDA for public and private markets
Source: Pitchbook as of December 31, 2024, Bloomberg Finance L.P. as of April 30, 2025. Middle market private equity consists of multiples on deals between $500 million and $1 billion. Large cap private equity consists of multiples on deals between $1 billion and $5 billion. Mega cap private equity consists of multiples on deals of $5 billion or more.
Why I’m not sweating multiple compression6
Here are the differences between expectations at the start of the year and the newly expected reality.
We had expected some degree of valuation expansion in private equity this year for the first time in years. However, at this point for calendar year 2025, that will require rapid resolution of the trade war (again, we’re making progress, but uncertainty still looms) and clarity that a recession has comfortably been avoided. So the bad news is that calendar year 2025 performance will be lower than it would have been otherwise, but the good news is future returns in calendar years 2026 and 2027 could potentially be better.
I am often asked if we are worried that, if the recent market sell-off sticks to the downside and markets give up more recent gains, and the U.S. has a mild recession, middle market private equity could suffer some degree of multiple compression like it did in 2022.
One can never categorically conclude that is impossible. However, given the relative cheapness of the asset class, and the fact it never experienced any multiple/valuation re-expansion like public markets have enjoyed, we are confident it will take quite a doozy of a bear market and recession to drive valuations meaningfully lower.
Middle market private equity is a good fit for uncertain times
Despite the trade war impact on capital markets and potential impact on the economy, would you rather invest in companies with greater growth at a cheaper price, with less balance sheet leverage and more economically resilient exit strategies or the opposite? Exactly.
The time for the right alts is still now. And boy oh boy, is the timeless GARP thesis of middle market private equity in uncertain times the definition of the right alt.
Coming up next: The impact of trade policy on private credit
The next strategy note will zero in on the impact of the trade war on private credit.
Until next time, my friends.
Investing in alternatives is different than investing in traditional investments such as stocks and bonds. Alternatives tend to be illiquid and highly specialized. In the context of alternative investments, higher returns may be accompanied by increased risk and, like any investment, the possibility of an investment loss. Investments made in alternatives may be less liquid and harder to value than investments made in large, publicly traded corporations. When building a portfolio that includes alternative investments, financial professionals and their investors should first consider an individual’s financial objectives. Investment constraints such as risk tolerance, liquidity needs and investment time horizon should be determined.
